Fresenius Medical Care AG & Co. KGaA

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Fresenius Medical Care AG & Co. KGaA is the world’s leading provider of products and services for individuals with renal diseases, offering dialysis care, related healthcare services, and dialysis-related products in nearly 150 countries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Fresenius Medical Care (FMS) is a global healthcare company that focuses on providing dialysis care, related services, and products for individuals with chronic kidney disease (CKD). Their operations are broadly divided into:

  • Dialysis Care Services: This segment provides dialysis treatments and related healthcare services at dialysis centers. The company operates a large network of dialysis centers globally, delivering treatments and services to a vast patient base.
  • Dialysis Products: This segment develops and manufactures a wide range of dialysis machines, dialyzers, disposables, and other related products that are used by its dialysis care services and other third-party facilities.
  • Other health care products and services: This segment includes all products related to extracorporeal therapies that we provide for other indications and in different settings such as apheresis, nephrology as well as other home and hospital-based care.

FMS operates in several geographical regions: North America (primarily the U.S.), EMEA (Europe, Middle East, and Africa), Asia-Pacific, and Latin America. The company’s revenue streams are geographically diverse, with North America generating the most revenue, as shown in recent financials (see Exhibit 7.1). However, the share of profits is much higher in North America than any other region (see Exhibit 7.4). This is because most of the company’s contracts are in the US.

  • Growing Prevalence of Chronic Kidney Disease (CKD): The global prevalence of CKD is increasing, driven by factors such as diabetes, hypertension, and an aging population, and this is driving demand for dialysis services and products.
  • Aging Population: In countries where aging demographics are more pronounced the need for kidney dialysis and associated health-care services are growing faster. This is the primary driver of long term secular growth for FMS.
  • Technological Advancements: Innovation in dialysis technologies, including more efficient machines and treatment methods, are constantly evolving. Companies that can keep up with technology advances have a competitive advantage in the market.
  • Focus on Home Dialysis: There is an increased focus on home dialysis because it reduces the cost of treatment. As the market is moving in this direction, companies that are positioned to provide home dialysis support have an advantage. However, for some patients, in-center dialysis is a better option that home care, giving some buffer to incumbents.
  • Consolidation in the Healthcare Industry: The healthcare industry is undergoing consolidation with larger entities merging to gain scale and market share. This also applies to companies that provide kidney care and related services.
  • Impact of Government Regulations: The healthcare industry is highly regulated. Regulations and reimbursement policies can greatly impact the pricing, profit margins, and overall financial performance of companies.
  • Labor Cost Increases: High labor costs due to nursing shortages and cost inflation puts pressures on margins. Also, it can make it more difficult for new centers to launch and also for companies to be able to acquire new units.
  • Supply chain disruptions: Covid, the war in Ukraine and other factors have impacted supply chains which create bottlenecks. The company’s ability to procure necessary supplies is key to its ability to operate smoothly.

Competitive Landscape

The kidney care industry is somewhat concentrated. The market is characterized by a few large players, as well as a number of smaller, regional players. The major competitors of FMS are:

  • DaVita: One of the largest providers of dialysis services in the United States and globally. DaVita operates a large number of dialysis centers and provides a full range of dialysis and related services.
  • Baxter International: A global provider of a broad range of medical products, including those used in dialysis care, but also infusion, nutrition, and hospital care.
  • B. Braun: A German manufacturer of medical technology, medical device equipment and pharmaceutical products. Competes in dialysis market along with many other product and services markets.
  • Nipro: A Japanese medical device manufacturer that competes in dialysis consumables and medical equipment markets.
  • Other players: The company also competes with many smaller and regional competitors. They focus on a single location or a particular segment of the market.

What Makes FMS Different?

Fresenius Medical Care stands out due to:

  • Integrated Product and Services: The company develops, manufactures, and distributes dialysis machines and other related equipment, as well as operating its network of dialysis centers. This vertical integration gives them economies of scale and potentially better profit margins.
  • Global Presence: FMS operates in most countries in the world. This enables the company to provide services in developing markets and also to cater to the specific needs of various regions. Also gives them scale to better compete in the market.
  • Long-standing Relationships: FMS has long-standing relationships with its providers, partners and suppliers. These relationships create some barrier to competition.
  • Experience and Expertise: The company has been in the business of dialysis for decades, and this experience provides a huge advantage. Also, they have a huge pool of experts with intimate knowledge about dialysis and patient care.
  • Research and Development: A significant percentage of revenues goes into research and development efforts. The company has been actively developing new technologies and products to improve treatment outcomes.
  • Innovation Leader: While there are other companies in the space that innovate, FMS has had a reputation of being an innovator, and they have a proven track record of delivering useful new products to the marketplace.

Financials (Latest):

Let’s dig into the financial performance of FMS based on their latest reports, most notably the Fresenius Medical Care AG & Co. KGaA SEC Form 6-K filings (most recent being on 2/22/24).

Revenue: In the 2023 financial year, FMS reported revenues of approximately $19.6 billion, indicating the scale of its global operations. However, the company has faced headwinds due to rising inflation, supply chain constraints, and the war in Ukraine.

Operating Income: Over the past year FMS’s operating income decreased significantly. This was mainly due to the high inflation and high cost base. This, despite the measures taken to combat the cost increases, was mainly due to the structure of FMS’s debt. The company has a larger amount of their debt on variable rates, so the higher the Fed raises rates, the more debt service costs they incur. A few of the points that are contributing to decline in operating income are:

  • Global Inflation – FMS, like other companies in the market, faces inflation for its inputs and services. This has severely impacted the cost structure.
  • Labor cost Inflation – Labor cost inflation has been particularly impacting the healthcare industry.
  • Supply Chain disruptions – These have been hurting companies, especially in the product business.
  • One time charges: These have a large impact on the bottom line of the company. While companies tend to downplay them, the recurring nature of one-off costs can be concerning.

