After not purchasing any stock with fresh capital last month for just the second time in more than four years I’m back to doing what I do best – regularly purchasing equity in high-quality businesses that reward me with rising dividends. Every share I purchase pushes me further away from the working class and one step closer to the investor class. And that’s a great transition, in my opinion, as being a member of the investor class means my money works for me, rather than me working for me. And my money doesn’t age, get tired, or get sick.
So I recently foreshadowed this most recent investment as I talked about a couple of stocks that were on my watch list for this month. And, as usual, I tend to put my money where my mouth is. I took a look at many opportunities elsewhere in the market, but kept coming around to this one particular stock. I think there’s a lot of value in following your gut, and I often follow my gut when purchasing stocks. Sometimes a stock purchase just “seems right” after performing a full analysis, and this case was no different. As such, I put some capital to work!
I purchased 15 shares of Baxter International Inc. (BAX, Financial) on 6/18/14 for $73.13 per share.
Overview
Baxter International is a global medical products and service company with product sales in more than 100 countries. It manufactures and markets medical products for hemophilia, immune disorders, kidney disease, infectious diseases and other conditions. They provide critical therapies and solutions to people with life-threatening and chronic conditions. They operate in two segments: BioScience (43% of 2013 sales on $5.8 billion in revenue) and Medical Products (57% on $9.4 billion).
This is the first time I’ve added to my position in Baxter in almost a year. And even though the stock price has appreciated quite a bit in the interim, I still think there’s some value in shares here.
A Planned Spin-Off
Now, if you follow Baxter you’ll notice the stock price shot up at the end of March, and this price action was on the heels of an announcement by the company that they will spin off the BioScience segment into a separate, stand-alone company in 2015. The company has laid out a compelling case for the split, where both companies will have diversified products with strong market positions. This should allow the two businesses to focus on their independent strengths.
The new medical products company, which will retain the Baxter name, will make full use of the $4 billion Gambro acquisition, as they currently have an approximate 33% market share of the $13 billion global dialysis product market, with an approximate 75% share of the at-home peritoneal dialysis. The new Baxter will retain the current CEO, Bob Parkinson.
The new biopharmaceuticals company, yet-to-be-named, has strong competitive advantages in the markets it serves. It’s been estimated the company has a ~45% market share of the global $6 billion hemophilia A market, with leading products in Advate and Recombinate. Ludwig Hantson, the current president of of the BioScience segment, will become CEO of this company.
This spin-off reminds me of a similar action Abbott Laboratories (ABT, Financial) performed when it separated its pharmaceutical business into a stand-alone company in Abbvie Inc. (ABBV, Financial). That move has worked out very well for shareholders, of which I was one at the time. I don’t know if the share price for the two independent stocks will appreciate like what we saw with ABT and ABBV, but I suspect BAX shareholders will end up with shares in two great healthcare companies when it’s all said and done.
Fundamentals
Reviewing the fundamentals of Baxter as a whole reveals impressive results over the last decade. Earnings per share are up from $0.62 in 2004 to $3.66 in 2013. That’s a compound annual growth rate of 21.81%, although that’s coming off a low base as Baxter had problems with competition in the hemophilia market and pricing pressure in plasma due to oversupply a decade ago. In addition, they were issuing equity to fund acquisitions. However, competition is lower now, Baxter is a more diversified company, and they’ve been aggressively buying back shares over the last five years. Revenue has grown from $9.509 billion to $15.259 billion during this same time frame, which is a CAGR of 5.4%.
Growth in global developing markets remains a key growth driver for Baxter : ~25% of sales are in emerging markets for the new Baxter, while only ~15% of sales are in these markets for what will be the new biopharmaceuticals company. This is a huge growth opportunity for the company. S&P Capital IQ predicts a 7% CAGR in EPS for Baxter over the next three years. Furthermore, the company is expected to earn $5.15 per share this year.
Dividend growth been very solid here, if still a bit unproven. The company has managed eight years of dividend growth, with a five-year dividend growth rate of 16.4%. The payout ratio currently stands at just56.5%, and this ratio stands to lower significantly with 2014 earnings. Overall, BAX appears poised for strong dividend growth for the foreseeable future, but there is some lack of visibility here in terms of how the two independent companies will reward shareholders. In the past, however, Baxter has been anxious to return cash to shareholders, sending more than $1.9 million shareholders’ way during 2013 – a little over $1 billion in dividends and just over $900 million in share repurchases.
Shares yield 2.84% on my cost, which is fairly attractive in this market. This is on a quarterly dividend of $0.52 per share.
Return on equity has oscillated between 21.6% and 33.8% over the last five years, which is strong. Net margins have averaged 14.89% over the last five years, finishing at 13.2% for 2013.
The balance sheet is solid, with a long-term debt/equity ratio of .96 and an interest coverage ratio of 17.4.
Qualitative Aspects
The company has many durable competitive advantages. Its renal care business is particularly strong, bolstered by the Gambro acquisition with gave it access to additional products to improve Baxter’s breadth, not to mention annual cost synergies of ~$300 million by 2017. As previously discussed, Baxter has a significant share of the global $13 billion dialysis market and $6 billion global hemophilia A market. In addition, they have significant offerings in biosurgery, hematology, fluid systems, and bio-therapeutics.
Healthcare is largely immune to economic cycles, and the company has plenty of growth opportunities here and abroad with demographic trends favoring them as humans live longer and demand for access to great healthcare grows. Penetration into developing markets should only bolster their future opportunities as many markets around the world are growing their middle classes which adds to Baxter’s potential client pool. They have significant economies of scale, great products, a strong history of solid performance, and a solid R&D pipeline with $1.25 billion spent on this budget in 2013. They have research and development activities spread throughout the world, with centers located in the US, Austria, Belgium, France, and Japan.
Risks
While there’s a lot to like with Baxter, risks remain. I think your primary risks when investing in a company like this are liability, regulation, competition, patent cliffs, and changes in technology. However, BAX has performed very well despite these challenges that are constant in their industry. Strong research and development and acquisitions that make sense should keep their economic moat strong and competition at bay.
Valuation
Shares are trading hands right now for a P/E ratio of almost exactly 20. However, looking at 2014 earnings, the forward P/E ratio drops to 14.33. So either we’ll see a P/E ratio compression over the next six months or we’ll see shares appreciate considerably. I’m willing to bet the latter with the spin-off acting as a catalyst and driving demand for BAX shares.
I valued shares using a Dividend Discount Model analysis with a 10% discount rate and a 7% growth rate. I used a slightly higher growth rate to value shares than I did last time because it’s in line with the predicted growth rate in earnings, but still far below Baxter’s own historical growth rate for both earnings and dividends over the last decade. This gives me a fair value on shares of $74.19. So shares appear pretty fairly valued here, with no real margin of safety. However, I still think there’s some value here with the upcoming split and some exciting growth that could happen due to two individual companies focusing on their independent businesses. I’ll be honest and admit I’d rather see the company stay whole as I view everything with a perspective of multiple decades, but history shows that these moves typically drive short-term appreciation.
This purchase adds $31.20 to my annual dividend income based on the current payout.
My portfolio still holds 47 positions, as this was an addition to an already existing investment.
I’m going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
*Morningstar rates BAX as a 4/5 star value, with a fair value estimate of $84.00
*S&P Capital IQ rates BAX as a 4/5 star Buy, with a fair value calculation of $83.00.
Full Disclosure: Long BAX.
What’s your opinion on BAX right now? Think it’s a good buy?
Thanks for reading.
