Is Becton, Dickinson And Company Poised To Continue Double-Digit Returns?

Summary

• Every $1 invested in Becton, Dickinson & Company 30 years ago has compounded at 14.9% annually and turned into $65.08 today.
• The shares are trading at $150.79, giving investors a current yield of 1.59%.
• Medium-term returns from the current price level look to be in the high-single digits, with a high likelihood of double-digit annual returns.
• Demographic trends will continue to spur growth and profitability of the best-run healthcare companies.

The healthcare industry is poised to continue to grow as the population continues to age. The unfortunate side effect of growing older is that your healthcare expenses tend to rise. A study from 2004 that analyzed the medical expenses of a cross-section of users found that almost half of lifetime healthcare expenses are incurred once you reach 65+.

With "Baby Boomers" retiring daily, this will lead to a rather large increase in the number of individuals aged 65 and over each year. There are currently around 45 million Americans over the age of 65, and that number is expected to increase to over 83 million by 2050. The most rapid growth in that segment of the population is expected to occur over the next 10-15 years, with slower, but consistent, gains each year until 2050. Here's how this population is expected to grow, based on a 2014 report from the Census Bureau.

One of my goals for this year was to increase my portfolio's exposure to the healthcare industry. Currently, my portfolio consists of just three healthcare companies that account for 8.7% of my investment capital and 6.4% of my forward 12-month dividends. Ideally, I'd like to get that to between 15-20% of both capital and dividends, so there's a lot of work to do on that front.

The demographic trends alone should continue to make the healthcare sector a very profitable one that grows faster than the economy as a whole. One healthcare company that has traditionally done very well is Becton, Dickinson & Company (NYSE:NYSE:BDX). Every $1 invested in BDX 30 years ago has compounded at 14.9% annually and turned into $65.08 today. Even better is that the company has rewarded investors along the way with 43 consecutive years of growing dividends.

Projected Earnings and Dividend Growth

Before we move forward, let's get some general information out of the way. My reference entry price will be the closing price from November 16, $150.79, with an assumed purchase date of November 17. For fiscal year 2015, Becton, Dickinson & Company paid out $2.40 per share in dividends, while generating $7.16 in adjusted earnings per share. That works out to a payout ratio of 33.5%. The sale date is assumed to be December 31, 2019, with a price calculated as 20x 2019 earnings.

Now let's get going. The following table shows the consensus analyst estimates for earnings per share, as tracked by ValueEngine, between now and fiscal year 2019.

There's only one analyst that has provided an estimate for 2019, so I assumed that would be the high estimate. In order to calculate the low earnings estimate for 2019, I used a 3% growth rate over the estimated 2018 earnings, and likewise used a 5% growth rate to estimate the 2019 mean earnings. These are relatively conservative growth values, so there's a built-in margin of safety.

I've highlighted the mean earnings estimates, since I will use those going forward.

I mentioned above that the payout ratio was 33.5% for fiscal year 2015. Going forward, I'll assume a modest expansion in the payout ratio to 35%, based on the annual earnings estimates from above, as well as a 30% and 40% payout ratio to give a range of potential dividends. The following table shows the projected dividends based on the mean earnings estimates.

The dividends look to grow quite nicely between now and fiscal year 2019. If the payout ratio is elevated slightly to 35% and earnings of $11.08 are reached in fiscal year 2019, the dividend could potentially grow by over 60%, or 12.8% per year.

Dividend growth should continue marching on at a solid rate. In the 35% payout scenario, annual dividend growth would work out to 12.8% per year. Even in the reduced 30% payout scenario, dividend growth would still be solid at 8.5% per year through fiscal year 2019. The current yield of 1.6x% leaves a lot to be desired, and I expect a high dividend growth rate to compensate for the lower starting yield. Becton, Dickinson & Company looks poised to deliver.

What's the expected return?

We now have everything we need to project dividends payments and a potential share price, so let's bring it all together to estimate a future return. As a reminder, the sale price at the end of 2019 is calculated as 20x 2019 earnings of $11.08, or $221.60.

Based on the historical payout schedule of dividend payments at the end of March, June, September, and December, you would receive 17 dividend payments totaling $14.88. That would be a 9.9% return from dividends alone. The change in share price from $150.79 to $221.60 would add another 46.9% to your expected return. The total return works out to 56.8%.

