DaVita Downgraded to Neutral

On Feb 22, 2013, we downgraded our recommendation on DaVita HealthCare Partners Inc. ( DVA - Analyst Report ) to Neutral from Outperform based on its high dependence on commercial payors and government reimbursements. Moreover, rising debt is hurting the company’s financial leverage. DaVita carries a Zacks Rank #3 (Hold).

Why the Downgrade?

A significant portion of DaVita’s dialysis and related lab services revenues are generated from patients who have commercial payors as the primary payor. However, the rising unemployment may result in shifting of people from commercial insurance schemes to government schemes due to the wide disparity in payment rates.

In fact, the mix of treatments reimbursed by non-government payors, as a percentage of total treatments, has been falling consistently over the years.

Moreover, DaVita’s debt refinancing continues to increase its financial leverage. Apart from using its free cash and credit facility,it issued senior notes in Aug 2012,to finance the acquisition of HealthCare Partners. This increased DaVita’s interest by $57.5 million annually, which will weigh on its already high expenses.

The issuance will also increase the company’s total debt, thereby deteriorating its financial leverage.In fact, DaVita has not repurchased any shares since Jul 2011 to conserve cash for acquisitions amid the volatile debt market.

However, despite these negatives, DaVita reported fourth-quarter 2012 operating earnings of $1.68 per share, beating the Zacks Consensus Estimate of $1.57 as well as $1.56 per share reported in the prior-year quarter.

The operating income is expected to increase further in 2013, which is reflected in the company’s guidance of $1.75–$1.90 billion. Moreover, the service agreement with Fresenius Medical Care ( FMS - Snapshot Report ) , announced in Jan 2013, is expected to boost the earnings of DaVita’s ancillary services and strategic initiatives segment, which covers its pharmacy services.

Other Stocks to Consider

Other healthcare companies worth considering are LHC Group, Inc. ( LHCG - Snapshot Report ) and RadNet, Inc. ( RDNT - Snapshot Report ) , which carry a Zacks Rank #2 (Buy).