– Healthcare stocks down but have outperformed significantly; that’s likely to continue

– DVA share price at healthy discount to long-term P/E; stock down 15% from high

– Strong international growth should continue; Berkshire Hathaway has a 31% stake

Everyone is worried about the rapid spread of the coronavirus and how bad it might get, and rightly so. While the world’s attention is on that, it might pay to prospect elsewhere.

With the uncertainty that comes with a bear market and the concerns about another potential leg down, my thoughts have run to healthcare. Nothing original here, as the market has naturally already privileged this group. From the Feb. 19 stock market high thru March 31, the broad market is off 24% and healthcare stocks are down 15%.

Before you call me too late, I’ll note that back in late January in these pages I noted that a neglected healthcare sector looked attractive, as it had underperformed for many years, and because it would be good ballast for a market that was hitting high after high and might pause. (Healthcare Looks Inexpensive; Some Healthy ETFs to Play, Signal from Noise, Jan. 29.)

It’s been much worse than a pause, unfortunately, but healthcare has been a place to hide with relatively lower risk while waiting for the market to stabilize.  Since our January 29 report ran, healthcare is off 13%, outperforming the market’s 21% drop over the same period. Additionally, in January, my colleague Tom Lee upgraded the HC sector to an Overweight rating from Neutral, his stance since Dec. 2015.

Instead of ETFs this time, I think that DaVita (DVA) is worth a look and could make an attractive long-term addition to the average investor’s portfolio, as well as a place to park your cash until the market clouds clear up. Healthcare does better in bear markets because their revenues and profits tend to be stable instead of cyclical.

Trying to handicap the winner of the race for a coronavirus cure seems an impossible task. Instead, I want to discuss kidney disease, which is an ongoing global problem.

Sadly, it’s a growing disease. Kidney disease, or end-stage renal disease (ESRD), is among the 10 leading causes of premature mortality in the U.S. People suffering from ESRD typically require either a transplant or dialysis a few times a week for the rest of their lives. In the U.S. there are about 500,000 people requiring dialysis, according to the U.S. Kidney Foundation, with about 100,000 people on the transplant waiting list. Only 20% of them get a transplant in any year.

The good news is that between 2001 and 2016, mortality rates decreased for dialysis patients in the U.S. by 29%. The bad news is that this patient group continues to grow at about 3.3% annually, though that has declined a little bit recently.

However, those cold facts mean that DaVita, as the biggest provider of kidney dialysis in the U.S., should be on your investment radar.  If you are looking for stability, DVA shares could fit the bill. It serves 207,000 patients, through over 2700 outpatient dialysis centers in the U.S. and satellite units in 900 hospitals. Outside the U.S., DVA has 259 centers, serving nearly 29,000 patients. Dialysis revenues represent 92% of DVA’s total in 2019.

DVA shares have bounced up nicely in the last few days but at around $71—a level first reached in late 2014—the stock is down over 15% from the pre-bear market high of $90. The shares trade at 2020 price/earnings ratio of 12 times consensus 2020 expectations of $6.09, a nice discount to its 17 P/E average of the previous three years.

A look at the company’s results over the years shows slow but steady revenue increases and steady earnings per share at about $4.70 to $5.00. In 2019, EPS rose to $4.60 from $3.62. It was $4.71 in 2017. Last year, DVA saw U.S. dialysis revenue (92% of the total) grow 2.2% and international revenue growth was up 13.6% (off a small base); a 2.5% rise in overall U.S. dialysis treatment count; a net increase of 89 U.S. and 18 international dialysis; and lower operating costs.

DaVita is a play on companies in healthcare that address specific and urgent needs,” notes Jake Dollarhide, a portfolio manager at Longbow Asset Management in Tulsa, OK, which owns shares for its clients.  “DVA is a best of breed company” and operates in a classic duopoly, which means stability for this revenues and profits, he adds. Indeed, DVA’s only large competitor is Germany’s Fresenius Medical Care (FMS).

On the downside, DVA does not pay a dividend, though Dollarhide notes he likes that the company is reinvesting that money into new technologies. And DVA has missed consensus revenue expectations occasionally, but if the stock drops that’s been an opportunity to buy in the past. Another investor concern about growth is that the patient incidence growth has slowed to 3.3% from 3.6%.

DaVita has about $6.9 billion in net long term debt and a little over $2 billion in shareholders equity, but that’s much less of a concern given the stability and urgency of its business, compared to say a widget making company. DVA produced $2 billion in cash flow last year. Fresenius, meanwhile, with a P/E of 10, has about three times as much debt and is showing a bit less growth.

Dollarhide points out that Berkshire Hathaway (BRKA), a company widely recognized for a long history of savvy investments, holds a roughly 31% stake in DaVita.  In my opinion, that’s like getting the Good Housekeeping seal of approval, and a convincing recommendation for me. There is a standstill agreement between the company and Berkshire.

Lastly, one contrarian sign I like is that Wall Street analysts don’t love the stock. Of the 13 who follow the stock, just three give it a Buy rating. The last time the approval rating was that low, DVA’s stock was at $55 in late 2017. It can pay to go against the herd.

Where I could be wrong:  The broad market could suddenly turn sharply higher in a short amount of time and investors could bail out of relatively safer healthcare stocks, including DVA.   

Bottom Line: Nevertheless, DaVita shares looks to have some long term promise as well as offer short term effectiveness for nervous investors as a stability component in a portfolio.

Prior “Signals”