Becton, Dickinson And Company: Expect More Cash To Head To Shareholders
Summary
- Becton, Dickinson and Company is a Dividend Champion with 49 consecutive years of dividend. Shares currently yield 1.35%.
- BDX has high recurring revenue that needs little additional capital investment to grow.
- BDX should begin returning a larger percentage of excess cash flow to shareholders.
- BDX is primed to ride the continued growth of the global healthcare space and could deliver 10%+ returns over time.
Becton, Dickinson and Company (NYSE:BDX) is a leader in the healthcare and medtech space. BDX is number one across a broad range of healthcare subcategories.
The substantial acquisitions over the last few years levered up BDX's balance sheet which has hampered dividend growth over that time. However, the de-levering process is nearing completion which frees up cash flow for more productive uses such as further R&D and innovation as well as faster dividend growth and a return of share repurchases.
Dividend History
The dividend growth strategy is the one that most appealed to me when I began my investment journey. The idea behind the strategy is to (1) find quality businesses that (2) pay and grow their dividend payments over time.
Image by author; data source Becton, Dickinson & Company Investor Relations
According to the CCC list, BDX is a Dividend Champion with 49 consecutive years of dividend growth. That's an impressive streak that dates back to 1973 and has lasted throughout all sorts of business, economic and geopolitical calamities.
During their 49 year streak, BDX has shown year over year dividend growth ranging from 2.2% to 40.0% with an average of 11.2% and a median of 10.6%.
Over that time there's been 44 rolling 5-year periods with annualized dividend growth coming in between 5.4% and 21.4% with an average of 11.3% and a median of 10.5%.
There's also been 40 rolling 10-year periods since the start of BDX's streak with annualized dividend growth ranging from 7.7% to 16.7% with an average of 11.5% and a median of 10.8%.
The 1-, 3-, 5- and 10-year period annualized dividend growth rates from BDX since 1962 can be found in the following table.
| Year | Annual Dividend | 1 Year | 3 Year | 5 Year | 10 Year |
| 1962 | $0.0035 | ||||
| 1963 | $0.0047 | 33.33% | |||
| 1964 | $0.0068 | 44.44% | |||
| 1965 | $0.0083 | 23.08% | 33.33% | ||
| 1966 | $0.0094 | 12.50% | 25.99% | ||
| 1967 | $0.0125 | 33.33% | 22.67% | 28.88% | |
| 1968 | $0.0156 | 25.00% | 23.31% | 27.23% | |
| 1969 | $0.0172 | 10.00% | 22.39% | 20.48% | |
| 1970 | $0.0188 | 9.09% | 14.47% | 17.61% | |
| 1971 | $0.0188 | 0.00% | 6.27% | 14.87% | |
| 1972 | $0.0195 | 4.17% | 4.35% | 9.34% | 18.71% |
| 1973 | $0.0219 | 12.00% | 5.27% | 6.96% | 16.65% |
| 1974 | $0.0250 | 14.29% | 10.06% | 7.78% | 13.95% |
| 1975 | $0.0266 | 6.25% | 10.79% | 7.21% | 12.29% |
| 1976 | $0.0328 | 23.53% | 14.47% | 11.84% | 13.35% |
| 1977 | $0.0394 | 20.00% | 16.35% | 15.05% | 12.16% |
| 1978 | $0.0469 | 19.05% | 20.84% | 16.47% | 11.61% |
| 1979 | $0.0538 | 14.67% | 17.88% | 16.54% | 12.08% |
| 1980 | $0.0588 | 9.30% | 14.27% | 17.21% | 12.10% |
| 1981 | $0.0641 | 9.04% | 10.97% | 14.32% | 13.07% |
| 1982 | $0.0695 | 8.54% | 8.96% | 12.04% | 13.54% |
| 1983 | $0.0719 | 3.37% | 6.95% | 8.92% | 12.63% |
| 1984 | $0.0734 | 2.17% | 4.66% | 6.44% | 11.38% |
| 1985 | $0.0769 | 4.68% | 3.40% | 5.53% | 11.21% |
| 1986 | $0.0850 | 10.57% | 5.75% | 5.82% | 9.99% |
| 1987 | $0.0963 | 13.24% | 9.44% | 6.72% | 9.35% |
| 1988 | $0.1119 | 16.23% | 13.32% | 9.25% | 9.09% |
| 1989 | $0.1275 | 13.97% | 14.47% | 11.67% | 9.02% |
| 1990 | $0.1375 | 7.84% | 12.62% | 12.33% | 8.88% |
| 1991 | $0.1463 | 6.36% | 9.34% | 11.46% | 8.60% |
| 1992 | $0.1538 | 5.13% | 6.44% | 9.82% | 8.26% |
| 1993 | $0.1700 | 10.57% | 7.33% | 8.73% | 8.99% |
| 1994 | $0.1900 | 11.76% | 9.12% | 8.31% | 9.97% |
| 1995 | $0.2113 | 11.18% | 11.17% | 8.97% | 10.64% |
| 1996 | $0.2375 | 12.43% | 11.79% | 10.18% | 10.82% |
| 1997 | $0.2675 | 12.63% | 12.08% | 11.71% | 10.76% |
| 1998 | $0.3025 | 13.08% | 12.71% | 12.22% | 10.46% |
| 1999 | $0.3475 | 14.88% | 13.53% | 12.83% | 10.55% |
| 2000 | $0.3725 | 7.19% | 11.67% | 12.01% | 10.48% |
| 2001 | $0.3825 | 2.68% | 8.14% | 10.00% | 10.09% |
| 2002 | $0.3925 | 2.61% | 4.14% | 7.97% | 9.83% |
| 2003 | $0.4500 | 14.65% | 6.50% | 8.27% | 10.22% |
| 2004 | $0.6300 | 40.00% | 18.10% | 12.64% | 12.73% |
| 2005 | $0.7550 | 19.84% | 24.37% | 15.18% | 13.58% |
| 2006 | $0.8900 | 17.88% | 25.52% | 18.40% | 14.12% |
| 2007 | $1.0200 | 14.61% | 17.42% | 21.05% | 14.32% |
| 2008 | $1.1850 | 16.18% | 16.21% | 21.37% | 14.63% |
| 2009 | $1.3600 | 14.77% | 15.18% | 16.64% | 14.62% |
| 2010 | $1.5200 | 11.76% | 14.22% | 15.02% | 15.10% |
| 2011 | $1.6800 | 10.53% | 12.34% | 13.55% | 15.95% |
| 2012 | $1.8450 | 9.82% | 10.70% | 12.58% | 16.74% |
| 2013 | $2.0300 | 10.03% | 10.12% | 11.37% | 16.26% |
| 2014 | $2.2350 | 10.10% | 9.98% | 10.45% | 13.50% |
| 2015 | $2.4600 | 10.07% | 10.06% | 10.11% | 12.54% |
| 2016 | $2.7100 | 10.16% | 10.11% | 10.04% | 11.78% |
| 2017 | $2.9400 | 8.49% | 9.57% | 9.77% | 11.17% |
| 2018 | $3.0200 | 2.72% | 7.08% | 8.27% | 9.81% |
| 2019 | $3.1000 | 2.65% | 4.58% | 6.76% | 8.59% |
| 2020 | $3.2000 | 3.23% | 2.86% | 5.40% | 7.73% |
Table by author; data source Becton, Dickinson & Company Investor Relations
The payout ratio is a way to quickly gauge the safety of a dividend. It can be used to see how much of the net income or free cash flow that management has committed to pay the dividend. All else being equal the lower the payout ratio the better.
Image by author; data source Becton, Dickinson & Company SEC filings
On a net income basis the payout ratio is clearly not looking that good. However, given the size of acquisitions there's a lot of noise in those numbers. BDX's 10-year average net income payout ratio is 81% with the 5-year average at 123%.
On a free cash flow basis the dividend looks significantly safer. The 10-year average free cash flow payout ratio for BDX is 38.2% with the 5-year average coming in at 38.8%.
Quantitative Quality
With a dividend oriented strategy the primary objective is to find quality businesses with the duration and strength to give you decades of inflation beating dividend growth. The future is always murky and so I like to use the rear view mirror across a variety of metrics to see how the business got to where it is today.
Image by author; data source Becton, Dickinson & Company SEC filings
Through both organic and acquisition growth BDX has grown revenues 119% in total across the last decade or ~9.1% annualized. Gross profits grew just 85% over that time or ~7.1% annualized.
Operating income has been an extreme outlier rising just 2% over the last decade or ~0.2% annualized. Using the TTM data vs FY 2011 data has the total growth at a still disappointing, but more palatable 42%.
Meanwhile operating cash flow grew more in line with revenues rising 106% in total or ~8.4% annualized across the last 10 years. Free cash flow has seen tremendous growth rising 146% or ~10.5% annualized.
Image by author; data source Becton, Dickinson & Company SEC filings
BDX's gross margins have been trending down over the last decade from 52.3% in FY 2011 to 44.3% for FY 2020. BDX has averaged 49.0% gross margins over the last decade with a 47.0% average over the last 5 years.
Free cash flow margins have been a bit choppier than gross margins, but they've trended higher over the last decade. The 10-year average free cash flow margin for BDX is 13.7% with a 5-year average of 14.4%. BDX is well above the 10% free cash flow margin that I like to see as a sign of a strong cash generating business.
