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Going Long Davita And Hedging With A Covered Call

|Includes:DaVita HealthCare Partners Inc. (DVA)

09/16/13 Covered Call Pick: DaVita HealthCare Partners Inc. (NYSE:DVA)

DaVita Healthcare Partners Inc. (DVA) is a United States based specialized healthcare provider focusing on kidney disease, damage, and conditions through care and prevention. Specializing in home and in-clinic dialysis including hemodialysis and peritoneal dialysis, the largest kidney care company in the Unites States also offers vascular management, chronic kidney disease education, and renal diet assistance through any of their nearly 2,000 outpatient dialysis centers in 44 states.

DaVita Healthcare Partners has a market capitalization of $11.85 billion with 212.6 million outstanding shares.

DaVita currently pays no quarterly dividend.

With a beta of 0.70, DVA currently trades with approximately 70% of the market's volatility.

We've talked many times in the past about how important trends are when trying to ascertain where to invest your money. Trends can be very important factors in what companies become successful, but figuring out exactly what is a tried and true trend, and what is going to turn into the next "Pet Rock" can be tough. They can be intensely nuanced in their development, and are by their nature, very difficult to forecast yet extremely profitable when you can. Think about how successful the investments were for the lucky few that believed the evolution of personal computing was a trend worth investing in, rather than the people that scoffed at the idea and deemed it just a fad? Sometimes though, the best way to figure out what trends are going to evolve moving forward doesn't require intense microscopic focus, but rather a "big picture" view.

Sadly, one of these "big pictures" views is that we as humans get sick. With the aging baby boomers coming into the healthcare picture, the healthcare industry will have a large supply of clients as one of the largest generations becomes increasingly more susceptible to injury and illness. One of the illnesses that we have seen steadily rise over the past decades is diabetes. Just 13 years ago the percentage of the U.S. population diagnosed with diabetes was close to 4%, and that number has nearly doubled since then. One of the effects of diabetes is kidney damage and renal failure, and that is where DaVita comes in.

DaVita has nearly 156,000 patients, and that number is expected to continue to grow, just like their revenue. Quarterly revenue growth has been accelerating particularly quickly since last year. This can be mainly attributed to rising dialysis treatments, which were up 7.6% year-over-year in the second quarter, helping to support the theory behind our trend, and drive DVA's profits. Despite narrowly missing their Q2 estimates, the company and analysts raised guidance on EPS for 2013 up to 21% over last year's on the back of the rising demand for their services.

We're not the only ones that believe in DaVita's story. It is hard to mention the company and the stock without mentioning legendary investor Warren Buffett and his holding company (and recommended stock investment earlier on this blog) Berkshire Hathaway (BRK. DaVita is Buffett's 9th largest holding at Berkshire, with a total of 14.9 million shares as of the June 30th 13f filling. That was added to early in July when it was announced he purchased an additional 639,200 shares. Buffett is known for investing in companies ripe with value, using his uncanny ability to discern what a company is worth and - more importantly - what a company WILL be worth. He has been a lover and an investor of DaVita for quite some time now, and it is hard to argue with his success when you consider the numbers in the stock.

Recently, the stock underwent a 2-for-1 split, which cut its market price in half (this normally doesn't matter that much, but since we have to buy a round lot of the stock in order to sell a Call, it allows investors with smaller portfolios to use the strategy without being overweighted in one stock). The stock has been coming down from its 52-week highs since early May off the announcement that Medicare plans to cut payments to dialysis centers by 9.4%, which have severely lowered 2014 estimates in the stock. That said, there is a likely chance that the proposed ruling will be amended prior to its actual deployment. We still believe this risk doesn't outweigh the strength of the trend we have identified, but it does limit the strategies we can effectively employ on the stock. Because of this announcement risk it is prudent to either 1.) Use a strategy that is short-term so we adequately adjust to any new information that might come out that will affect the stock price, or 2.) Use an extremely long-term strategy that smooths out the effects of any near-term stock price movement due to an unfavorable ruling. Since DVA only has Options available out till April of 2014, we are going to go with the first strategy. That is why we are recommending buying DVA and selling the January 2014 $60 Call.


  • Buy 100 shares of DVA @ $56.19 = $5,619 + Commission ($12.95) = $5,631.95
  • Write 1 DVA January 2014 $60 Call @ $1.55 - Commission ($8.70) = $146.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.

Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

(1.46)/56.32 X (365)/122

= 7.76% Static Return

If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

(1.46 + 60 - 56.32)/56.32 X (365)/122

= 27.30% If-Called Return

Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

Posted by OaktreeAdvisors at 9/16/2013 10:02 AM
Categories: Weekly Picks

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Disclosure: I am long DVA.

Additional disclosure: As active managers, OakTree is currently long DVA and have sold calls on some of these long positions. We will continue to monitor and will buy or sell positions as determined.

Stocks: DVA