Baxter Is A Buy At Current Valuation – We Call A Value Play Into 2021

Investment Thesis

Previously we wrote an in-depth equity research report and long thesis on Baxter (NYSE:BAX) at the end of August (found here) and were impressed with the company’s defensive outlook, market positioning and capital structure over time, evidenced through insensitivity to recent business cycles alongside key differentiators within their operating segments, most notably within the renal dialysis domain. We encourage all readers to first glance at that analysis prior to reading this report, to make the most informed decision for their own investment reasoning. Since this time, we’ve observed a small pullback of around -6.5% to $80.98, thus presenting with a favourable entry point for value players considering our estimates of fair value at $84, now with a value gap of +5%. With planned dividend increases announced, adequate dividend coverage and strong posture on FCF, this case is only heightened for long-term players.


Baxter has elicited a compelling chart display since September 2016, bouncing off the longer term support line nicely 5 to 6 times over the 4-year period until today, where it currently is being tested at todays current support. This will be a good testing point for BAX within the market, with technical players analysing movement from this month to garner a greater understanding of the next moves for the stock. Notice on the chart below BAX bouncing from the support line since 2016, showing ongoing new highs with an upward trend over this same period. We are confident that BAX has the fundamental momentum alongside market desirability to continue along this long-term pattern into 2021 and beyond.

Data Source: Trading View & Seeking Alpha, BAX

What has been an impressive factor for BAX particularly throughout the pandemic-induced market turbulence, has been the superior posture on ROIC and ROA to date. With 10.53% of ROIC at our last analysis, alongside a strong ROA figure of 5%, we firmly believe that the valuation and stock price will reflect the superiority in these numbers over the next 12 month period. The above figures are bolstered by a 65% turnover in assets, with exceptional correlation and causation from R&D expenditure to top-line earnings for the company historically. This shows that with any additional R&D expenditure, the increase in expenses will likely be reflected positively in revenues, without placing additional margin pressure from an increase in variable expenditures. Expanding on managements effectiveness in decision making, the above points are supported by 30% growth in return on capital employed, with 12.5% ROCE recorded from the previous quarter’s filings.

Data Source: Author’s calculations from previous analysis

Data Source: Author’s calculations from previous analysis

Valuation

What is exciting for all value players is the recent pullback’s effect on the dislocation between value and market price since our last analysis. The -6.51% pullback has meant a correction in valuation based on the implicit inputs in our DCF valuation, the snapshot of which can be observed below, with full sets of numbers found in the larger research report outlined earlier. As usual for our analyses, we assign a terminal growth rate related to the PRAT model of DuPont, alongside a discount rate combined of the opportunity cost of the risk-free rate plus the S&P500 total return.

With this information, backed by the fundamental differentiators and competitive advantages that widen BAX’s economic bastion, there is an excellent case made for immediate entry based on todays market price. We have been long BAX for some time now, however in light of this recent move back down to $80, this gives us greater reallocation scale back up to our 12-month price target of $90, which was outlined in our long thesis. Further to this, we’ve been able to allocate smaller position sizes on each round of purchasing, to cover risk and reduce exposure to the downside.

Data Source: Author’s calculations

Sensitivity of DCF inputs:

Data Source: Author’s Calculations

The market certainly feels the same way also; on a P/E of 25.01x, FWD P/E and FWD PEG of 26.27x 2.45x respectively, investors certainly believe that the company will perform and survive the remainder of the pandemic-induced market turbulence. We are drawing on evidence within the market to date where solid companies have shown equally as solid growth within the S&P500 albeit holding high P/E’s and PEG labels.

Other valuation metrics have been discussed in other analyses, but what is certainly compelling right now with recent price corrections is P/Sales of 3.58, P/CF of 16.44 and most notably P/FCF of 2.48, making the company far cheaper respective to the industry median, and a far cry from numbers seen in previous analysis. Right now, BAX is certainly a buy on valuation from objective screening. Respective to the industry also, alongside all major competitors, BAX is cheap on a EV/EBITDA front also on a FWD figure of 16.47x, compared to Abbot Labs (ABT) 27x, Edwards Lifesciences (EW) 37.02x, West Pharmaceutical (WST) 45.52x, Becton Dickinson (BDX) 25.41x and Boston Scientific (BSX) 56.04x, by way of example. Further support is seen in FCF yield of 3.58% in an upward trend for shareholders, and only illustrates managements prowess and handle on liquidity as an insight into future decision making.

Data Source: Author’s calculation’s


Our previous analyses support a blue-sky scenario as well, with valuation continuing to be a compelling factor and investors seeing additional compensation for any downside risk through dividend increases and price returns over the coming 5-year period. Further to the correction in valuation, the blue-sky scenario calls for immediate action for all long-term players who are interested in a defensive stock that has the fundamental legs to withstand all of the market pressures being thrown around, particularly coming out of the pandemic.

Data Source: Author’s calculation’s

Conclusion

Baxter is now a buy more than ever in light of recent price corrections, reflected positively in the valuation that supports our blue-sky scenario of previous analyses. Value players should look to enter now, in the chance of capturing an at least fairly valued company that has the added benefit of offering total returns through a decent dividend that, by all accounts, should increase over the years to come. We would advocate sound risk management by smaller capital allocation and position sizes in light of market volatility, in the realms of 0.1-2% NAV, which figure to chose depending solely on the size of one’s NAV at time of writing. We are in favour of allocating 0.1-0.5% of NAV in the current market climate, as these smaller position sizes give greater wiggle room to refine the hypothesis and make a swift exit should things suddenly head south beyond our liking. Furthermore, consider a longer-term horizon for BAX, as this is a defensive play in a portfolio and will give sound returns through price and dividends over years to come.

Disclosure: I am/we are long BAX. 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.

Business, Investment Ideas

Leave a Reply

%d bloggers like this: