Saturday, May 23, 2015

Baxter International (BAX) Dividend Stock Analysis


Hello, this is Div4Son.



Baxter International Inc. is an American healthcare company that focuses on products to treat hemophilia, kidney disease, immune disorders and other chronic and acute medical conditions.

Baxter currently has two main businesses: BioScience and Medical Products. Baxter’s BioScience business produces medicines, therapies and vaccine products to treat blood related disorders such as hemophilia and immune deficiencies. Baxter’s Medical Products business produces intravenous and inhaling solutions and other products used in the delivery of fluids and drugs to patients. 

Last year, Baxter announced plans to create two separate, independent global healthcare companies—one focused on developing biopharmaceuticals and the other on medical products. The move is expected to be completed by middle of this year. The medical products company will keep the name Baxter International Inc. and the biopharmaceuticals company will be named Baxalta.

Baxter International Dividend Stock Analysis

In general, my basic DGI strategy is:

Good quality + high yield + high growth (+ time & patience)

This strategy follows the same framework as the SBI book.

I use a simple screen for stocks:
  • Yield over Avg Yield > 1.10
  • Yield > 2.5% (but less than 7%)
  • Payout Ratio < 0.8
  • Chowder > 10
BAX meets my simple screen in all areas. The next step to to apply my due diligence process to analyze the fundamentals based on several criteria on Quality, Dividend Growth/Yield and Valuation.




BAX May 2015AreaCriteriaCheckListComment
Quality Company
Dividend Growth>5 yearsYes7 years
ROE/EPS/Op MarginStableYesSee Chart
Long term Avg GrowthStableYesSee Chart
FCF over DividendsYesYesSee Chart
M* MoatWide MoatYesM* Wide
M* & S&P
Credit Rating
> BBB+YesS&P A-
Cash to Debt & Interest Coverage, Debt to EquityCash Debt >1 or Interest Coverage > 5Yes - but Debt to Equity relatively highCash to Debt 0.25, Interest Coverage 16
Debt to Equity ~90%
M* & S&P Stars> 3 Stars for bothYesM* 4 Stars
S&P CapIQ 4 Stars A Quality
Payout Ratio<60%Yes~57%
Dividend Growth
& Yield
Dividend Yield>3%Yes3.00%
Dividend Growth>5%Yes5Y CAGR 15.1
Chowder>12%Yes18.10%
Valuation
Yield/Avg Yield>1.1Yes1.11
Dividend Yield Theory Mid PointBelow Mid PointYesMid Point 101;
Low Point 63
DRRM~10%YesAssuming 7% growth; projected return=11.8%
M* Estimate<M* estYesM* 79
S&P Estimate< S&P cap IQ estYesS&P Cap IQ 84

Quality analysis

Years of Dividend raises

BAX has 7 years of dividend raises. I generally prefer companies with dividend growth >10 years. However, if the underlying company has good fundamentals, a lower number is acceptable.

Stability of key metrics

These ratios provide an indication of how wide the moat is. I am looking for overall stability (or even better - growth). If the ratios decline year over year, then this is an indication of moat reduction. I also compare these ratios with other companies within the same sectors.  


As you can see, BAX has ROE and Operating Margins are very stable indicating a good moat. Also, compared with the industry, the ROE compares reasonably well.

Average growth 

Here, I look for the stability of growth indicators over ten years using the EPS and Revenue.


BAX EPS and Revenue have grown for the last ten years. (CAGR Revenue ~7%, EPS ~11%).

The 10 years average growth numbers are also in line.

The 3 years average growth numbers look okay too.

 Free cash flow over dividends 

I use the free cash flow per share and compare this with dividends per share. FCF should cover the dividends.  As you can see BAX's FCF YoY are covering the dividends except that it is close in 2014. 




M* Moat

I simply use the moat indicator from M* to validate my findings.  M* indicates that BAX has a wide moat. This is due to BAX owning the right patents and being a leader in the Bioscience and Medical Products areas. 


Credit rating

Here, I look for companies with credit rating of BBB+. Just like banks wanting good credit from you when you apply for a loan, you want companies which are stable from a credit perspective. 

BAX's credit rating from S&P is A-  


Debt

I look at the debt to equity ratio (<50) and cash to debt (<1) and interest coverage (>5).
Sometimes, a little good debt is good for a business. But too much debt can be a burden. 

