You Can Clean Up On a DaVita Buy

Berkshire Hathaway (NYSE: BRK) CEO Warren Buffett's latest successor-in-training used to run a Peninsula Capital Advisors, a hedge fund. One of Peninsula's biggest investments, kidney dialysis center owner, DaVita (NYSE: DVA), caught my attention. Should you invest?

Like Apple's (NASDAQ: AAPL) Steve Jobs, Buffett is a business hero who shares a common feature with the rest of humanity -- he won't last forever. So Buffett has been hiring investment managers and giving them multi-billion dollar chunks of his portfolio to see how they do. His first was Todd Combs and now Buffett has hired Peninsula's manager, Ted Wechsler.

Wechsler won an anonymous bid to have lunch with Buffett in 2010 -- topping $2.6 million, according to Fortune. Peninsula put in a pretty good performance for its investors -- since its 2000 inception, it returned 1,236% -- far better than Berkshire B stock that gained a relatively small 146%. One of Wechsler's biggest bets as of earlier this year was DaVita.

But has Wechsler already taken full advantage of the profit opportunity in its stock? Here are three reasons to consider an investment:

• Low valuation. DaVita trades at a Price-Earnings-to-Growth ratio of 0.71 — a P/E of 19.2 on earnings forecast to grow 27.1% to $6.13 in 2012.
• Good earnings reports. DaVita has been able to beat analyst’s expectations in four of its past five earnings reports.
• Higher sales and profits and decent balance sheet. DaVita sales have grown at a 6.9% annual rate over the last five years from $4.9 billion (2006) to $6.4 billion (2010) and its net income has increased at an 8.9% annual rate from $289 million (2006) to $406 million (2010) -- yielding a decent 6% net margin. Its debt has risen -- but its cash has soared at a much higher rate. Specifically, its long term debt rose at a 3.2% annual rate from $3.7 billion (2006) to $4.2 billion (2010) while its cash climbed at a 29.4% annual rate from $315 million (2006) to $883 million (2010).

One negative:

• Out-earning its cost of capital. DaVita is earning more than its cost of capital – but it’s not progressing. How so? It’s producing no EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, DaVita's EVA momentum was 0%, based on six month annualized 2010 revenue of $6.3 billion, and EVA that fell from six months annualized 2010's $110 million to six months annualized 2011's $121 million, using a 7% weighted average cost of capital.

DaVita looks like a solid investment given its financial strength and low valuation. And you didn't have to pay $2.6 million to learn about it.