The bundling of dialysis reimbursement from Medicare has created its fair share of questions for DaVita (DVA), which operates 1,642 dialysis centers serving 128,000 patients. However, with clarity comes innovation and higher prevalence of chronic kidney disease, tied to higher incidence rates of hypertension and diabetes, which supports future demand growth.
Dialysis is necessary for the 527,000 patients with chronic kidney disease in the United States. And, according to the NIH, 11.5% of adults show evidence of kidney disease due primarily to diabetes and hypertension. Of those receiving dialysis, 338,000 of 368,000 patients receive in-center treatment at centers like DaVita's. And, an aging, increasingly diverse and overweight population is increasing incidence rates. In 2007, the NIH estimates 111,000 people were newly diagnosed with chronic kidney disease, making dialysis a $35 billion industry.
The majority of people receiving dialysis treatment at DaVita centers are Medicare and Medicaid patients. But, historically, this patient population has driven cash flow more than profit growth. Instead, profit growth has come from the commercially insured population. This dynamic challenged DaVita in the recession as falling private jobs shifted the patient mix further toward government programs. But, with private insurance enrollment growth returning and government jobs being pared back, patient mix should swing back toward private. And, that will be good for upside.
Margins will also benefit from DaVita's shifting cost control strategy, particularly in its use of drugs such as Amgen's (AMGN) Epogen, which Medicare previously reimbursed separately. A reduction in guidelines for stopping Epogen treatments at 12g/Dl from 14g/Dl significantly reduces cost per treatment and hints at DaVita's ability to reduce costs to maintain margins.
Of those with end stage renal disease, the 10-year prognosis is only 10.2%. But, improving healthcare overall is extending lives, suggesting DaVita's patients will receive treatment for longer periods. The company's patient care costs were inline year-over-year at 69.4%, despite the switch to bundled pricing cutting average revenue per treatment by $5, or 1.4%.
DaVita's predictable patient stream generated $407 million in levered free cash flow last quarter. And, the company exited Q1 with $1 billion in cash on its books, which it's using to fund acquisitions and share buybacks. In February, it announced a $689 million all cash acquisition of competitor DSI Renal, boosting DaVita's footprint by 106 centers and 8,000 patients. DaVita also bought back 162,000 shares in Q1 and another 969,000 shares in April. Exiting April, DaVita's buyback authorization had $583.5 million remaining.
DaVita shares are trading 14x rising 2012 consensus estimates and the company has beaten the street in three of the past four quarters. This has prompted analysts to boost their 2012 expectations to $5.90 per share from $5.38 90 days ago. As analysts and investors warm up DaVita's post payment bundling strategy, shareholders will be rewarded.
Disclosure: I am long AMGN.