Investor Essentials Daily

This healthcare company is here to help fix the results of decades of health misunderstandings

DaVita Inc. (DVA)
August 17, 2021

Unfortunately, Type 2 diabetes is a major problem in America, a country where more than a quarter of the population suffers from obesity.

Without proper care, these individuals may face long-term negative health consequences, from diabetes and heart disease to kidney failure.

Yet, looking at as-reported financial metrics for one of the nation’s biggest dialysis providers, the scope of the problem and the company’s role in providing solutions seems to be going unnoticed.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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As I’ve gotten older, I’ve made it a point to try to learn more about how to stay healthy and youthful.

One of the people I trust most when it comes to these issues is a medical expert who has also come to be both an advisor and friend, Dr. Jason Fung.

Some time ago, as I was writing about intermittent fasting, Dr. Fung – whose research I was specifically citing – sent me over a copy of one of his books, The Obesity Code, which I read cover to cover.

One of the key things Dr. Fung highlights in his research is that the oft-repeated adage about losing weight through balancing calories-in and calories-out is incomplete. We think that through a simple dieting strategy or the latest health craze, we can lower our calorie intake and directly lose weight.

In truth, most weight and health problems have to do with insulin resistance and metabolism issues that require a much deeper understanding of health. A reduction in calories can make the body change its insulin levels and metabolism, hoarding energy and paradoxically gaining weight.

This is significant because insulin resistance can eventually lead to Type 2 diabetes, which according to some studies impacts a staggering 10% of Americans.

Regrettably, while there is still much to learn from Dr. Fung’s work. Many people are simply unaware of the dieting implications, relying on other more indirect methods to treat diabetes such as dialysis and treatments from one of the biggest providers in the space, DaVita (DVA).

DaVita is a healthcare company which provides kidney dialysis services through centers and home-based solutions for those with renal issues.

Considering the scope of the problem, as well as DaVita’s dominant position in the dialysis market, one might be surprised to learn that on an as-reported basis, the company earns a weak 5%-6% ROA, around the cost-of-capital.

In reality, after adjusting for distortions in as-reported financials, we can see clearly that the true economic picture for DaVita is much different.

Thanks to its essential offerings, as well as sizable demand for its products, the company actually generates a return 2x what as-reported metrics reflect.

Often, a compelling story is left buried thanks to the GAAP tendency to misconstrue true profitability.

Much like how those concerned with their health should heed Dr. Jason Fung’s research – which cautions against blindly following the day’s prevailing weight loss strategy – investors should caution against carelessly relying on distorted financial figures.

SUMMARY and DaVita Inc. Tearsheet

As the Uniform Accounting tearsheet for DaVita Inc. (DVA:USA) highlights, the Uniform P/E trades at 19.3x, which is below the global corporate average of 23.7x, but around its own historical average of 17.8x.

Low P/Es require low EPS growth to sustain them. That said, in the case of DaVita, the company has recently shown a 51% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, DaVita’s Wall Street analyst-driven forecast is a 17% EPS growth in 2021, followed by an immaterial EPS decline in 2022.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify DaVita’s $130 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow immaterial annually over the next three years. What Wall Street analysts expect for Walmart’s earnings growth is above what the current stock market valuation requires in 2021, and in line with that requirement in 2022.

Furthermore, the company’s earning power in 2021 is 2x the long-run corporate average. Also, cash flows and cash on hand are almost 3x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk.

To conclude, DaVita’s Uniform earnings growth is below its peer averages, and the company is also trading above its average peer valuations.

 

Best regards,

Joel Litman

Chief Investment Strategist at Valens Research