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Baxter International Inc. (NYSE:BAX) is a U.S.-based health care company particularly specialized in treatments for various severe medical conditions including hemophilia, immune disorders, infectious diseases, and kidney diseases.

Baxter trades on the New York Stock Exchange under the ticker “BAX.” BAX is part of the S&P500 index. BAX is an American corporation and therefore pays its quarterly dividends in U.S. dollars. All the following figures are thus in U.S. dollars. Notably, foreign investors will likely be subjected to withholding tax.

DIVIDEND CALENDAR

BAX pays a quarterly dividend. The dividends are generally declared in November, February, May, and July, and are generally paid in January, April, July, and October.

BAX generally increases its quarterly dividend once a year. However, in recent years, there has been no regular pattern for the dividend increases. The last increase in May 2013 was of 8.9% (from $0.45 per quarter to $0.49 per quarter).

DIVIDEND HISTORY

With the most recent increase, BAX has increased its quarterly dividend for 7 consecutive years, making BAX a dividend challenger (between 5 and 9 years of consecutive dividend increases).

The evolution of the annualized dividend and of its growth over the last ten years is presented in the graph below.

After keeping its dividend steady for a couple of years, BAX started to aggressively increase its dividend starting in 2007. Since then, despite some ups and downs, BAX has maintained an average dividend growth rate around 19%.

Though the pace at which BAX increases its dividend is likely to slow down, I expect it to remain around 10% at least for the next few years.

DIVIDEND ANALYSIS

In this section, I verify two important aspects of the dividend:

  1. Is the current dividend safe?
  2. Is the current dividend likely to grow?

Understandably, answering no to either one of these questions should mark the stock under consideration as being unsuitable for dividend investment purpose.

Is the current dividend safe?

To determine the safety of the dividend, I check the historical levels, the current level and the evolution of the payout ratio with respect to the earnings and, when relevant, with respect to the free cash flow.

First, the evolution of the earnings, dividends, and payout ratios.

Then the evolution of the free cash flow, dividends, and payout ratios.

The graph above show two clear trends. First, despite some downs, the earnings and free cash flow are trending upwardly, which is great. As dividend investors, we want to see a company which makes more money year after year.

Second, with respect to both the earnings and the free cash flow, the payout ratio is rising. Though the current payout ratios are still manageable, the fact that they rise clearly indicates that the dividend has been growing faster than the earnings and the free cash flow. This is less good.

Still, as of right now, with rising earnings and free cash flow and with relatively high but manageable payout ratios, I think the current dividend is safe.

Overall, I think the current dividend is safe.

Is the current dividend likely to grow?

If we look at the recent history of BAX’s dividend, we can safely assume that the dividend will continue to grow.

The only question is at what rate?

As we have seen above, BAX’s payout ratios have been on the rise, indicating that the dividend growth rate was higher than the earnings and free cash flow growth rates. Over time, this is not sustainable. So BAX’s dividend growth rate will need to slow down to allow the earnings and free cash flow to catch up.

Hence, in the foreseeable future, I estimate the BAX’s dividend growth rate will more or less follow the growth in earnings and free cash flow. A growth rate around 10% is probably achievable.

Overall, I think the current dividend is likely to grow in the foreseeable future.

STOCK VALUATION

Estimated Fair Values

To calculate a range of fair values, I calculate how much one share will return in cumulative dividends over the next 20 years, according to different scenarios, and adjusted for inflation.

For BAX, I’ve used the following inputs:

  • Share price: $73.00
  • Dividend rate: $1.96
  • Dividend growth rate:
    • Optimistic scenario: 14.0%
    • Realistic scenario: 11.2%
    • Pessimistic scenario: 8.4%
  • Inflation rate: 3.5%

The optimistic DGR generally corresponds to the 10-year average, while the realistic and pessimistic DGRs respectively correspond to 80% and 60% of the optimistic DGR.

According to the above values, the range of estimated fair values for BAX varies from $63.02 (pessimistic) to $114.12 (optimistic) with a realistic value of $84.32. With a current share price around $73.00, BAX appears fairly valued.

I’ve also calculated that the DGR would need to be 9.83% over the next 20 years to justify the current price of $73.00.

A DGR of 9.83% is lower than the average DGR over the last 10 year while almost matching the average free cash flow growth rate over the last 10 years. Hence, such a DGR appears reasonable.

At $73.00, I think BAX is fairly valued as a dividend investment.

Estimated Cash Return

With the estimated cash return, I calculate how much cumulative dividends a fixed investment in the stock under consideration will return over a period of years.

Estimated cash return values allow to compare dividend stocks with different yields and different growth rates.

For BAX, I’ve used the following inputs:

  • Initial investment: $1000
  • Current yield: 2.68%
  • Dividend growth rate:
    • Optimistic scenario: 14.0%
    • Realistic scenario: 11.2%
    • Pessimistic scenario: 8.4%

Notably, the DGRs are the same as the DGRs used for valuation.

I also compare the various estimated cash return values with the estimated cash return of a benchmark dividend stock having a yield of 3% and a dividend growth rate of 8% (e.g. Procter & Gamble (NYSE:PG) or Johnson & Johnson (NYSE:JNJ)).

The first thing to notice is that if BAX maintains even the pessimistic DGR, i.e. 8.4%, an investment in BAX would be comparable to an investment in the benchmark stock, at least with respect to cash return.

However, if BAX can maintain an average DGR above 8.4%, an investment in BAX would return more money than a similar investment in the benchmark stock.

This means that as long at BAX can at least maintain a DGR of 8.4%, there is not much risk in buying BAX, at least with respect to cash return.

At the current price and yield, I think BAX would be a low-risk dividend investment.

CONCLUSION

After reviewing BAX, I conclude that it would make a sound dividend investment. The yield is reasonable (~2.68%), the estimated future dividend growth rate is very reasonable (~10%) and the payout ratios are relatively high but manageable (around 50%).

However, as you all probably know by now, BAX has recently announced that it would split the company into two distinct companies. This is what got me interested in BAX.

Though the eventual split will certainly bring uncertainty about the future of BAX’s dividend, I think this uncertainty is more than compensated by the growth opportunities that the two distinct companies will probably have.

So, if you are looking only for a dividend stock, BAX would be a sound investment but there are better options.

However, if you are looking for a dividend stock with a possibility to spice up your portfolio, I think you should take a closer look at BAX.

Final recommendation: I think you could buy BAX at the current price.

Disclosure: I currently own shares of BAX. I don’t intend to add to my position in BAX within the next 72 hours.

Source: Baxter International Inc. - Dividend Fact Sheet