EUR 850.00 For Business Accounts Only

Morningstar | 4Q Results Meet Expectations and Guidance Finally Looks Achievable; Stock Undervalued

Fresenius Medical Care reported 2018 results that largely tracked our expectations. Following a volatile third quarter, we're encouraged by the broad strength across business lines to end the year. We think this illustrates the stability that has characterized the dialysis-services market over the long term and the narrow economic moat Fresenius has been able to build. As we update our model, we may raise our EUR 79 per share fair value estimate ($49 per ADR) modestly to reflect the cash flows received since our last update.

First, we're pleased to see the drawn-out acquisition of NxStage Medical finally approved by Federal Trade Commission and expect the deal to close in the coming days. The company will have to divest NxStage's hemodialysis bloodline tubing business to satisfy its settlement with FTC, but this shouldn't prove too onerous a requirement to get the deal done.

Second, while we're encouraged by the firm's modest reported beat versus guidance outlined in December, it seems fairly clear to us that its prior outlook that contemplated 10% annual revenue growth is more aspirational than realistic--guidance now calls for mid-single-digit and mid- to high-single-digit growth in 2019 and 2020, respectively. This is in line with our current expectations and longer-run projections.

Finally, the dialysis business continues to progress at a solid clip. Interestingly, Fresenius' measure of organic treatment growth in the fourth quarter accelerated compared with its year-to-date performance as of the third quarter, versus the deceleration reported by DaVita. However, management indicated that it expects continued margin compression with per treatment reimbursement flat to down and costs flat to up over the course of the year. As an offset, the company expects to find additional savings from its global efficiency program in the next few years, in line with our forecast of a flat to moderately higher operating margin for the consolidated company.

In connection with the earnings release, Fresenius announced a relatively rare EUR 1 billion buyback authorization expected to be completed over the course of 2019 and 2020, along with the retirement of long-time CFO Michael Brosnan. We're encouraged to see management agree with our view on the firm's valuation and think remaining shareholders will be well-served by a buyback program that takes out roughly 5% of the company's current market capitalization at a discounted valuation. The company expects to hire a successor to fill the CFO position by the end of the year, and Brosnan intends to stay on throughout that process. We think this should be a relatively seamless transition for the firm.