5.874 % yield to worst/call in 2016
DaVita Inc (DVA) operates as a provider of dialysis services in the United States. Located in Los Angles since forming as Davita in 1999, the company has plans to relocate to Denver, Colorado by the start of 2011. The name DaVita means giving life in Italian. It currently has outpatient operations in 43 states where they operate 1582 clinics servicing about 122,000 patients. It also has operating agreements with 720 hospitals to provide dialysis services. DaVita has been recognized five years in a row in Fortune Magazine's “Top 10 most Admired Health Care Companies”. With over 34,000 employees, DaVita is one of the largest dialysis providers in the Untied States.
At Durig Capital, we have developed a process to review, select, purchase and monitor corporate bonds on an ongoing basis. Enclosed is our review, along with supporting documents, showing why we believe DaVita’s bond makes sense in clients' portfolios. We reviewed thousands of separate corporate bond listings to find what, we believe, is currently the best corporate bond for investors. The following illustrates our selection criteria.
Step 1 - Yield Curve at 4-7 Years Out
With 2010 coming to a close rather quickly, we expanded our search this week to include issues that mature in 2018. DaVita does mature at the end of this time frame, but also does contain multiple call options between now and then.
It seems as if everyone is waiting this week for the Federal Reserve meeting this week to see what is said. They have expressed intent to continue what is known as quantitative easing, meaning they are buying bonds on the secondary market. This action suppresses yields that investors receive while also pumping money into the economy. These actions have many worried about inflationary pressures on the US Dollar. Owning fixed income instruments during an inflationary period could affect the purchasing power of the principal while reducing the real return.
With the Fed's actions not yet clear, we are not comfortable with long term--10 year plus bonds. The yields we are seeing on short term notes are nonexistent and in some cases, we found negative yields. The four to seven year term seems to be an area of the curve that can provide both decent yield while not putting too much elongated purchasing power risk on principal. This DaVita issue matures in 2018 and is callable every November between 2013 and 2016.
Step 2 - We like companies that are profitable
One of the main reasons we like DaVita is that it has illustrated solid, consistent and almost predictable operating results. The last three years have provided a difficult business environment for almost everyone. DaVita has not experienced the same economic pressures to profitability. The industry they are in is defensive in nature, as people will need dialysis no matter the economy.
They have, in fact, slowly increased their bottom line since 2006, when earnings were $2.73 per share. In 2009, they reported $4.06 earnings per share and this year they have earned $2.10 per share for the first half of the year. Profit margins have also remained constant for the last five years.
One material question that should be considered is, how are the new health care reforms going to effect DaVita? One can approach this question from many different angles. Without politicizing this material fact, the events of the health care reform could drastically alter DaVita’s operating environment.
Step 3 - We like companies with higher cash to long term debt ratios
DaVita does not have the the high levels of cash to debt that we have found in other companies that we have included in our This Week's Best Bond review. However, the trend in the level of overall debt to assets has been diminishing since 2005. This can be attributed to two factors that we believe benefit bond holders. The overall debt levels have diminished slightly and assets have grown. As of last quarter, the company had $566 million in cash and $3.52 billion in long term debt. With the consistency of DaVita’s income flow, the outstanding long term debt does not appear to be of concern.
Step 4 - We like companies that have flexible balance sheets
As mentioned above, the overall trend in debt to assets has been diminishing over the last couple years. Because DaVita is paying down debt, their ability to ability to issue debt, if needed, should improve. The ability to obtain credit can be illustrated with the announcement on October 20, 2010 that they were approved for a $3 billion dollar credit line. This line of credit will seemingly be used for refinancing existing debt at lender friendlier rates.
They currently have a market capitalization of $7.3 billion dollars with a total debt load of just over $3.6 billion. The debt to market capitalization ratio of just under .5 is higher than we have experienced in the past, however it is common for mature defensive industries to have ratios at or near this level. Their current balance sheet can be viewed here.
Step 5 - We like high yields
The yield to worst for this bond would occur if the issue were called in 11/2016. The worst case yield of 5.824% is still outstanding considering the current interest rate environment. This yield does compensate investors for higher risk, but in our opinion it over compensates. Being a callable bond allows the issuer the right, not the obligation, to call away the debt instrument. Investors are compensated for this risk with a higher yield when compared to non callable bonds. Enclosed is a link to current high yield bond offerings to use as a benchmark against DaVita’s offering.
Important Call Prices
This is a good 5.824% yield till worst case scenario. Even though it doesn't have an investment grade rating, a history of steady income, the defensive nature of the industry, and investment coverage and profitability illustrates the relative health of the company. These metrics are similar to our previous bond reports such as Seagate Technology (SPX), Expedia (EXP), and Netflix (NFLX), which have done quite well for our clients.
Yield to Worst 5.824% 11/1/2016
Yield to Maturity 5.937% 11/1/2018
Current Yield 6.204%
Disclosure: Durig Capital’s clients currently do have positions in DaVita’s bonds.