As the number of elderly patients increases the demand for medical services may also increase in the future. This will eventually create a higher demand for medical equipment manufacturers and suppliers such as Baxter International Inc. (BAX). Therefore, I aim to examine the impact of an increasing older population on Baxter's performance. Furthermore, I have conducted a detailed analysis of the company's past performance and identified future growth prospects for the company in order to determine whether or not it is a profitable investment opportunity.
Business Model& Revenue Breakdown
Baxter has two segments: bioscience and medical products. Both segments are managed separately. Each segment manufactures, develops and markets distinct products and services.
As shown in the following graph, Baxter generated 44.64% revenue from its bioscience segment and 55.36 from its Medical Products segment.
Fluid systems, renal, specialty pharmaceuticals and BioPharma solutions are the four sub-segments of the medical products segment. The medical products sales increased by 1%. Fluid systems contributed 37.17% of the sales of the medical products segment. Fluid systems experienced a growth of 2% in the most recent quarter of the current fiscal year compared to the results of the 2012. The renal segment sales increased by 3%. The renal segment represents 32.20% of the total sales of the medical products' segment. Increase in sales from fluid systems, renal and specialty pharmaceuticals partially offset the decrease in the sales of BioPharma solutions.
The Bioscience segment consists of four sub-segments: Biotherapeutics, BioSurgery, hemophilia and vaccines. Overall, the sales of the Bioscience segment increased by 5% in the second quarter of the current fiscal year compared to the corresponding period of the previous year. The hemophilia segment generated approximately more than 50% of Bioscience's sales in the most recent quarter of the current fiscal year. Hemophilia sales grew by 2% to $849 million. The Biotherapeutics segment contributed 31.31% of the total sales of the Bioscience segment. This segment experienced a 6% growth in sales in the second quarter of the current fiscal compared with the second quarter of fiscal year 2012.
Baxter's gross margins increased by 0.44% because its increase in revenues was higher than the increase in cost of revenue as a percentage of sales. Operating expenses also decreased by 0.37% as a percentage of sales. This eventually helped the company to report a higher operating margin in the most recent quarter of fiscal 2013 in comparison to last year's quarterly performance.
However, due to other expenses totaling $63 million, in the most recent quarter, Baxter reported a lower net profit margin compared to last year's results. Due to a lower net profit, diluted EPS decreased by 10.08% to $1.07 in the second quarter of the current fiscal year in comparison to the second quarter of the previous year.
Although, the company's overall performance was better on a standalone basis its performance was not up to par when compared industry standards. As shown in the following table, Baxter's revenues grew with a CAGR of 4.20% in comparison to the industry's CAGR of 5.40%. Net income grew at a pace over the last 3 years compared with the industry's performance. However, the company's operating margins and ROA are higher than the industry average.
Baxter's ROE is 32.10% which is well above the industry average of 15.90%. However,the higher ROE is mainly attributable to higher financial leverage and that is not a healthy sign for the company.
According to the U.S. Census Bureau's International Database, there were more than 40 million Americans aged 65 or more in the U.S. in 2011. By the year 2060, the U.S. Census Bureau is expecting this number to increase to 92 million and that is approximately a 122% increase. Moreover, the total national health care spending is expected to increase from $2.7 trillion to $4.8 trillion by 2021. Therefore, I can infer that Baxter should experience a decent growth in the long-term owing to an aging population, a higher demand for medical services and increased health care spending.
Aging citizens tend to require more health care services than younger citizens. According to a report issued by National Hospital Discharge Surveys, 40% of hospital discharges involved patients aged 65 or older. Whereas they were 12% of the total population in 1999. Moreover,the number of people aged 65 or older is expected to outnumber children under age 5 over the next five years. This increase in the aging population is attributed to a remarkable increase in life expectancy. Therefore, I believe Baxter will experience a high demand for its products in the future.
Moreover, to capitalize on the high demand, Baxter is focusing on increasing its focus on research &development. R&D costs increased by a CAGR of 7.42% over the last five years while its revenues grew with a CAGR of only 3.52%. Therefore, management's strategy to develop R&D in order to capitalize on the potential high growth is quite evident.
Also, the company's capital expenditures increased by $136 million in fiscal year 2013. The company's investment in capital expenditures was primarily driven by additional investment in support of capacity expansions and the construction of new manufacturing facilities. It is quite obvious that the company is preparing itself to benefit from the high demand for its products and services in the future.
Baxter has a long history of dividends. Currently, its dividend yield is 2.9% which is higher than the industry's average dividend yield of 1.2%. Moreover, Baxter's dividend policy is clear and related to the earnings of the company. Therefore, I believe the dividend discount model is most suitable valuation technique to calculate the intrinsic value of the company's stock.
The company's average modified payout ratio of the last five years has been above 100%. I believe it is impossible for the company to carry on such a high payout in the future. The company's earnings grew with a CAGR of 12.45% over the last 10 years. However, I believe the company will not be able to sustain this growth in the future. Although, there will be high demand for Baxter's products in the future it will be impossible for the company to achieve higher than its historical earnings growth.
Therefore, I gave different weighting to different growth estimates in order to calculate the growth of the model. By assigning different weights the growth of the company equals 11.01%.
(click to enlarge)(click to enlarge)Baxter's cost of equity is 9.77% which was calculated by using an adjusted beta of 0.74. The current risk free rate of the 10 year Treasury bond is 2.63% while the market generated a 12.28% return in the post-financial crisis period. By using a discount rate of 9.77% Baxter's intrinsic value per share equals $79.44 which gives a 23.34% capital return to the investors.
In order to calculate the high and low target price of the stock I have conducted a sensitivity analysis. Since the dividend discount model is more sensitive to the cost of equity and growth estimates I used these two key factors to study the sensitivity of the stock. As shown in the following table, the stock is more sensitive to expected growth rate. The high target price for Baxter is $85.73 per share which offers a 33% upside potential. Its low target price is $73.02 which gives a 13.36% capital return to the investors.
Baxter's performance in the most recent quarter of fiscal year 2013 was better than its quarterly performance of the previous year. However, its performance improved in some aspects and it bested industry averages.
Although, the company did not completely outperform the industry in the last few years due to its expansionary policies and bright outlook, I believe it will be in a better position to report more positive results in the future.
Moreover, the dividend discount model shows a potential 23.34% capital return. The company's high and low target prices are above the current price of the stock. Therefore, on the basis of fundamentals, I would recommend buying the stock.