For a company expecting long-term earnings to grow at 8% to 10%, Baxter International (BAX) is looking mighty cheap today. Using the low end of the company's topline growth projections with recent operating margins improving at 25 basis points annually gives the company a fair value north of $85, using a DCF model. Even after the recent pop from winning both an FDA approval and a CE mark on Dec. 19 and 20 respectively, Baxter appears undervalued by more than 20%.
Diverse, not sprawling
Baxter's operations are split nearly evenly between its BioScience and Medical Product segments. As a medtech firm, Baxter doesn't command a share of the market anywhere near that of Johnson & Johnson (JNJ) or Medtronic (MDT), but it has carved out a nice sized corner.
Its $3.9 billion acquisition of Swedish dialysis competitor Gambro should quickly be giving the company a large share of the European dialysis market. Analyst consensus provided by the Evaluate Group puts growth of the company's medtech segment at around 9% just below management estimates of 10%.
Bolstering Baxter's hemodialysis (HD) position in the EU is the recent CE mark awarded to its Vivia system. The home HD system includes a wireless interface that allows full, remote monitoring of a patient's treatments by healthcare professionals. Overall the global dialysis market is expected to outpace the medtech industry as a whole, growing at a CAGR of over 6% over the next five years.
On the BioSciences front, Baxter's hemophilia franchise comprises just over half of all sales in the operating segment. Growth has been strong, rising 9% on year in Q3 2013. Investors can expect continued growth on the back of a recent FDA approval for a Feiba prophylactic regimen. This is the first treatment option for routine prevention of bleeding episodes for hemophilia A or B patients in the US.
Mature and still highly profitable
Non-segment charges related to the Gambro acquisition, the Colleague infusion pump recall, and restructuring costs have long been eating away income generated by highly profitable operations. In 2012, BioScience and Medical Product segments produced $3.9 billion in pretax income from $14.19 billion in net sales. Excluding non-segment charges, the company's operating margin for 2012 was 27.5%. After just over $1 billion in non-segment charges, that figure fell to just 20.4%.
9 Months Ended Sept. 30, 2013. (In Billions)
EBT as % of sales
Baxter's focus on a narrow range of chronic conditions have made it a highly profitable firm, that retains an impressive level of geographic and operational diversity. Despite deriving about 45% of sales from the typically lower margin medical products, the company's return on equity is miles above peers with a combination of medtech and pharmaceutical exposure.
Although free cash flow has dipped over the past few quarters, it remains strong at more than $1.6 billion, on a trailing twelve month basis. Going forward, the company should have plenty of ammunition available for strengthening its position through further acquisitions.
Dividends and repurchases
The company has increased its distributions by a blazing CAGR of 13.5% over the past five years. That's just too good to last, but the company does have a long history of steady dividend growth. Going back all the way to 1986, distributions have grown by a CAGR of 8.8%.
Baxter also has a strong history of stock repurchases. In July 2012, its board authorized repurchases of $2 billion; at the end of Q3 2013, about $1.1 billion remained. The company's board sensibly authorizes repurchases based on company's cash flows, existing debt and market conditions. Annual buybacks averaging about $1 billion are likely going forward. This very roughly represents a reduction in total shares outstanding by 2-3% each year.
Clearly, the biggest risk to Baxter's growth is reimbursement uncertainty caused by the rollout of the Affordable Care Act. I don't think anybody can accurately quantify the potential impact, but I believe the serious and chronic nature of the indications targeted by Baxter's products should alleviate much of the concern. Also, the company derives less than half its revenue from the US. In 2012, more than 28% of sales originated outside of the US and EU, a trend that should continue.
From 2005 through 2012, the Colleague and Syndeo infusion pumps recall cost about $888 million. Should another recall on this scale occur, earnings growth would surely be reduced, but not enough to make a long position in Baxter now unprofitable. Overall, the likelihood of further additional high-margin contributions from the BioScience pipeline, over the long term, far outweigh recall, and reimbursement risk.