Of course, the time value of money needs to be accounted for, because a 56.8% total return in 4 years compared to 20 years is a completely different story. The internal rate of return for these dividend payments and sale date comes to 15.9% annual returns.

Low Projected Earnings and Dividend Growth

I like to repeat the previous analysis using the low earnings estimates in order to get a base-case scenario moving forward. This gives a semi "stress test" and baseline return expectation.

The low earnings values were shown above, so I'll skip ahead to the projected dividends based on the low earnings estimates.

Assuming a constant payout ratio, it's obvious that the projected dividends would come in lower. However, the growth still looks to be solid, with total growth of 55%, compared to the current rate of $2.40 annually.

Even in the low earnings growth scenario, dividend growth would still come to 11.6% annually by 2019. Things are starting to look pretty good for Becton, Dickinson & Company at the current price.

Do the returns suffer much?

Once again, we have all the necessary information to calculate the return going forward. The sale price is estimated as 20x the low earnings estimate for 2019, $10.62, and comes to $212.39.

You would still receive 17 dividend payments if the normal payout schedule is maintained. However, they would total just $14.47, which is slightly lower than the mean earnings estimates case. From dividends alone, you would generate a 9.6% return. The rest of the total return is made up from share price appreciation, which would see the share price increase by 40.9%. The expected total return comes to 50.4%, which is slightly lower than the mean earnings scenario total return of 56.8%.

Accounting for the time value of money means that you would generate a 14.3% annualized return even in the low earnings and constant 35% payout ratio case. That looks solid to me.

Range of Returns

Forecasting the future is difficult, if not impossible, so I like to look at various scenarios to see how things would play out in order to get a range of returns. I'll use the same step-by-step analysis as before, but won't walk through each scenario.

First up is the assumed P/E valuation for earnings in 2019. A 20x earnings seems reasonable for a company that is very high-quality, in my opinion, and is tied to an industry that should continue to see robust growth with an aging population. Morningstar has the average P/E ratio over the last 5 years at 17.2, so investors, on average, haven't been willing to pay 20x earnings. Maybe the 20x ratio is a bit too aggressive, so I'll see how the returns look if we reduce the P/E ratio to 17.

Second, I wanted to examine how the returns would look, assuming different payout ratios. Maybe management will be more generous and pay dividends at a 40% payout ratio. Or maybe management will want to conserve more capital for potential acquisitions and be conservative with just a 30% payout ratio.

The following table shows the dividend return, share price return, total return, and internal rate of return for each scenario described above.

While the range of returns has a big split between the highest and lowest, different by a factor of 2, pretty much every return scenario is intriguing even from the current price levels. Even in the 30% payout ratio and lower 17x P/E ratio, the returns are expected to come in around 8.4% annually. A potential investment with that kind of "worse-case" scenario sounds pretty good to me.

One thing you'll notice is the rather large disparity between the price return, but tight grouping of dividend returns. This speaks to the power and consistency of dividends, since they always provide a positive portion of return. Over the short to medium term, you are guaranteed to have a gain from the dividends you receive, but there's no telling what the share price will do.

Conclusion

The biggest drawback to Becton, Dickinson & Company is the relatively uninspiring current yield of just 1.59%. For companies with yields below 2.00%, I require an expected dividend growth rate above 10%. Becton, Dickinson & Company has provided investors with annualized dividend growth above 10% for the last 1-, 3-, 5-, and 10-year periods, and based on this analysis, it appears that should continue over the next 4 years as well.

Annual returns look to be excellent over the medium term, with high single-digit returns in a worst-case scenario, and with a high likelihood of double-digit annual returns. That's something I can get behind. I've been looking for opportunities to add to my small position in Becton, Dickinson & Company, and would feel comfortable doing so at the current price levels, subject to capital availability and other opportunities at the time. Management should be announcing an increase in the dividend later this month, and another double-digit increase should be expected.

Analyst’s Disclosure: I am/we are long BDX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am not a financial professional and all thoughts/ideas here are my own and for entertainment purposes only. Investing involves risks. Please consult a financial professional and do your own due diligence before investing. The author is not responsible for losses of any kind by readers. This analysis uses forward looking, although conservative, estimates that may not come to pass. All charts/images and data are sourced from my personal stock analysis spreadsheet, Morningstar, Yahoo!Finance, Becton, Dickinson & Company's Investor Relations page, and ValueEngine.