Image by author; data source Becton, Dickinson & Company SEC filings
My preferred profitability metric is the free cash flow return on invested capital, FCF ROIC. The FCF ROIC represents the annual return of free cash flow compared to the total capital currently invested in the business.
Despite free cash flow margins that have shown improvement over the last decade, that hasn't translated into an improving FCF ROIC namely due to the amount of debt BDX took on to complete their various acquisitions.
BDX's FCF ROIC was solidly above 10% for FY 2011 and FY 2012 but has struggled since. The 10-year average FCF ROIC for BDX is 8.9% with the 5-year average dropping to just 6.5%.
As management continues to pay down debt and the business continues to grow, the FCF ROICs should start to head higher as we've seen over the last 2 years.
To understand how BDX has used its free cash flow, I calculate three variations of the metrics, defined below:
- Free Cash Flow, FCF: Operating cash flow less capital expenditures
- Free Cash Flow after Dividend, FCFaD: FCF less total cash dividend payments
- Free Cash Flow after Dividend and Buyback, FCFaDB: FCFaD less cash spent on share repurchases
An ideal investment candidate would show high levels of FCFaD signifying plenty of room for future dividend growth and ample excess cash flow to be used for paying down debt, repurchasing shares or improving the balance sheet with cash for future opportunities.
Image by author; data source Becton, Dickinson & Company SEC filings
As we saw earlier, BDX's FCF has shown excellent growth over the last decade. Cumulatively, BDX has generated $16.2 B in FCF over the last decade. Management has used $6.2 B of that FCF to pay dividends to shareholders putting the 10-year cumulative FCFaD at $10.0 B.
From FY 2011 through FY 2014 buybacks had been quite significant, but have been muted since. Over the last decade, BDX has spent $4.1 B on share repurchases putting the cumulative FCFaDB at $5.9 B.
Image by author; data source Becton, Dickinson & Company SEC filings
BDX's share count has risen 24.8% over the last decade thanks in large part to the sizable acquisitions. From FY 2011 through FY 2014, the share count had declined 12.6% which is quite impressive, but makes the dilution since then even more disheartening.
That being said management saw an opportunity to improve their business with the acquisitions and the raw financials have shown solid improvement over the last decade even if the per share numbers have lagged.
As an investor in the equity of a business, I want to make sure that the balance sheet is in good health. I generally want to see a stable debt-to-capitalization ratio over time and significant changes warrant further investigation.
Image by author; data source Becton, Dickinson & Company SEC filings
The 10-year average debt-to-capitalization ratio for BDX is 50% with the 5-year average at 52%. Despite the sizable increase in total debt, which has risen from $2.8 B in FY 2011 to $17.9 B in FY 2020, the overall capital structure hasn't materially changed.
When analyzing the balance sheet of a prospective investment, I focus more on the debt in relation to a variety of income metrics. This allows me to see how quickly the balance sheet could be de-levered should the debt markets demand higher rates on new debt issuances.
Image by author; data source Becton, Dickinson & Company SEC filings
The debt ratios that I look at are net debt versus EBITDA, Operating Income and FCF. Prior to BDX's large acquisitions their debt ratios were very manageable and each coming in below 2.0x. As the debt heavy acquisitions have been completed, the debt ratios have seen significant increases. At the end of FY 2020, BDX's ratios were 4.1x, 8.4x and 5.5x, respectively.
Valuation
To value potential investments I like to use several methods in order to come up with range of valuations for the business. The methods I use are the minimum acceptable rate of return, "MARR", analysis, dividend yield theory and a reverse discounted cash flow analysis.
A MARR analysis requires you to estimate the future earnings and dividends that a business will generate, apply a reasonable multiple on those future earnings and then calculate the expected return from an investment in that asset. If the expected return is higher than your hurdle rate, you can feel free to invest.
On average, analysts expect BDX to report FY 2021 EPS of $12.84 and FY 2022 EPS of $13.42. The analysts also expect BDX to be able to show 12.0% annual EPS growth across the next 5 years. I then assumed that BDX would be able to generate 5.0% annual EPS growth for the next 5 years. Dividends are assumed to target a 25% payout ratio.
In order to determine a reasonable expected multiple range I like to see how BDX has historically been valued by market participants. It's difficult to get a good idea of the historic multiple that BDX has traded for as the acquisitions have muddied the waters over the last few years. Prior to early 2015 BDX appears to have traded between ~15x to ~20x on a TTM basis.
