Baxter: Some Real 'Buy' Appeal

Summary

• I've been on a crusade for the past 2 weeks to highlight investable dividend-paying quality business as we're experiencing a market drop.
• My work takes me now to revisit the company Baxter International, a quality business in the medical supply field. I wrote about the company several months ago.
• The company has dropped significantly since my last piece. I'm putting Baxter on the "buy more" list.
• Looking for more investing ideas like this one? Get them exclusively at iREIT on Alpha. Learn More »

Simon Roughneen/iStock Editorial via Getty Images

Baxter international (NYSE:BAX) is a premium-valued healthcare equipment company that's been recovering from a valuation decline starting in 2015, following an EPS drop of almost 50% YoY. Since that time, Baxter has seen annual EPS growth rates on average of 16.3%, even with a 2020, pandemic-induced EPS headwind of 7%. It's back to growth now, and performing very well.

Despite these solid numbers, the company has been trading down for several months at this point. The recent stock decline brought the price down from 23.5X P/E to a current average weighted P/E of around 18.5X.

In this article, we're going to explore if this is a justified development, or if the company is somehow being underestimated.

Baxter International - Revisiting Recent Results

1Q22 is the latest set of earnings we have, and we've seen a full Hillrom integration into the company (see my previous articles on BAX for some details as to this exactly).

The company's recent 1Q22 sales numbers in no way reflect or justify a lowered share price development. Sales were up double digit, and operations were up as well, with improved adjusted margins on a gross and OM side, as well as a significant improvement in adjusted EPS.

Baxter International 1Q22 (Baxter IR)

The company saw improvements due to, among other things, improving rates of non-COVID hospital admissions, elective surgeries and a contribution increase from the Hillrom M&A. BAX also initiated several new partnerships, key among them Digital Diagnostics for the ability to offer AI diagnostic services in combination with one of the oft-used imaging systems used by the company.

This company doesn't pay the best dividend, at less than 2%, but it's certainly a stable dividend that's worth counting on.

The company actually beat its stated 1Q22 guidance on every single metric, with drivers based on pandemic recovery trends in Renal Care, Medication Delivery growth, Clinical Nutrition, Advanced Surgery growth (due to increased volumes of elective surgeries), and above all, Biopharma Solutions seeing a 21% YoY growth. Now this latter part continues from the contract manufacturing of COVID-19 vaccines, which is of course a non-recurring item in the long term, but it's still a strong contribution. Hillrom alone contributed $755M for the quarter, which is almost as much as the company's biggest segment, Renal Care.

The company continues to be a business with a strong international profile and an actual international, non-US weighting in its sales.

Baxter 1Q22 Sales (Baxter IR)

And on the fundamental side, everything continues according to plan. The company continues its dividend, guides for moderate share repurchases in the near term to focus on effective de-levering, reinvesting into the business, and strong OCF. The company has provided guidance for 2022E, currently guiding for a 3% full-year operational sales growth and a double-digit increase In adjusted EPS.

Baxter 2022 Guidance (Baxter IR)

Risks? Yeah, some exist. The continued logistical challenges during the crisis have an impact on the company, especially from an international perspective. The company is also in a complex pricing action balance with its customers to try and retain its margins while shrugging off the inflationary impacts as well as other problems it's currently facing. The company has confirmed they're taking pricing and shipping actions, but with no specifics as to size or geography. There's a lot happening both at the top and the bottom of the company, at the same time that the company is still integrating its new Hillrom M&A.

The company had this to say with regards to the supply chain impacts and issues.

We are faced with 1 of the most complicated supply chain environments, I have personally seen the war in Ukraine, coupled with an already fraught supply chain creates very significant short-term factors impacting our performance. Do I think we'll be talking about supply chain in 2 years? I certainly hope not, nor do I expect that, that will be the case. But at least for the next 9 months as we see it, there will be continued pressure on the supply chain. And if you think about our mission, that's our primary focus, but it's more costly to do that in the short term.

(Source: Jay Saccaro, Baxter 1Q22 Earnings Call)

The company believes in long-term price increases for oil, but the company is confirming that it's trying to manage some very choppy waters in terms of impacts. The company is, for instance, seeing about $500M in incremental costs over a period of several years, including impacts from labor costs, material costs, freight costs and other factors that are driving this significant uptick in overall cost inflation.

There are some significant tailwinds as well, including recoveries in hospital admission rates, surgical procedure recoveries and other business areas related to this, outside of Asia which is still in COVID-19 lockdowns.

