Although it does not receive much coverage, healthcare company Davita has quietly become one of Berkshire Hathaway’s fifteen largest holdings. Davita is a $12 billion company, and Berkshire owns 19.2% of the stock, which carries a present value of $2.3 billion. Since becoming publicly traded in 1995, Davita has compounded at a rate of 13.2% annualized, turning every dollar invested in the stock into just shy of $17 over this time frame.
What I like about the business is the simplicity and necessity of its business model. It provides dialysis services and aids in other treatments for kidney failure at an average rate of $350 per treatment, approximately 7% or $24.50 of which flows through to shareholders as net profits after all expenses including taxes are paid.
Over the past ten years, demand for Davita’s dialysis services have grown by a whopping 18% annualized rate, and Davita’s own internal projections call for growth in the dialysis segment of 14% annualized between last year and 2027.
From an investor standpoint, that should strike you as a very, very interesting opportunity. Here, you have a company that provides dialysis treatments in connection with 2,350 medical facilities across the United States, giving it a huge plurality share in the overall dialysis market. And this entrenched position is expected to grow naturally at a rate of 15% annualized.
Davita’s chances of participating in that segment growth is not only bolstered by the typical inertia that we associate with the early movers in industries, but Davita also benefits from its relatively low 7% net profit margins. Sometimes, you see a business like Visa earning 60% returns on every dollar expended, and think: “It would be great to be a new market entrant as I could make the business venture gloriously profitable at a 55% profit margin rate.”
With Davita, those 7% net profit margins are the byproduct of economies of scale. A close at Davita’s bulk purchasing of dialysis supplies indicates that about five percentage points of its total net profits can be ascribed to lower supply costs, and the other two percentage points are attributable to Davita’s exercise of pricing power. From the perspective of a new competitor, Davita would appear to be earning 2% net profits which is lower than Wal-Mart’s 3.5% net profit margins–in other cents, the profit motive for a startup is essentially nonexistent as Davita’s advantage relates to its established networks and bulk ordering.
I am intrigued by Davita’s decision to sell its managed care assets (i.e. non-dialysis related) to UnitedHealth Group for $4.9 billion. By nearly all outsider accounts, this is a massive overpay on behalf of United Health. It is funny, United Health actually argues over $40 costs with patients without blinking an eye, but then turns around and overpays for an asset that most thought was worth between $2.0 billion to $2.5 billion.
When Davita gets its hands on this $4.9 billion, I expect that it will make a series of bolt-on acquistions in the dialysis and kidney care area and acquire majority market share, bolstering its pricing power even more.
It’s almost entirely a United States based business, meaning that all of its profits stand to benefit from the decrease in the U.S. tax rate. I expect $4 per share in profits this year, and $5 per share next year.
For the past few years, Davita has traded at around 20x earnings. The current price of $67 per share suggests that the stock is trading at around 16x earnings. If profits rise to $5 per share next year, and the P/E ratio returns to the 20x earnings range, Davita is once again a stock valued at over $100.
It has a lot going for it. Lowered taxes. Buffett’s ownership and potential to buy the company outright. A coming $4.9 billion cash infusion. A lower than usual P/E ratio. A dominance in the dialysis market, and with obesity and American dietary habits being what they are, a high likelihood of double-digit segment growth. A proven track record of 13% annual returns over the past decade. Not too shabby.
This is a publicly available version of an article shared with The Conservative Income Investor’s Patreon followers on May 25, 2018.