We came across a bearish thesis on DaVita Inc. (NYSE:DVA) on ValueInvestorsClub by Fenkell. In this article, we will summarize the bears’ thesis on DVA. The company’s shares were trading at $147.00 when this thesis was published, vs. the closing price of $140.03 on Apr 17.

Patients connected to dialysis machines in a hospital ward, highlighting the company's dialysis and intravenous therapies.

DVA provides kidney dialysis services for patients suffering from chronic kidney failure in the United States. It operates kidney dialysis centers and provides related lab services in outpatient dialysis centers.

Operating in a duopoly with Fresenius, it is expected that DVA should have a high pricing power. However, the US offers a unique challenge where dialysis is covered under Medicare, with private insurers stepping in for the first three years for those having coverage. Medicare is looking to limit the reimbursements and private insurers are not keen on providing coverage for dialysis. Therefore, DVA has not been able to ramp up the prices despite providing a critical service.

DVA has been closing clinics, a sign that the volume growth has stalled. The End-Stage Renal Disease (ESRD) population grew by ~4%/year from 2007 to 2014, but this has dropped due to higher mortality of this population during COVID. The rate of new ESRD cases continues to fall with better treatment, healthier habits and a preference towards transplants. DVA has guided an average of 20 clinic closures per year which indicates that the post-COVID headwinds are certainly not temporary in nature. Dialysis treatment volumes are expected to grow at 3-5% with pricing growth limited due to the involvement of Medicare.

There are other risks to factor that include kidney failure medications by Novo Nordisk and legislation to limit dialysis reimbursement rates that would curb DVA’s ability to charge private insurers higher. DVA has also been accused of manipulating patients away from transplants in a bid to boost its own business. All these negativities have had a direct impact on its stock, with prices plunging 7-18% every time a negative news is announced.

DVA has commanded a 17x forward FCF multiple under the assumption that growth rates would be higher. However, the industry headwinds should keep FCF flat at $9 if DVA manages to keep costs under check. A 10-12x multiple is justified due to the limited growth potential, offering a price target of $90-110. This presents a 22% downside when a higher multiple is considered.

While we acknowledge the potential of DVA as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than DVA but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article was originally published at Insider Monkey.