However, this doesn't affect the company's appeal for me. And following the recent drop-down in earnings, the company is more than just "somewhat" appealing.

We're looking at an upside so significant that it warrants serious consideration and mentioning.

Let me show you what I mean.

Baxter's Valuation

Baxter's recent decline pushed the company down to less than 18.7X P/E, and far less than the company's average of 24.4X on a 5-year basis. What's more interesting, the trend goes straight against the grain of the company's 3-year forecasts, expecting a 14% average EPS growth until 2024E.

Baxter Valuation history (F.A.S.T graphs)

As you can see, the decline in share price represents a historical buying opportunity. At any time if you had bought at 18X P/E, you'd have ended up with significant, double-digit returns to the company's more "standard" valuation.

It also means that the upside at what we see today, has gone from conservative single digits, to potential 15-30% without even assuming that much of a premium.

Baxter International Upside (F.A.S.T graphs)

The upside for Baxter based on a 24.4X forward P/E is almost 27.5% annually until 2024. The company also often trades somewhat above this, verifying that 30% annual upside, at least potentially, is realistic.

Baxter continues to be a very conservative sort of business with an investment-grade credit rating. The company is somewhat higher leveraged given its recent Hillrom M&A and now comes in at a long-term debt/cap of around 64.5%. It also bears mentioning that Baxter has a horrendous track record of analyst accuracy for its forecast. However, the reason I don't consider this very worrying is because this tradition is primarily based in the years 2009-2015. Since that time, the company has beaten estimates 23% of the time, and I consider it established that the company as a "safer" EPS forecast accuracy than before.

S&P Global agrees with my assessment regarding the valuation for the company. With 15 analysts calling for a range of between $77 and $105 and an average of $92.5/share, it's quite clear that at the current share price, Baxter is significantly undervalued to any conservative valuation. S&P Global calls for a 31% undervaluation here at today's price.

Current S&P Global forecasts call for continued EBITDA growth at around double digits, slowing down from 2023-2024 and forward. Forecasts also call for continued dividend growth at around 14.3% CAGR until 2024E.

It's my stance that the company's undervaluation at this point is significant enough to warrant real consideration. You could buy the common share. Given the company's lackluster dividend, you may want to consider options alternatives. These certainly exist - though at this time, I wasn't able to find one with a more than 8-9% annualized RoR based on the current available contracts.

Based on this, I would say keep an eye on the options, but I don't see any immediate opportunities. My choice is to keep investing in the common, which shows an upside of 30% annually here based on the company's average premium.

Given that I view this as valid, this is where I end up - with a "BUY" and a price target of $95/share.

Thesis

My thesis for Baxter is as follows:

• The company is a solid healthcare company with interesting segments that both suffer and gain tailwinds from the current situation. I continue to estimate the net effect of a pandemic unwinding to be about 1:1 for Baxter, which means that overall longer-term growth potential is intact.
• At current valuations of below 23X P/E, I consider the company a buy to a forward 22-25X P/E range.
• BAX is a "BUY" here. A price target that I would consider attractive for investment based on my goals would be around $95/share - though every investor of course needs to look at their own targets, goals, and strategies. I would also always consult with a finance professional before making investment decisions such as this.

This company also fulfills every last one of my investment criteria.

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has realistic upside based on earnings growth or multiple expansion/reversion.

Based on such trends, current earnings, and forecasted EPS growth in 2022, I consider BAX a "BUY" with an upside of at least 25-30% this year, potentially more in a 3-year period.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BAX either through stock ownership, options, or other derivatives. 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.

While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment, and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. The author's intent is never to give personalized financial advice, and publications are to be viewed as research and company interest pieces. The author owns the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in the articles. The author owns the Canadian tickers of all Canadian stocks written about.

Comments

[Pendyke]

Does the writer still think Baxter has appeal? What has this CEO done this year? Baxter is down 32% since the first of Jan. 2022. Time for a CEO change. I'm concerned that this leader is a good talker but is clueless.

[freebird588]

BAX has changed a lot. How has your current BAX goal changed?

[terziev]

I respect the authors ability to publish several articles per day. However, I definitely miss Wolf's monthly portfolio update series or at least a quarterly update.

I am unable to follow through all the companies that Wolf writes about but lately I vehemently disagree with most of his "buy" ratings. I consider BAX to be 20% overvalued with no margin of safety at 72,05.

[Pendyke]

I did not see a projected year on when your $95 would hit. I am hopeful that you are correct but I don't see $95 for some time. Is it time for a new CEO?