Dialysis is the process of using a medical circulation device (either at home or at a clinic) to substitute kidney functions for patients with end-stage kidney failure. Each year, over 100,000 Americans with new cases of renal failure visit dialysis clinics to receive appropriate treatment. The cost of this care has been fully covered by Medicare for all patients since the Nixon administration.
Since the full cost of dialysis treatments is reimbursed by the U.S. government, a wave of providers has moved to capitalize on the opportunity. One such company is DaVita (NYSE:DVA), which treats about 200,000 patients in the U.S. annually. The company is an enticing investment idea because it's been classified as an essential service provider during the COVID-19 pandemic and has its core revenues protected.
What are the investment risks involved?
The main risk surrounding the company is potential fatalities at dialysis centers due to COVID-19. Unfortunately, dialysis patients are classified as high-risk because many of them are immunosuppressed. Although DaVita has moved a large number of its patients to at-home care, there have been reports of COVID-19-related patient deaths at dialysis centers nationwide.
Beyond the coronavirus, organ donations pose another (perhaps surprising) potential risk for the company's sales. Patients with various forms of kidney disease will be functionally cured of their conditions should they receive an implant from a compatible donor. As a result, they would no longer require services from DaVita or other dialysis clinics. Last year, nearly 40,000 transplants were conducted in America, setting an all-time record.
Despite efforts from the Trump administration to reform the organ donation system, however, the current wait time still remains excruciatingly long -- an average of three to five years. Meanwhile, the current wait list for kidney transplants amounts to 95,000 patients; tragically, more than 8,000 of them die each year.
A far more concerning risk is that of a recent California bill to cap the profits of dialysis providers for more than 3,700 low-income patients in the state, starting in 2022. The industry practices revealed in the bill are troubling, as it claims companies like DaVita are currently making upwards of 350% returns on reimbursements from dialysis treatments. If other states begin following suit to regulate the pricing of dialysis, DaVita's cash flow will certainly face material declines.
Are the company's financials sound?
Since 2013, DaVita's revenue has remained flat at about the $11 billion mark. Its operating and profit margins have not changed much, either. Last year, the company recorded more than $1 billion in net income, placing its price-to-earnings ratio at 17 and its price-to-sales multiple at just 1.
Although the company has long-term debt amounting to more than 3 times shareholders' equity, net of cash, it does produce enough in earnings before interest, taxes, depreciation, amortization, and rent (EBITDAR) to meet its obligations ($2.9 billion per year in EBITDAR vs. $11 billion in debt and financial leases).
All in all, the company performs very well when it comes to value and profitability, but there are short-term woes with regards to potential deaths at dialysis centers due to COVID-19. In addition, the company may have trouble defending its core revenue should more states follow California's example and cap its profits.
Many more Americans will age in the coming decades, which will lead to an increase in demand for dialysis services, but this is a trend that will take a great deal of time to materialize. As a result, I would avoid DaVita for now and look at other healthcare stocks, such as this provider of supplies to dialysis clinics and hospitals. There's just too much uncertainty as to what kind of long-term trend will materialize in this sector.