Is It Time to Buy These 4 Dialysis Stocks?

Investors in DaVita Healthcare Partners (DVA 1.23%) and Fresenius Medical Care (FMS 0.54%) breathed a sigh of relief on Tuesday after the Centers for Medicare and Medicaid Services, or CMS, announced that it would only reduce payments to kidney dialysis providers by less than 1% over the next two years -- scrapping the controversial 9.3% reduction that it had proposed in July.

Following the announcement, shares of DaVita immediately surged 9% and Fresenius climbed 7%. DaVita and Fresenius, the two largest dialysis companies in the world, control 33% and 37% of the U.S. market for dialysis products and services, respectively.

Source: YCharts.

Both companies had been weighed down over the past four months due to the uncertainty of the Medicare cuts, since 85% of dialysis patients in the U.S. depend on the federal insurer to help pay for their treatments.

This roller coaster ride of uncertainty has also affected other smaller dialysis companies, such as NxStage Medical (NXTM) and Rockwell Medical (RMTI -1.01%).

Now that the biggest weight on all of these companies' top line growth has been lifted, are these four companies solid investments again, or are there other challenges on the horizon?

A fundamental comparison of DaVita and Fresenius

First and foremost, we should compare DaVita to Fresenius on a fundamental basis.

Source: Yahoo Finance, as of Nov. 26. TTM = trailing 12 months.

DaVita is much smaller than Fresenius, but it has higher growth potential, as reflected by its much lower PEG and price-to-sales ratios. DaVita also has much stronger top line growth, partially aided by its $4.4 billion acquisition of Health Partners last July.

Merging with Health Partners brought a network of 667,000 patients and 700 physicians under DaVita's umbrella, better positioning the company to deal with uncertain changes in Medicare reimbursement. Last quarter, Health Partners generated $803 million in revenue, accounting for 27% of DaVita's top line.

However, DaVita's margins and bottom line growth still lag behind those of Fresenius.

Key differences between DaVita and Fresenius
The key difference between the two companies is global exposure. Although both companies enjoy dominant market shares in the U.S., DaVita is mostly dependent on the U.S. dialysis market, while Fresenius only generates 66% of its revenue from North America. 20% of Fresenius' revenue comes from Europe, the Middle East, and Africa, while Asia and Latin America account for the remaining 8% and 6%, respectively.

By comparison, only 66 of DaVita's 2,108 dialysis centers are located in non-U.S. countries. However, DaVita has been ramping up its international expansion efforts to catch up to Fresenius -- last quarter, it acquired 18 new dialysis centers in Malaysia to expand its footprint in the Asian market.

DaVita reports its revenue in three segments -- Dialysis/Lab Services, Healthcare Partners, and Ancillary/Strategic Services. Dialysis/Lab Services, its largest segment, reported 10% year-over-year sales growth. By comparison, Fresenius reports its revenue in two main segments -- dialysis products and services, which grew 5% and 8%, respectively, last quarter.

Both DaVita and Fresenius have recovered a lot of lost ground with the recent Medicare ruling, but DaVita appears to be a better growth play, due to its smaller size. In addition, Warren Buffett's Berkshire Hathaway boosted its position in DaVita by 23.5% earlier this month, a shrewd move that cleverly preceded the recent CMS decision.

NxStage and Rockwell are higher growth opportunities
While DaVita and Fresenius are directly affected by the CMS decision, we should also take a look at two smaller, higher-growth companies in the dialysis field -- NxStage Medical and Rockwell Medical.

NxStage Medical is a smaller company that has attracted a lot of attention with its top product, the NxStage System One -- the first portable home hemodialysis system approved by the FDA. The system can be taken on vacation, and convert ordinary tap water into dialysate, the liquid used during dialysis.

The NxStage System One, a portable home dialysis machine. Source: Company website.

Although the big reduction in dialysis payments has provided a big boost for the overall dialysis industry, NxStage shares jumped on the announcement that the CMS would boost the hourly rate for home hemodialysis trainers from $33.44 to $50.16.

Last year, NxStage publicly criticized the proposed changes to the ESRD (end-stage renal disease) Prospective Payment System for 2014, arguing that home hemodialysis trainers should be paid higher hourly wages to ensure higher quality care, which could lead to higher adoption rates. Home hemodialysis systems are cheaper and more convenient than treatments administered at dialysis centers like DaVita and Fresenius, but only 2% of patients currently use them -- representing a huge potential growth market for NxStage's products.

Another company to watch is Rockwell Medical, a leading manufacturer of hemodialysis concentrate solutions and dialysis kits. Rockwell sells its dialysis products to DaVita and Fresenius, which means that when the big players suffer, the losses eventually trickle down and affect its top line growth. Hemodialysis concentrates account for 94% of its top line.

However, only one product really matters now for Rockwell investors -- Triferic, its iron treatment for anemia. Dialysis often causes anemia in patients, which makes Triferic an essential product for dialysis companies like DaVita and Fresenius, which both took part in Rockwell's phase 3 trials.

If Triferic is approved, analysts believe it could achieve annual peak sales of $250 million -- a major boost for a company that only reported $49.8 million in revenue last year.

The Foolish takeaway
10% of Americans currently suffer from chronic kidney disease and 8.3% are living with diabetes, which both often require dialysis. Combine those factors with a rapidly aging population, and we reach the unfortunate conclusion that the market for dialysis treatments will continue growing over the next few decades.

Therefore, companies like DaVita and Fresenius, which dominate clinical dialysis, will continue rising slowly, while NxStage's home hemodialysis kits and Rockwell's Triferic represent higher growth opportunities in the market, due to their untapped market potential.