Data by YCharts
The following table shows the potential internal rates of return that an investment in BDX could generate provided the assumptions laid out above are reasonably close to how the future plays out. Returns are calculated assuming a purchase price of $246.10, Monday's closing price, and that dividends are taken in cash.
| IRR | ||
| P/E Level | 5 Year | 10 Year |
| 25 | 17.1% | 11.4% |
| 20 | 12.0% | 9.0% |
| 17.5 | 9.0% | 7.6% |
| 15 | 5.7% | 6.1% |
| 12.5 | 1.9% | 4.3% |
| 10 | -2.5% | 2.6% |
Alternatively, I reverse that process in order to determine what price I could pay today in order to generate the returns that I desire from my investments. My typical hurdle rate is 10% and I'll also examine 8% and 12% return targets.
| Purchase Price Targets | ||||||
| 10% Return Target | 12% Return Target | 8% Return Target | ||||
| P/E Level | 5 Year | 10 Year | 5 Year | 10 Year | 5 Year | 10 Year |
| 25 | $339 | $294 | $313 | $250 | $368 | $347 |
| 20 | $274 | $241 | $253 | $205 | $297 | $284 |
| 17.5 | $242 | $215 | $223 | $183 | $262 | $253 |
| 15 | $209 | $188 | $193 | $161 | $227 | $221 |
| 12.5 | $177 | $162 | $164 | $139 | $192 | $190 |
| 10 | $145 | $135 | $134 | $116 | $157 | $158 |
Dividend yield theory is another valuation method that is best used for large, stable businesses. The valuation model is built on the premise that dividend paying enterprises will be valued at a "normal" dividend yield level by market participants. The 5-year average dividend yield will be used as the proxy for the fair value of BDX.
Image by author; data source Becton, Dickinson & Company Investor Relations and Yahoo Finance
BDX shares currently offer a 1.35% dividend yield compared to the 5-year average dividend yield of 1.38%.
A reverse discounted cash flow analysis can be used to decipher what the current valuation of a business implies about the future cash flows that are expected. I use a simplified DCF model built on a static EBIT margin of 16.2%, a tax rate of 20%, and revenue growth. The WACC is derived using the dividend capitalization method for the cost of equity with an estimated dividend growth rate of 7% which yields a WACC of 7.1%.
Under those assumptions, BDX needs revenue growth of 5.0% across the forecast period to justify the current share price. Using the same assumptions as above but with the EBIT margin expanding by 10% over the forecast period gives required revenue growth of 4.5% to justify the current valuation in the market.
Conclusion
BDX is a good company in the healthcare sector that I'm glad to call myself an owner of. Growth has been strong over the last decade fueled in large part by acquisitions. The capital structure remains largely intact with levels prior to the acquisitions; however, the total level of debt has increased sharply as well as the share count.
BDX generates strong FCF margins 14-15% range and the amount of OCF converted to FCF has been rising over the last decade and was up to 77% for FY 2020. The large acquisitions have severely hampered FCF ROICs, taking them down to just 6.5% for FY 2020, although as management continues to grow the business and de-lever, the ROICs should improve.
BDX has ample FCFaD that can be used to improve the balance sheet and return to a faster pace of dividend growth. Over the last 3 years, BDX has generated an average of $1.38 B in FCFaD which could put a serious dent in reducing the debt.
Dividend yield theory suggests a fair value range for BDX between $218 and $267. The MARR analysis based on 10% IRRs suggests a 5-year fair value range of $209 to $274 assuming a terminal P/E ratio between 15x and 20x. With a 10-year horizon, the 10% IRR fair value range drops to $188 to $241. The reverse DCF doesn't throw up any red flags regarding the future returns.
BDX's leverage is back in better shape, although still higher than I'd like to see. However, now that it's within management's target range that frees up plenty of cash flow for more interesting uses including more R&D, growing dividends at a faster pace, further bolt on M&A and a possible return of share buybacks.
Couple the freeing up of cash flow with continued growth of the business and BDX appears attractive at current levels. I expect ROICs to improve going forward as long as management avoids the temptation of another large acquisition. Excess free cash flow will increasingly be funneled back to shareholders via rising dividends and share buybacks. My expectation is that BDX should be able to deliver double digit annual returns looking out 5 years assuming a reasonable future market environment.
This article was written by
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. Please consult an investment advisor and do your own due diligence prior to investing. Investing involves risks. All thoughts/ideas presented in this article are the opinions of the author and should not be taken as investment advice.
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Comments (10)
I use the rear view mirror to try and get a sense of (1) how the business has done historically, (2) where is it at now, and (3) get an idea of a possible base rate scenario. It helps me to get comfortable with the qualitative aspect of the business and also to see if current expectations deviate widely from the historic norm. That doesn't mean they can't be hit, but if a business has reliably grown revenues or cash flows at 5% annually but current expectations are for 15% annually it's a sign that the reasons for those expectations need to be scrutinized more closely.I share your sentiment about not knowing how to reliably outperform the market. I just try to look for situations where I believe I'm getting a reasonable return on my investment capital and I'm comfortable with my perception of the quality of the business. I think that's all we can really aim for.