DaVita Maintained at Neutral

We have reiterated our Neutral recommendation on DaVita Inc. (DVA - Analyst Report) based on strong top-line growth, partially offset by higher operating expenses.

However, we continue to exercise caution in the near term due to the volatile economic environment, which can have a negative impact on earnings.

DaVita reported second-quarter net operating income of $114.4 million, or $1.17 per share, which exceeded the Zacks Consensus Estimate by 3 cents. The earnings were also higher than $110.4 million or $1.06 per share in the comparable quarter of last year.

DaVita has been generating strong operating cash flow, which it expects to continue in the future. This makes the company confident about meeting its future cash requirements for capital expenditures as well as share repurchases and acquisitions.

Additionally, DaVita’s preferred growth strategy over the years has been the acquisition of dialysis centers and businesses that own and operate dialysis centers, as well as other ancillary services and strategic initiatives.

In addition, the company is slowly moving into the international market with the opening of a center in Singapore and an acquisition of a minority stake in a company with two centers in India. These factors are expected to drive modest growth in the long run.

However, a significant portion of DaVita’s dialysis and related lab services revenues are generated from patients who have commercial payors as the primary payor, but the mix of treatments reimbursed by non-government payors, as a percentage of total treatments, has been falling consistently over the years.

Moreover, the shift in payor mix will be additionally harmful as the Medicaid rate has been reduced by many states in 2011 with more states considering the possibility of reducing the rate.

Plus, DaVita is facing multiple investigations that allege over-billing of Medicare and over-use of Epogen, a medicine used for increasing the red blood cells in kidney patients. If the charges are found to be true, DaVita will not only suffer substantial reduction in goodwill, but will also face several lawsuits and heavy penalties, weighing heavily on the financials.

The Zacks Consensus Estimate for the third quarter is currently at $1.29 per share, up about 12.24% year-over-year. Of the 14 firms covering the stock, two have revised their estimates downwards in the last 30 days with no upward revisions.

For 2011, earnings are expected to be about $4.81 per share, climbing about 9.92% year-over-year. The company competes with Gentiva Health Services Inc. (GTIV - Analyst Report) and HealthSouth Corporation (HLS - Snapshot Report).

DaVita currently caries a Zacks #2 Rank, implying a short term Buy rating.

Read the full analyst report on DVA

Read the full analyst report on GTIV

Read the full analyst report on HLS