By the Valuentum team
Baxter International (NYSE: BAX) has a broad portfolio of medically necessary products and therapies, and its brand strength is a key advantage as the majority of its sales come from products with leading positions in the market. Some of its products include dialysis therapies, intravenous solutions, infusion systems and devices, parenteral nutritional therapies, advanced surgical equipment, smart beds and respiratory health devices, among others. The company’s products can be found in nearly every healthcare facility, from hospitals to nursing homes and beyond, in more than 100 countries.
In December 2021, Baxter acquired Hillrom in a deal worth approximately $12.5 billion in enterprise value. Within three years of closing the transaction, Baxter aims to generate approximately $250 million in annualized pretax cost synergies due to the highly complementary nature of Hillrom’s portfolio. Going forward, Baxter is prioritizing deleveraging activities and the expanded business should be an exceptional free cash flow generator. We believe Baxter shares start to look attractive at around $60 each, as our estimate of fair value derived from our discounted cash flow process is north of $80 per share. The shares are yielding around 1.9% at the time of this writing, although we note that the company’s dividend is not as strong as others based on our dividend cushion analysis.
Deconstructing the dividend cushion ratio, shown in the image above, reveals the numerator and denominator of the dividend cushion ratio. Basically, the larger the numerator, or the healthier a company’s balance sheet and future free cash flow generation, relative to the denominator, or a company’s cash dividend obligations, the larger the dividend. sustainable. In the context of the Dividend Cushion ratio, Baxter’s numerator is lower than its denominator, suggesting low dividend coverage going forward. The dividend cushion ratio deconstruction picture places available sources of cash in the context of financial obligations alongside expected cash dividend payments over the next 5 years in a side-by-side comparison. Because the dividend cushion ratio and many of its components are forward-looking, our assessment of dividends may change in subsequent updates as future forecasts are changed to reflect new information.
Baxter’s Key Investment Considerations
Baxter has a broad portfolio of essential renal and hospital products. Its global footprint allows it to play a key role in expanding access to healthcare in emerging and developed countries alike. The majority of the company’s revenue is generated by products with leading market positions. The company spun off via a tax-free distribution to shareholders in 2015.
Baxter’s strong image and brand are reinforced by an extensive global footprint and distribution force. The company continues to focus on growing international sales, which should be helped by its strong pipeline of new product launches.
In December 2021, Baxter acquired Hillrom in a deal worth approximately $12.5 billion in enterprise value. Hillrom had a highly complementary medical technology portfolio and within three years of closing the deal, Baxter aims to generate approximately $250 million in annualized pre-tax cost synergies. Deleveraging activities are a medium-term priority.
Baxter’s net debt swelled following its deal for Hillrom and its pro forma adjusted EBITDA to net debt ratio was around 4.2x immediately after the acquisition closed. Within two years of closing the transaction, management aims to bring Baxter’s leverage ratio down to ~2.75x.
Baxter’s dividend was slashed following its split into two independent companies in 2015, but management has stepped up major payout increases since then. Competing capital allocation options may impact the rate of dividend expansion in the future.
Due to Baxter’s acquisition of Hillrom in December 2021, management is prioritizing deleveraging efforts as Baxter’s net debt load has increased to fund the deal. Within two years of closing the deal, Baxter aims to reduce its net debt to adjusted EBITDA ratio to ~2.75x, down sharply from ~4.2x on a pro forma basis immediately following the close of the deal. ‘OK.
Baxter Economic Profit Analysis
The best measure of a company’s ability to create value for its shareholders is expressed by comparing its return on invested capital to its weighted average cost of capital. The gap or difference between ROIC and WACC is called the economic profit gap of the firm. Baxter Intl’s 3-year historical return on invested capital (excluding goodwill) is 17.9%, which is higher than its cost of capital estimate of 8.7%.
As such, we give the company an EXCELLENT value creation rating. In the chart below, we show the likely trajectory of ROIC in the coming years based on the estimated volatility of the main drivers of the metric. The solid gray line reflects the most likely outcome, in our view, and represents the scenario that results in our estimate of fair value. Baxter is a powerful generator of economic value.
Baxter Cash Flow Valuation Analysis
We think Baxter is worth $81 per share with a fair value range of $63.00 to $99.00. The safety margin around our estimate of fair value is determined by the company’s AVERAGE ValueRisk rating, which is derived from an assessment of the historical volatility of key valuation factors and a future assessment of these. .
Our near-term operating forecasts, including revenue and earnings, do not differ materially from consensus estimates or management guidance. Our model reflects a revenue compound annual growth rate of 8.4% over the next five years, faster than the company’s historical 3-year compound annual growth rate of 4.8%.
Our valuation model reflects a projected 5-year average operating margin of 18.9%, which is above Baxter Intl’s 3-year average. Beyond year 5, we assume that free cash flow will grow at an annual rate of 4% for the next 15 years and 3% in perpetuity. For Baxter Intl, we use a weighted average cost of capital of 8.7% to discount future free cash flow.
Baxter’s Margin of Safety Analysis
Our discounted cash flow process evaluates each business based on the present value of all future free cash flows. Although we estimate the company’s fair value at approximately $81 per share, each company has a range of likely fair values that is created by the uncertainty of key valuation factors (such as future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn’t see much volatility in the markets, as stocks would trade precisely at their known fair values.
This is an important way to view markets as an iterative function of future expectations. As future expectations change, the value of the company and its stock price should also change. Stock prices are not a function of fixed historical data, but rather act to capture future expectations as part of constructing company valuation. It’s a key part of our book Value Trap: Universal Valuation Theory.
Our ValueRisk Rating defines the margin of safety or range of fair value we assign to each stock. In the chart above, we show this likely range of fair values for Baxter. We think the company is attractive below $63 per share (the green line), but quite expensive above $99 per share (the red line). Prices that fall along the yellow line, which includes our estimate of fair value, represent a reasonable valuation for the business, in our view.
The short term looks a little tough for Baxter, as the company cut its 2022 revenue forecast to a high teen growth rate from a previous range of 23% to 24% when it released its results for the year. second quarter on July 28. guidance for adjusted earnings per share in the range of $3.60 to $3.70 from a previous range of $4.12 to $4.20 at that time. However, we expect the company to right the ship in a relatively short time. Baxter has one of the best product lines in healthcare, is a strong generator of free cash flow and generates significant economic value for shareholders. With its shares trading at a handsome discount to our estimate of fair value, they may be worth considering.
This article or report and any links it contains are for informational purposes only and should not be considered a solicitation to buy or sell securities. Valuentum is not responsible for any errors or omissions or results obtained from the use of this article and assumes no responsibility for how readers may choose to use the content. Assumptions, opinions and estimates are based on our judgment as of the date of the article and are subject to change without notice.