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Morningstar | DaVita's 1Q Weaker Than Expected, but Shares Remain Attractive

Narrow-moat DaVita posted first-quarter results that came in modestly below our expectations, but the firm appears on track to meet our outlook for the full year. The underlying source of weakness was same-facility treatment growth, which continued to decelerate to 2.4% from 2.6% in the fourth quarter of 2018. Both figures are the lowest we've seen in some time and stand in stark contrast to the 3.3% and 3.0% rates from Fresenius Medical Care's North American segment during the same periods. While these metrics aren't perfectly comparable, we find it notable that Fresenius has outgrown DaVita on a same-facility basis in only five quarters since the beginning of 2011, including the two most recent. We intend to leave our long-term forecasts largely unchanged and don’t expect a meaningful adjustment to our $79 fair value estimate.

We expect DaVita to regain lost market share over time and continue to project total treatment growth near a 3.5% compound annual rate over the coming five years. Profitability in the firm's U.S. dialysis segment remained constant with our expectations, and its break-even international unit looks poised to contribute marginally to consolidated EBITDA on an annual basis beginning this year. In discontinued operations, DaVita Medical Group posted the best first-quarter adjusted margin in the last three years while improving markedly from the second half of 2018, consistent with our expectations. Management said that the DMG sale has continued to progress toward receiving final regulatory approval since it provided the last update a few months ago, and we are looking forward to the close of the transaction in the coming weeks.

The expected $4.3 billion cash inflow will help the firm rightsize its balance sheet while providing enough dry powder to complete its remaining $1.3 billion share-repurchase authorization at a favorable valuation. These actions should be immediately accretive to equity, in our view.

Cash flow was uniquely weak in the quarter, largely due to working-capital variances that should normalize throughout the remainder of the year. Management maintained its outlook for $1.375 billion-$1.575 billion cash flow from continuing operations, consistent with our forecast of roughly $1.45 billion for the year. However, management conceded that the firm may fall below its 2.5%-3.5% same-facility treatment growth projection, given the slow start to the year. While there may be some added conservatism in the firm's guidance given the upcoming CEO transition, we'd reconsider our forecasts should DaVita continue to lose share to Fresenius over an extended period.