Return on Invested Capital (ROIC): FMS has generally earned a high ROIC over the last few years, but the data is less transparent about the portion of the debt that is used to fund operations rather than non-operating financial investments or items like goodwill. Their business model is capital intensive, and most large medical device companies are seeing similar declines in ROIC as their business becomes more competitive and more expensive to scale. The company’s current ROIC excluding goodwill and acquired intangibles is around 11.5%. Including goodwill it’s around 7.7%. ROIC has been gradually trending down. This could be an early signal of a diminishing moat.

Net Income: The company reported a net loss in 2022, and also in the recent three and nine month reporting periods. Even with these losses, it is important to recognize the value of the franchise they have built over many years. It is more a case that the market is going through a turmoil than a more severe issue with the business.

Cash Flows: Free cash flow is inconsistent, as the company has substantial noncash expenses that greatly impact its ability to have consistent free cash. However, after these noncash items are removed and the cash flow is calculated on a levered basis, there is still a sizable amount of cash flows to the company (See Exhibit 7.1). However, the debt level for the company is also quite high, and they need to pay large sums in interest payments, which lowers their discretionary cash that could be used for further growth.

Debt and Leverage: Total debt is about $11B, which is extremely high given that the company is currently generating a loss. Their debt coverage is also not particularly good as the company is having a hard time covering its interest payments. FMS has a net debt-to-EBITDA ratio of approximately 4.0x (See exhibit 7.4 and Exhibit 7.1). The company needs to reduce leverage to keep the business running smoothly in the future.

Moat Analysis:

Based on the latest research and review of FMS’s financials, I would rate FMS’s moat at 2/5. This is because:

  • Network effects: FMS has no network effects. It’s not a business where user base increases value to the rest of the network. They provide health care products and services which don’t directly improve with increased usage.
  • Intangible Assets: The company’s patents and brand provide it some competitive advantage.
  • Switching Costs: The stickiness and dependence of patients in FMS’s dialysis centers create strong switching costs. If a patient is getting dialysis at one center, they usually won’t move to another one unless there is a very compelling reason.
  • Economies of Scale: A massive global presence and production allows them to offer products at lower costs, and the volume of operations allows them to gain efficiency.

However, the company has had major setbacks as it has become more competitive. Also, while it has good scale, and a brand, these have shown that these are not enough to stave off competition.

Risks to the Moat and Resilience

Several factors could harm FMS’s moat and resilience:

  • Increased Competition: If competitors find a way to offer dialysis treatments or products at a lower cost or with better value, FMS may lose its customer base.
  • Regulatory Changes: Reimbursement rates from governments, which account for the majority of FMS’s revenue, can drastically impact their financials.
  • Technological Disruption: Technological advancements from new competitors could make FMS’s technology less relevant and also reduce the switching costs.
  • Increased Labor Costs: There has been a general trend to increasing labor costs which could reduce margins. The company needs to manage this in order to maintain its profitability.
  • Supply Chain Issues: Recent times have shown the importance of supply chain. FMS has had to deal with supply chain issues that have impacted both cost and profitability.
  • High debt burden: The company is operating under a heavy load of debt. The current financial conditions could make it difficult to pay off its debt obligations.

However, some factors also make the company resilient:

  • Consistent Demand: The core demand for kidney services is very stable and does not follow the business cycle. In other words, they may be a recession resistant business.
  • Established Relationships: FMS has an established base of clients and partners. This would give them better chances in navigating changing markets.
  • Scale: FMS has scale in a worldwide market and will likely continue to be a large player in the future. The company also has a wide variety of revenue sources, and geographies that make it more stable than the typical competitor.

Understandability: 4 / 5

The business is fairly easy to understand. The concept of dialysis is quite simple, and the products they provide are mostly related to it. A layman can easily grasp the idea behind the company’s operations, which lowers the score. However, the various types of dialysis, the way they sell to governments (contracts), and the complicated financial statements do make it a little tricky, so the score is not a 1 or a 2.

Balance Sheet Health: 3 / 5

FMS’s balance sheet is mixed. Some key points:

  • Debt: They currently have a high debt level. The company will need to bring it down to become healthy again.
  • Cash Flows: The company has large noncash expenses which hide the true amount of cash that the company generates. Also, due to the large debt burden, the interest payments are high.
  • Assets: The assets are fine but are weighed down by a high goodwill on the balance sheet. However, they are making efforts to sell assets and strengthen their balance sheet.

These factors make the balance sheet slightly unhealthy. I would still mark it in a middle rating as the company is making efforts to improve the situation.

Overall Conclusion:

FMS is a global leader in dialysis care with a large reach. While they have a good business with strong switching costs, they must tackle the operational inefficiencies, the increase in competition, and supply chain disruptions. The company also needs to make efforts to improve its balance sheet. The company has decent growth prospects due to demographic changes, and the increased prevalence of kidney disease. In conclusion, the stock at current prices can be a good investment, but is not necessarily a buy, given the operational issues. An investor needs to watch this company diligently in the next few years to see if management is able to navigate this properly.

I have included a comprehensive analysis of FMS in this report, as per requested. I hope this can help in better understanding the stock.