Buffett’s Next Acqusition Is…

Warren Buffett (TradesPortfolio)’s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) owns over 38.5 million shares of DaVita Inc. (NYSE:DVA), good for a 20% stake. It is only a matter of time before they buy the whole entity, right? Especially since it is better as another wholly-owned subsidiary producing $2.4 billion in pre-tax income than as a losing stock transaction. Buffett (or his investment team) first bought DaVita back in 2011 and is down slightly on the total position.

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DaVita provides specialized health care services to a growing number of elderly patients, focusing mainly on kidney dialysis. Estimates are that by 2050, 83.7 million people in the U.S. are expected to be 65 years or older, which is nearly double the estimated 43.1 million in 2012. That is good news for an entire class of stocks set to capitalize on these and other multiyear trends.

With our dietary and lifestyle habits, whether or not they are changing, there will be explosive health care demand from this demographic, which DaVita is poised to cater to. DaVita has more than 2,300 outpatient centers. Life expectancy on dialysis is five to 10 years depending on a patient’s medical conditions and ability to follow a treatment plan. The company’s dialysis supplements kidney function and filters out extra salt, waste and fluid to clean the patients blood as it is sent back through their body via a second needle in the arm.

A tough topic to discuss

Kidney disease is the ninth leading cause of death in the U.S. with over 30 million people having chronic kidney disease (CKD). As humans age, the body starts to break down. To prolong life, we have to depend on technology. DaVita is in a dominant position to help.

Kidney dialysis is a secure profit channel. Once a patient begins the program, they typically need these services for life. Of course, health care is a major concern because costs rise faster than inflation despite new advancements in technology. DaVita generates excellent profits in some of its centers to cover massive losses in others. Any legislation Congress passes that affects its ability to do that would likely hurt margins.

Currently, DaVita is a very profitable business with strong margins, high returns on equity and invested capital and trades well below its historic price multiple average. Even with a 15.2 forward price-earnings (P/E) ratio, the company’s long-term prospects look extremely good.

DaVita missed analysts’ expectations in its second quarter due to elevated labor costs and Medicare reimbursement. In addition, the industry is filled with uncertainty as the government continues to debate the future of health care. Hopefully, that will be put to rest soon.

Philosophy on health care aside, owning the stock would be a good idea. Its revenue has tripled in the last decade and should continue to grow faster than the industry. It is buying back stock, boosting shareholder ownership and pounds out cash. No wonder other big name guru investors like Ray Dalio (TradesPortfolio), Jim Simons (TradesPortfolio), Joel Greenblatt (TradesPortfolio), Mario Gabelli (TradesPortfolio) and Steven Cohen (TradesPortfolio) all own the stock, riding Buffett’s coattails.

As for Berkshire, it has 1.5% of its assets in DaVita, but has not added to its position since 2014. Over the last five years, the market value has been flat while the net income and book value continue to grow. The enterprise value is north of $20 billion, which is a number Berkshire can afford to spend. If DaVita is not an acquisition target, owning 20% of the stock makes it harder for Buffett and company to unwind their position, so any changes or big block sells could indicate it is time to run for the exit.

Disclosure: I am not long or short DaVita.





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