Despite its Risks, Baxter Still Undervalued
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While the 2.3% excise tax on medical devices imposed by the Affordable Care Act has been under-emphasized, the fundamentals of the affected companies have been neglected even more. As to how much this tax has already been factored into the stock market is up for debate; in my view, however, any downside left is more than offset by strong fundamentals.
Baxter (NYSE: BAX), for example, offers a variety of technologies that target different markets. The July quarter was particularly strong as plasma growth accelerated alongside higher margins. While capacity constraints and risks from Biogen may limit upside, the firm is progressing. Market demand and capacity improved in the recent quarter - management recently said that the business is now doing better than its long-term expectation of 6-8% growth. Although the deal with Sanquin does not mitigate capacity constraints, it offers meaningful flexibility.
Investors also have the Advate hemophilia pipeline to get excited about. This catalyst has seen sound patient switches under an assumption of market share loss. Octapharma may struggle against competition, which has kept prices low, but Phase III 18 month IVIG data on Alzheimer's for the first half of 2013 should keep multiples elevated. Greater visibility over capacity, in addition to HyQ data, will be provided early next month. I believe that visibility in HyQ will remain limited but that strong plasma growth and re-acceleration in Renal will keep the upside story intact.
Covidien & Abbott
Relative to peer Covidien (NYSE: COV), Baxter is valued at a discount. It trades at around 12.1x forward earnings versus 13x for Covidien. On the other hand, the latter is forecast 10.3% annual EPS growth over the next five years, which is around 170 bps greater than what is forecast for Baxter each year. Assuming Covidien meets expectations, it will generate 2016 EPS of $5.90. This translates to a future stock value of $89.60 at a 16x multiple. Discounting backwards by 10% yields a present value of $55.63 - slightly below the current price. The present value using the same multiples and rates suggests that Baxter has even more to lose.
Several other risks increase downside. This includes the next-generation rFVIII therapies that are being developed by competitors, which may take away Baxter's crowning jewel. Poor performance by Octapharma could also make investors weary. Despite all of these risks, I am optimistic about the company's trajectory. From delivering strong performance to engaging in value-added deals and business, Baxter is positioned more towards reward than risk. The multiples are also low enough that most of the downside will have to come from poor earnings, which have thus far been terrific.
Like Baxter and Covidien, Abbott's (NYSE: ABT) device business, which it decided to split into "AbbVie," has also seen strong growth. One of the main points in doing the split to begin with was to get the business to be valued by its own growth and not that of the pharmaceutical business. However, unlike Baxter and Covidien, the fundamentals of Abbott's device line is less secure. They have failed to establish a meaningful position beyond the drug-coated stent line where other peers have established in-roads. Possible takeover activity may emerge from producers being unwilling to deal with the 2.3% excise tax. If AbbVie proceeds with a growth through acquisitions strategy, it will not be much unlike Teva, which has done the same thing successfully in generics. For now, however, I encourage going with Baxter and Covidien as safer pure device stocks.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Abbott Laboratories. Motley Fool newsletter services recommend Covidien Ltd.. 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.If you have questions about this post or the Fool’s blog network, click here for information.