Baxter Appears Very Reasonably Valued

Nov.11.10 | About: Baxter International (BAX)

Click to enlarge There are many places that I find ideas. Occasionally we have friends that sometimes seem to be wise and actually deserve more credit than we attribute to them in selecting stocks for investments and in general making wise observations about the world.

My good friend Dennis C. is a neonatal specialist whom I run into during the course of my own work. I have learned that when Dennis talks, I reall ought to listen (with my apologies to E. F. Hutton!). I promised Dennis that I would certainly take a look at Baxter (NYSE:BAX) and indeed I liked what I saw and wanted to get around to sharing it with all of you. I do not currently own any shares of Baxter but family members of mine do own some shares at this time. Baxter closed at $51.90 on 11/10/10, up $.23 or .45% on the day.

Years ago I owned shares of Baxter Travenol, the parent company of Baxter. I found a fascinating summary of the history of this company:

In 1931, physicians Donald Baxter of Los Angeles and Ralph Falk of Boise, Idaho, started the Don Baxter Intravenous Products Corp., which made supplies for IV systems in hospitals. In 1933, Baxter started a manufacturing plant in Glenview. A pioneer in blood preservation methods as well as IV supplies, Baxter grew steadily. In 1947, it moved its headquarters to Morton Grove; the company soon employed over 500 people in the Chicago area. Annual sales grew from about $10 million in the mid-1950s to more than $100 million by 1967, when the company was making dialysis equipment, heart-lung machines, and many other equipment items for hospitals. In 1975, when it employed about 2,200 in the Chicago area, the company moved its headquarters to suburban Glenview; the following year, its name changed to Baxter Travenol Laboratories. The company grew rapidly thereafter. In 1985, when annual sales stood at about $2 billion, Baxter bought the American Hospital Supply Corp., an even larger Chicago-area medical supply company. The new company, which in 1988 became Baxter International Inc., was an enormous entity that soon approached $10 billion in annual sales; about 10,000 of its 50,000 employees worldwide were in the Chicago area. During the 1990s, however, Baxter sold off several divisions, including many of the old American Hospital Supply Corp. operations.

But what about Baxter International today?

The company still makes intravenous equipment but now has become a major plasma product company as well as dialysis product supplier. According to the Yahoo "Profile" on BAX, the company,

..through its subsidiaries, develops, manufactures, and markets products for people with hemophilia, immune disorders, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. It operates in three segments: BioScience, Medication Delivery, and Renal.

On October 21, 2010, Baxter reported 3rd quarter results. In the third quarter the company had net earnings of $594 million or $1.01/share, up from $532 million or $.87/share in the same quarter the prior year. Analysts had been expecting $.97/share according to Thomson Reuters, thus the company exceeded expectations on earnings during the quarter [see call transcript].

Sales for the quarter rose 3% to $3.2 billion. The company also went ahead and raised guidance with sales growth in 2010 at 2-3% from prior guidance of 1-3%, and earnings of $3.96 to $3.98/share ahead of the prior quarter's guidance for 2010 of $3.93 to $3.98/share.

Shortly after this earnings report, The Motley Fool released a nice review of Baxter asking the quaestion, "Is Baxter International the Perfect Stock?". They didn't actually think that Baxter was perfect, but "it's a decent play for conservative investors," according to The Fool.

Just Tuesday (November 9, 2010), Baxter announced that it would be raising its quarterly dividend from $.29/share to $.31/share.

Longer-term, looking at the Morningstar "5-Yr Financials", we can see that revenue has increased steadily from $9.8 billion in 2005 to $12.8 billion in the trailing twelve months (TTM). Earnings, however, while increasing from $1.52/share in 2005, peaked at $3.59/share in 2009, but dipped to $2.61/share in the TTM. Average shares increased from 629 million in 2005 to 656 million in 2006 but since then has decreased with share buy-backs from that level to 654 million in 2007 and to 601 million in the TTM.

The company, according to Morningstar, has total current assets of $8.27 billion and total current liabilities of $4.46 billion, yielding a current ratio of 1.85. I appreciate seeing this ratio above 1.5 in terms of expressing the company's ability to pay off liabilities in the immediate future.

Free cash flow, as reported by Morningstar, has increased steadily from $1.1 billion in 2005 to $2.9 billion in 2009 and $3.05 billion in the TTM.

In terms of valuation, we can review the "Key Statistics" on BAX from Yahoo where we find that this is a large cap stock with a market capitalization of $30.33 Billion. The trailing p/e is reported at 19.02 with a forward p/e (fye Dec 31, 2011) of 12.24. The PEG Ratio (5 yr. expected) works out to an acceptable 1.40.

Yahoo reports 584.37 million shares outstanding with 583.23 million of those shares that float. Currently, as of 10/15/10, there were 8.11 million shares out short representing a short interest ratio of 1.9 trading days, well under my own 3 day level of significance. The company pays a forward annual dividend rate of $1.24 with a forward yield of 2.39%. The company has a payout ratio of 44% suggesting adequate room to pay and increase its dividend in the future. The last stock split was a 2:1 stock split back in May, 2001.

If we review the 'point & figure' chart on Baxter International, we see that the stock has actually been trading sideways for the past 3 years in the $40 to $67 range. The company recently broke through support and is moving up towards a resistance level of $55. Technically, from my amateur perspective, I would like to see this stock break through this resistance level and create a new support line to confirm its move to the upside. Certainly the stock chart does not appear over-extended.

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To summarize, Baxter International has reported strong earnings that beat expectations and the company recently raised guidance as well as announced an increased dividend payment. Valuation appears reasonable and the company has been buying back shares while producing increasing free cash flow and growing revenue. Earnings the past five years have not been as consistent but appear to be back on track.

With our aging population dealing with an ever-increasing number of diabetic patients, we may well need to prepare for a growing kidney disease problem which can result in dialysis. Combined with increasing access to medical care with likely continuing healthcare reform worldwide may mean more business for Baxter with basic medical products like I.V. devices to more complex products such as plasma products and dialysis supplies.

The stock appears to be very reasonably valued and if anything we are early in the price appreciation of this company which has moved little since late 2007.

Disclosure: I do not currently own any shares of Baxter but family members of mine do own some shares at this time.