Baxter Still Defensive, But Is Now The Time For Offense?

May.15.12 | About: Baxter International (BAX)

The best thing about Baxter (NYSE:BAX) is that so much of its business comes from oligopolistic markets with pretty steady demand and reimbursement. The worst thing about Baxter is that so much of its business comes from oligopolistic markets with pretty steady demand and reimbursement.

In theory, Baxter is a good stock to own during slow patches in the med-tech world because the demand for profitable businesses like infusion, recombinants, plasma-derived therapies, and other bioscience products doesn't drop much with the economy, and Baxter reports growth while others contract . On the flip side, the company has historically not looked to target new growth markets, and the company's growth looks pretty pokey when the sector revives.

With a few signs of life here and there in med-tech, as well as oncoming competition in biosciences, it is worth asking whether Baxter is still a name that investors want to hold today.

Decent First Quarter Results

Although Baxter's first quarter was messy and a lot of sell-side analysts seemed to have trouble building their models, it was on balance a decent quarter. Revenue grew 3% on a reported basis and organic revenue was as high as 5% depending upon the adjustments you wish to make.

Growth was also relatively balanced. BioScience revenue rose 5% (constant currency), with U.S. growth slightly stronger on the basis of strong performance in recombinants. Regenerative medicine was up double-digits, though helped by the Synovis acquisition. Medical revenue was up 3%, as weakness in injectables and renal offset growth in infusion and anesthesia.

Profitability was a "no news is good news" sort of situation. Gross margin did drop a bit from last year and a point from the fourth quarter, and operating income did fall a little, but analysts were generally expecting worse.

HyQ Takes A Lot Of Wind Out Of Baxter's Sales

A big part of the buzz on Baxter over the last year or so has been a pipeline that holds more promise than most casual Baxter observers might expect. Unfortunately, a big part of that buzz got silenced when the FDA informed the company that it needs more data on the long-term use of its experimental Gammagard HyQ.

Gammagard HyQ is a combination of Baxter's Gammagard IVIG product and a recombinant human hyaluronidase from Halozyme Therapeutics (NASDAQ:HALO). The appeal here is that instead of getting weekly subcutaneous injection or a monthly infusion, patients can self-administer an injection once a month. With Gammagard representing a significant part of the antibody therapy business, and plenty of competition from CSL and Grifols (NASDAQ:GRFS), this was to be a powerful differentiating product - one that now looks to be delayed to well into 2013 at a minimum.

Like as not, that's going to lead investors to worry even more about the state of the company's recombinants business, as companies like Novo Nordisk (NYSE:NVO) and Biogen Idec (NASDAQ:BIIB) look to enter the rFVIII market in a few years' time.

Not Much Juice In The Device Business

It also won't help Baxter that its medical device business doesn't really enjoy a great reputation in terms of growth. While substituting Sigma Spectrum pumps for recalled Colleague pumps seems to have helped mitigate some of the damage, rival CareFusion (NYSE:CFN) has definitely picked up some share as a result. Overall, Wall Street just doesn't get that excited about the infusion systems (pumps) or IV therapies business at Baxter, CareFusion, or Hospira (NYSE:HSP).

Likewise, few analysts or investors get all that excited about business segments like injectables or renal. Yes, Baxter has benefited from Medicare changes that make peritoneal dialysis more competitive, but it lacks the scale of Fresenius (NYSE:FMS) or the growth buzz of NxStage Medical (NASDAQ:NXTM) (though a lot of the excitement in that latter name has petered out over the last six months).

Still Some Solid Reasons To Own

With the bear case largely laid out, I still think Baxter is a pretty good company. For starters, there are sizable barriers to entry when it comes to plasma-derived therapies; although analysts seemed taken aback by the announcement that a new plasma facility will cost about $1 billion to build, that's the going rate for a soup-to-nuts plant and not lot of companies have that kind of cash just lying around.

It's also worth noting that Gammagard could still be a growth story. Phase 3 data from a study of Gammagard in Alzheimer's should be coming out in 2013, and if the data replicates positive Phase 2 data, this could be an interesting alternative to drugs under development at Lilly (NYSE:LLY) and Johnson & Johnson (NYSE:JNJ) (which would be co-marketed with Pfizer (NYSE:PFE)).

Baxter management has also made it pretty clear that acquisitions are still on the table as a growth plan. While I don't expect management to go in a dramatically new direction here, there are plenty of tuck-in acquisition candidates out there across the BioScience and device businesses.

The Bottom Line

Wall Street is well aware that Baxter reaps profitable revenue from its BioScience business in good times and bad, and it's rare to see the stock trade significantly below fair value unless there's an exogenous event like the Colleague pump recall. Not surprisingly, while the disappointing news on HyQ dropped the stock, it hasn't dropped it so far to make it an obvious buy.

For investors who want a steady, lower-risk dividend growth story, Baxter is certainly worth a look alongside names like Johnson & Johnson. With an expectation of mid single-digit compound free cash flow growth, though, investors looking for more capital gains should probably consider names like Covidien, St. Jude Medical (NYSE:STJ), or Stryker (NYSE:SYK) instead.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.