A Value Play in Healthcare

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

According to various sources, around 78.3 million babies were born in the US, between 1946 and 1964 i.e. post World War 2. People of this generation are often referred as baby boomers, the era is remembered as the baby boom. Today, those babies have grown up and are aged between 49 and 67 years. It’s a well-known fact that the elderly have greater health concerns, and those baby boomers (if not all) would be requiring healthcare services.  This presents a bullish case for healthcare companies like Baxter International (NYSE: BAX).

The Company

Baxter has been a decently performing investment, but it is beginning to look attractive. The medical instrument manufacturer with a market cap in excess of $36 billion recently declared its quarterly dividend of $0.45 per share. According to Finviz, its trailing yield averages to 2.7% with a modest payout ratio.

The company recently announced that would be acquiring Sweden based dialysis company, Gambro for $4 billion. “Gambro is a global medical technology company that manufactures products for Dialysis treatment. The company is a global leader in developing, manufacturing and supplying products and therapies for Kidney and Liver Dialysis, Myeloma Kidney Therapy, and other extracorporeal therapies for Chronic and Acute patients.” As mentioned on its website, Gambro has 13 production facilities spread in 9 countries, and operates in over 100 countries around the globe.

The table below displays the annual sales and gross margins for their respective periods.

<table> <tbody> <tr> <td> <p>Year</p> </td> <td> <p>Sales</p> </td> <td> <p>Margin</p> </td> </tr> <tr> <td> <p>2010</p> </td> <td> <p>$1.8 billion</p> </td> <td> <p>-NA-</p> </td> </tr> <tr> <td> <p>2011</p> </td> <td> <p>$1.56 billion</p> </td> <td> <p>31.7%</p> </td> </tr> <tr> <td> <p>2012</p> </td> <td> <p>$1.6 billion</p> </td> <td> <p>-NA-</p> </td> </tr> </tbody> </table>

Assuming that its margins and sales remain constant, its returns on investment equate to around 9% with a payback period 8 years. Given the fact that Gambro had over $1 billion in debt with little cash suggests that most part of its earnings were going to interest payments. But with joint operations, Baxter would be able to restructure or repay its debt. Moreover, Baxter alone operates in more than 100 countries and has manufacturing facilities in 27 nations. Hence the medical supplies giant would look to enter non-overlapping markets/countries.

As a part of any acquisition, Baxter too will have to opportunity to “let-go” redundant man power, and unify its offices to cut down on operating expenses. The management of Baxter told that it is aiming for $4.5 billion in annual revenuesby 2017, and the acquisition of dialysis specialist holds the key to its growth.

Peer Talk

Baxter International shares its market space with Becton Dickinson (NYSE: BDX) and CR Bard (NYSE: BCR)

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Forward P/E</p> </td> <td> <p>Net Profit Margin</p> </td> <td> <p>EPS growth 5 yr.</p> </td> <td> <p>Forward PEG</p> </td> <td> <p>Operating Cash Flows</p> </td> </tr> <tr> <td> <p>Baxter</p> </td> <td> <p>12.84x</p> </td> <td> <p>16.39%</p> </td> <td> <p>8.78%</p> </td> <td> <p>0.75x</p> </td> <td> <p>$945 million</p> </td> </tr> <tr> <td> <p>Becton Dickinson</p> </td> <td> <p>14.09x</p> </td> <td> <p>14.55%</p> </td> <td> <p>7.84%</p> </td> <td> <p>0.28x</p> </td> <td> <p>$234 million</p> </td> </tr> <tr> <td> <p>C.R Bard</p> </td> <td> <p>12.9x</p> </td> <td> <p>17.92x</p> </td> <td> <p>8.67%</p> </td> <td> <p>0.65x</p> </td> <td> <p>$225 million</p> </td> </tr> </tbody> </table>

(Source : Finviz, Ycharts)

Financial metrics don’t reveal much. All three mentioned competitors appear to be undervalued with similar margins and EPS growth estimates.

<img src="http://media.ycharts.com/charts/71fa0535e0633cb46fb14410456eb9f3.png" />

BAX Liabilities data by YCharts

The chart attached above somewhat gauges the health of Baxter International. Although its liabilities and expenses have increased quite a lot, its cash flow from operations has shown a radical growth to outclass any financial crunch. Moreover its margins are also trending upwards, and I don’t think there’s anything worrisome about the company.

<img src="http://media.ycharts.com/charts/17697401d276a39e3c258a19a7d95427.png" />

BAX Cash from Operations Quarterly data by YCharts

From the chart above, its not hard to conclude that the operating cash flow of Baxter International grew faster than its peers. But what's important here is that its cash flow is already 3x to 4x larger than its peers, and even then it outperformed its smaller peers.


Both Gambro and Baxter are operating in the developing world, and their managements are well aware of their growth prospects. Although Becton Dickinson and C.R Bard have nothing against them, I think Baxter offers more value due to its Gambro acquisition. The company is already present in India and China, which are together resided by over 2.55 billion people. I believe that the organic growth in these countries alone could take the company higher. I think Baxter is worth a buy rating.

PiyushArora has no position in any stocks mentioned. The Motley Fool recommends Becton Dickinson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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