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Morningstar | Dialysis Remains Moatworthy Despite Regulatory Concerns

We've long believed the kidney care industry is one of the few healthcare provider markets supportive of durable economic moats. The attractive returns on capital posted by DaVita and Fresenius Medical Care support this view, as these firms have carved out unique competitive positions underpinned by cost advantages attainable by only the largest companies in the space. This lends itself to pricing power when negotiating with private insurers, and per-treatment cost advantages that allow these firms to treat patients more efficiently than smaller providers.

With the industry's convoluted reimbursement structure again front-and-center in investors' minds, we took a closer look and came away confident in our outlook for both companies and for the industry. These pricing concerns have weighed more heavily on DaVita's valuation given its focus on dialysis services and reliance on the U.S. market. Fresenius has fared a bit better, with a more relevant international presence and a dominant dialysis products business that helps diversify its operations. Ultimately, we believe the critical products and services provided by both DaVita and Fresenius ensure their economic moats will endure over the long run. We think long-term oriented investors will benefit from acquiring these above average businesses at discounted valuations.

Following recent weakness, DaVita and Fresenius trade at roughly 20% and 13% discounts to our fair value estimates, respectively. With DaVita trading near 13.0 times our 2019 adjusted earnings estimate, and Fresenius closer to 14.3 times, we think the market is pricing in a too-pessimistic outlook for industrywide pricing going forward. Helped by treatment volume growth that we expect to grow near 3% annually in the U.S., we think both firms' narrow economic moats will protect investor returns over the coming years.

For a deeper dive into the dialysis industry, upcoming regulatory issues, and company valuations, please see our report "Dialysis Remains Moatworthy Despite Regulatory Concerns."