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Morningstar | FME Updated Forecasts and Estimates from 14 Nov 2018

Narrow-moat Fresenius Medical Care released full third-quarter results that were largely in line with its preliminary announcement on Oct. 16. While there are many moving parts in management's adjusted guidance for the year, our expectations were largely in agreement with this updated outlook, and we don't plan any meaningful changes to our EUR 81 fair value estimate ($48 for the ADRs). With the market implying a valuation of roughly 14 times our 2019 adjusted earnings estimate and shares currently trading in 4-star territory, we think Fresenius represents a compelling investment opportunity.

Compared with our estimates, much of the weakness came from the firm's products business and coordinated care, with the dialysis services operations actually holding up reasonably well despite negative commercial mix and facility certification delays in the United States. Same-market treatment growth expanded at a 2.8% pace in the company's North America segment, and closer to 3.5% in international markets. These numbers are largely consistent with our long-term outlook. Per-treatment cost inflation has outstripped pricing improvements on a year-to-date basis, which we think will likely result in modest margin contraction for the U.S. dialysis business for the full year. Many of the headwinds in this segment should ultimately prove transitory, including elevated lobbying efforts, negative patient mix, and lengthened facility certification timelines.

The international business saw headwinds from currency and increases to bad debt reserves as emerging economies have continued to struggle this year. As a result, we saw year-over-year margin compression across all three international business segments. In aggregate, however, for both the quarter and on a year-to-date basis the firm has reported roughly flat adjusted EBIT margins compared with the prior-year periods, helped by improving profitability in coordinated care globally partially due to the divestiture of Sound.

Turning to guidance, while we think management's 2%-3% revenue growth target for 2018 is likely too conservative over a multi-year period, we think its maintained long-term outlook calling for 10% annually will prove too optimistic. We take the middle ground and model organic growth near 4%-5%, which moves nearer 5%-6% when incorporating the effect of NxStage Medical. Management and NxStage agreed to extend the merger deadline until February given the longer than anticipated regulatory process, but management still expects the deal to close prior to year-end.

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