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Morningstar | California Bill 1156 Vetoed, Representing a Win for the Dialysis Industry

On Sept. 30, California Gov. Jerry Brown vetoed Senate Bill 1156, which would have limited the effectiveness of charitable assistance programs for patients enrolled on the books of commercial insurers in the state. Our focus is on DaVita, given its outsize market share in California (roughly 50% of clinics in the state), and with the news shares have recouped the bulk of recent underperformance tied to the bill's surprise passage in the state assembly. Full enforcement of 1156 would have likely been a low- to mid-single-digit hit to firmwide EBITDA, so today's rally seems reasonable. We estimate the passage and implementation of Proposition 8 could be a mid- to high-single-digit hit to EBITDA, depending how "allowable costs" are ultimately defined and interpreted. That said, we haven't incorporated any of these effects in our base cash flow forecasts, as we think Prop 8's success remains a relatively low-probability event, with odds that have only worsened with the governor's veto. As a result, we're maintaining our fair value estimates for narrow-moat DaVita and Fresenius Medical Care of $81 per share and $48 per ADR share, respectively.

While the veto news represents a small positive for the dialysis industry, we think the broader implication suggests that blanket legislative efforts to curb industry profits will likely prove unsuccessful. With a vote on Prop 8 coming on Nov. 6, we think executive branch roadblocks would likely make the ballot measure difficult to implement even if it receives a majority vote in the election. Prop 8's industrywide pricing cap is a more heavy-handed proposal that we believe would more broadly harm patient access as DaVita, Fresenius, and smaller operators would likely find many facilities unprofitable under the proposed regulation. While we'd expect DaVita and Fresenius to ultimately navigate through these types of changes, we doubt that the roughly 30% of clinics not tied to these franchises would prove as successful.