Why Warren Buffett's Berkshire Hathaway Owns DaVita HealthCare Partners

By Markets Fool.com

Berkshire Hathaway has long been a hunting ground for wise investment ideas. Warren Buffett's keen eye for great businesses selling at reasonable prices has rewarded Berkshire shareholders and those who follow the stocks he buys.

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Buffett also has an eye for talented investment managers such asTodd Combs and Ted Weschler, who manage an increasing share of Berkshire's investment portfolio. Buffett wrote in his 2013 letter to shareholders that Combs and Weschler had significantly outperformed Buffett's picks for the year.

Weschler is bullish on DaVita HealthCare Partners. Weschler owned DaVita at least as far back as 2003 when he managed his own hedge fund, Peninsula Capital Advisors. He still held the stock when Buffett tapped him to work for Berkshire, and soon began building a position for his new employer. As of the end of September, DaVita is Berkshire's ninth-largest public equity holding.

Investors of all stripes should be interested to find out why Weschler is so keen on DaVita.

DaVita is a longtime favorite of Ted Weschler.

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A simple business
When it comes to health care businesses, DaVita's is relatively simple. The company derives three-fourths of its profit from dialysis centers located around the U.S. Kidney dialysis is necessary for patients suffering from end-stage renal disease, or ESRD. The condition, typically caused by diabetes or high blood pressure, is irreversible. It is fatal unless patients undergo a kidney transplant or three dialysis treatments per week for the rest of their lives.

Long wait lists and high costs make kidney transplants infeasible for most ESRD patients. There were approximately 430,000 ESRD dialysis patients in the U.S. in 2011, compared to just 16,000 kidney transplants.DaVita serves roughly one-third of those dialysis patients.

DaVita's primary concern is future pricing. About 90% of the company's dialysis customers are covered by Medicare, Medicaid, or some other form of government assistance. Medicare reimbursements are under continual pressure and are generally set at breakeven prices. That means DaVita must make all of its profit from the remaining 10% of patients.

Patients who are covered by commercial insurance plans typically are covered by them for just 33 months before Medicare takes over, so there is a continual need to find new commercially-insured customers. About 16,300 of DaVita's patients are currently on a commercial insurance plan. That means it needs to add roughly 6,000 new patients per year just to maintain the same number of clients using commercial insurance. With the dialysis market growing by 4% per year, DaVita simply needs to maintain a 35% market share to keep its current level of profitability.

Pricing power
In addition to maintaining its customer base, DaVita will likely be able to raise prices on commercial insurers. The company's captive customer base needs treatment regardless of cost, and insurers must cover the treatment. Insurers that do not include DaVita in their plans will effectively eliminate more than one-third of dialysis centers from their networks -- an untenable proposition for most large commercial insurers. Therefore, DaVita has bargaining power over insurers, allowing it to raise prices and extract higher profits on a stable customer base. This bodes well for DaVita's long-term earnings power.

Value
DaVita is likely a good long-term compounder -- not a stock you buy today and sell in one year. This is no surprise for Weschler, who has owned shares for over a decade. The stock trades at 20 times next year's consensus earnings per share-- up 5.6% from this year's consensus EPS. The stock isn't screaming cheap, but the company operates in an industry that has inelastic demand and thus a fair degree of pricing power. Over the long run, DaVita could be exactly what Buffett-like investors want in their portfolio.

The article Why Warren Buffett's Berkshire Hathaway Owns DaVita HealthCare Partners originally appeared on Fool.com.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.