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Baxter International: A Health Care Stock With an 89-Year History

- By Robert Abbott

The Baxter International Inc. (NYSE:BAX) share price dropped recently. But is it enough of a pullback to justify the interest of investors?

According to its description in the 10-K for 2019, Baxter and its subsidiaries provide "a broad portfolio of essential healthcare products, including acute and chronic dialysis therapies; sterile intravenous (IV) solutions; infusion systems and devices; parenteral nutrition therapies; inhaled anesthetics; generic injectable pharmaceuticals; and surgical hemostat and sealant products."


Of the six categories of products and services it sells, renal care is the biggest driver, with second-quarter revenue of $919 million. Pharmaceuticals and clinical nutrition were the second and third-largest.

Altogether, it took in $2.7 billion in the second quarter, and also noted, "Second-quarter U.S. GAAP earnings per share (EPS) of $0.48 declined 20%; adjusted EPS of $0.64 declined 24%."

Baxter has now put behind it an embarrassing accounting snafu. In a news release on March 17 of this year, it announced it had finished restating its annual reports for 2017, 2018 and 2019, as well as some quarterly reports. It explained, "The company has now completed its internal investigation into certain intra-company transactions that impacted its previously reported non-operating foreign exchange gains and losses as it relates to the financial statement impacts."

Looking ahead, it is one of a dwindling number of companies still offering guidance for 2020. The second-quarter earnings release included this outlook:

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

If we consider Baxter as an investment for the long term, we will want to analyze its fundamentals, valuation, dividend and guru confidence.

Financial strength

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

The first five lines of this table give us readings about the state of Baxter's debt. The red and orange bars in the Versus Industry column suggest it is not doing as well as its competitors and peers.

The light green and yellow bars under Versus History tell us the company's debt situation is in line with previous years.

Adjacent to the interest coverage ratio is a red bar, indicating that its status on this metric has slipped. Still, the interest coverage ratio tells us the company is bringing in enough operating income to cover its interest expenses more than seven times over.

The Piotroski F-Score of 5 is considered typical for a stable company, while the Altman Z-Score is strong.

Finally, we see the return on invested capital is greater than its weighted average cost of capital, which means Baxter is profitably employing the capital it has received from investors and lenders.

Profitability

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

The first four lines in the profitability table show us Baxter keeping up with its peers, but doing less well than it has in its own past.

More proof of that follows in the last two lines of the table, where we see negative results for Ebitda and earnings per share (without non-recurring items). Both of those negative numbers are substantial.

It doesn't take much sleuthing to find out why the negative growth was so high; as this chart shows, earnings per share blipped extraordinarily high in 2017 and everything since looks bad in comparison:

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

The chart for Ebitda looks much the same, so we can take the last two lines with a grain of salt (although both Ebitda and earnings per share dipped from 2018 to 2019).

Valuation

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

With a valuation score this low, we should expect to find an overvalued stock.

That's true of the price-earnings ratio, which is higher than it has been in the past, but is not too far out of line for a company in the medical devices and instruments industry. The 10-year median for the industry is 38.81.

The PEG ratio is also high, since a ratio of 1.0 is the fair value mark. Anything above 1.0 is considered high, and Baxter's 7.03 is the result of a high price-earnings ratio and negative Ebitda growth in the past five years.

Because the company has an earnings predictability score of just one out of five stars, its discounted cash flow score is prone to error. And that appears to be the case here, since the margin of safety is -350%.

Dividends

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

At just 1.09%, the Baxter dividend is low and well below the S&P 500 average of 1.88%. In part, that's because the company cut it by roughly three-quarters in the mid-2010s:

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

And it is also partially due to rising share price:

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

The payout ratio, at 51%, means the company is distributing about half its free cash flow to shareholders and is keeping back about half to grow the company.

The three-year average dividend growth rate of 19% suggests Baxter wants to grow the dividend again, perhaps to get it back up to earlier levels.

That growth rate isn't doing much for the five-year yield on cost, which is quite low at 0.47%. The reason the yield on cost is below the current yield is because the formula behind it looks back five years, rather than three. In doing so, the outcome is affected by the big cuts made mid-decade.

Finally in this section, we see the company has an average buyback ratio of 2.1 over the past three years, meaning it has been actively repurchasing them. This chart shows how the share count has been reduced since 2010:

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

This reduction in the share count means the earnings per share have been pushed up because those earnings are being divided among fewer shares.

Gurus

At the end of the second quarter, Baxter was owned by 17 of the investment gurus. However, they have been doing more selling than buying lately:

Baxter International: A Health Care Stock With an 89-Year History
Baxter International: A Health Care Stock With an 89-Year History

Al Gore (Trades, Portfolio) of Generation Investment Management is the largest holder among the gurus with 10,606,094 shares, representing a 2.10% stake in Baxter and 5.27% of his assets under management. He added 4.38% to his holding during the quarter.

The Vanguard Health Care Fund (Trades, Portfolio) had 5,007,541 shares, good for almost 1% of Baxter's shares outstanding. Its stake was unchanged over the quarter.

Daniel Loeb (Trades, Portfolio) of Third Point was left with 4,000,000 shares after reducing his stake by 65.46%.

Conclusion

Growth investors might want to take a chance on Baxter International. While it is currently overvalued, it is also quite likely the company will continue to grow over the next five to 10 years. Although its fundamentals are mixed, there's no doubt this is a solid company in the growing health care sector.

For value investors, there is too much debt to ignore and the price is far too high. Given it is in the growing health care industry and likely to remain popular among other investors, it is not likely to offer a margin of safety very often.

Income investors will find little of interest in Baxter. Given the cuts mid-decade, it's not likely to be competitive on dividends for quite some time.

Disclosure: I do not own shares in any companies named in this article.

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This article first appeared on GuruFocus.

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