We Are Confident About Baxter's Plan to Create Two Separate Health Care Companies

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Mar 28, 2014

Baxter International Inc. (BAX, Financial) develops, manufactures and markets products for people with hemophilia, immune disorders, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. The company manufactures products in 27 countries and sells them in more than 100 countries. The company’s operations are comprised of the BioScience and Medical Products segments.

So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment for a market leader that suffers significant competitive pressures from competitors like Bayer AG (BAYRY, Financial).

Independent Health Care Companies

Baxter will split into two companies, one focused on developing biotechnology and pharmaceutical products and one that sells medical products. The transaction is expected to be completed by mid-2015, follows the split of Abbott Laboratories (ABT, Financial) into two companies last year. “Baxter has an established history of executing successful spinoffs, and we have continued to evaluate the separation of these two businesses in response to diverging business dynamics and the rapidly changing macro-environment,” said Baxter Chairman and Chief Executive Officer Robert L. Parkinson Jr.

The Gambro Acquisition

In September 2013, Baxter acquired Gambro AB, a Swedish maker of dialysis products with indicated sales of about $1.6 billion, for about $4 billion in cash and debt. This acquisition strengthens the company´s role in the hemodialysis (HD) and renal replacement therapies complementing its peritoneal dialysis (PD) renal care business. Baxter is expected to benefit from the deal, because Gambro will expand Baxter's footprint in foreign markets, especially in European markets, where Gambro had a strong presence. Furthermore, it will also be in a stronger position to grow revenues in Asian and Latin American markets.

Analyst Recommendation

The firm is currently Zacks Rank # 3 – Hold, and it also has a longer-term recommendation of “Neutral.” A Hold rating indicates that the stock, over the next one to three months, will perform at an annualized rate of 10.56%, which is very similar to the one projected for the S&P 500.

P/E, Earnings and ROE

In terms of valuation, the stock sells at a trailing P/E of 19.3x, trading at a discount compared to the industry mean. Earnings per share (EPS) decreased by 37% in the most recent quarter compared to the same quarter a year ago, to $0.59 per share for the fourth quarter of 2013, but beating the Zacks Consensus Estimate by a penny. We include in the next graph the stock price because EPS often lead the stock price movement. As we can appreciate in the chart, the price performance makes the stock appealing with an upward trend over the last ten years.

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Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has decreased when compared to the same quarter one year prior. Let´s compare the current ratio with the peer group in the next table:

Ticker Company Name ROE (%)
BAX Baxter International 23.77
ABT Abbott Laboratories 10.23
MDT Medtronic, Inc. 18.57
COV Covidien PLC 18.39
SYK Stryker Corporation 11.12

As we can see, the firm has a higher ROE than Abbott Laboratories, Medtronic Inc. (MDT, Financial), Covidien Plc (COV, Financial) and Stryker Corporation (SYK, Financial).

Final Comment

The goal of the split is to innovate and provide flexibility to reach growth and increase revenue and profitability, with both companies being global leaders in their respective markets. With respect to the Gambro acquisition, we think it will provide a number of longer-term growth opportunities as well as cost synergies.

According to Yahoo! Finance, the estimated one-year target share price is $76.85, so if you buy shares at current market price ($68.39), your return from price appreciation would be 12.4%. In addition, you have to consider any cash flow received by the asset. So for holding the stock one year, you'll be paid a dividend of 49 cents per share each quarter, totalizing $1.96 at the end of the year. If we divide this number by current price per share, we obtain the dividend yield, which is the other component of the return on an investment for a stock, and in this case is 2.9%. So the total expected return for investing in Baxter is 15.3%.

I would recommend investors to add Baxter to their long term portfolios. Hedge fund gurus have also been active in the company in fourth quarter 2013. Gurus like Scott Black (Trades, Portfolio), John Rogers (Trades, Portfolio), Robert Olstein (Trades, Portfolio), Bill Frels (Trades, Portfolio), Jeff Auxier (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio) and John Buckingham (Trades, Portfolio) have taken long positions in it.

Disclosure: Victor Selva holds no position in any stocks mentioned.