BAX's Cash to Debt 0.25 with Interest Coverage 16 which means it can easily cover their debt. However, the 
Debt to Equity ratio is close to ~90% - which is relatively high.




As you can see, the debt to equity ratio has been steadily growing for the last five years, meaning BAX is taking in more debt to grow its business.

M* and S&P capital IQ rating

I am looking for 3 stars and above from either. A four star is a bonus.  

M* gives BAX 4 Stars and S&P CapIQ gives 4 Stars with A quality company

I am seeing that if the combined M* & S&P Capital IQ stars is 7 or more, then this usually is a good indication to buy (if the company has good fundamentals). 

BAX combined stars is 8 - which means it is a good indication to buy.

Dividend Yield and growth 

Dividend yield is 3.0% which is at my threshold of 3%.
5Y CAGR 15.1% which is above my threshold of 5%


As you can see below, the YoY dividend growth is quite significant with an average of ~15%. 


BAX's Chowder is 18.1%. 

Payout Ratio

The payout ratio for BAX is around 57% which is slightly below the threshold of 60%. The average range is around 35% - which is also their target number after the demerger for the new BAX. This could mean that the current ratio is considered too high which raises a potential for the combined dividends of the two companies to be lower than it is now. 

Value analysis

Average yield

The current yield per average yield for 5 years ratio is 1.11. I use this as a quick indicator for valuation. This simply means that the current yield is 11% over the average yield from the last 5 years. 

Dividend yield theory mid point

Using the dividend yield theory spreadsheet (based on the Dividends Don't Lie book), I calculate the mid and high points for the yield, from which I derive the price. 

Note: You can get the spreadsheet at: http://div4son.blogspot.com/2015/03/dividend-yield-theory-spreadsheet.html



I estimate the high and low yields to be 3.30% and 1.50% respectively.


This gives me a Mid and Low prices:

Mid Price:101.26
Low Price:63.29

Considering that BAX has been trading at the low price range for the last few years, I think a range in the mid 60s would be considered fair. 

Dividend Drill Return Model

Also, using the DDRM model per the Dividend Playbook, I try to estimate the total return. Using the growth information from above, I estimate a conservative  growth rate of 7%. Of course, things will look very different post demerger. 

DDRM
Dividend Rate ($)2.02
Divided by: share price67.37
Current yield (%)3.00
Core Growth Estimate (%)7.00
Divided by: ROE (%)28.83
Multiplied by: EPS ($)4.34
Cost of Growth (%)1.05
Earnings per Share ($)4.34
Minus: Dividend2.02
Minus: Cost of Growth1.05
Funding Gap ($)1.27
Divided by: Share Price ($)67.37
Share Change (%)1.88
Core Growth (%)7.00
Plus: Share Change (%)1.88
Total Dividend Growth (%)8.88
Plus: Dividend Yield (%)3.00
Projected Total Return (%)11.88

This gives a projected total return of 11.88% which is above my 10% threshold.

Rearranging the numbers using the estimated growth%:

Dividend Rate ($)2.02
Required Return (%)10.00
Growth (%)7.00
Price67.37

So, the price is close to  my mid 60 estimation.

M* and S&P valuations 

Morningstar gives BAX a fair value of 79. S&P capIQ gives a fair value if 84. Therefore, with a current price around 67, BAX is reasonably priced. 

Risks
  • Credit Rating demerger risks from the future spinoff biopharmaceutical Baxalta
  • Competitors like Biogen/Roche provide more convenient Haemophilia drug options 
  • Baxter aquired Gambro in the dialysis market, but its growth is low
  • Potential risk of combined dividends being lower due to demerger. The recent Baxter/Baxalta presentations suggest payout ratios below than the current payout ratio of BAX.
--

I think the BAX has very good fundamentals though the debt to equity ratio is relatively high (and rising). 

There is probably going to be short term price volatility before and after the demerger.

There is a definite risk of lower combined dividends from the two companies due to the lower payout ratio targets. It all depends on how quickly BAX management enforces the target payout ratio.

Having said this, I do believe both companies will grow their dividends healthily once the dust settles after the demerger.

Therefore, this is a risk and reward play. I anticipate the dividends to be on par or even slightly lower than what we have today in the short term. I expect the dividend growth will kick in soon after the two companies are up and running.

I recently added 25 more shares of BAX at ~$68 to increase my yearly forward dividends of BAX to just over $100.

That's it for now. What do you think of BAX?

Div4son



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