Investing in Bausch Health (BHC): Navigating the Thin Line Between Value and Trap
Value-focused investors are always on the hunt for stocks that are priced below their intrinsic value. One such stock that merits attention is Bausch Health Companies Inc (NYSE:BHC). The stock, which is currently priced at 7.66, recorded a loss of 8.54% in a day and a 3-month increase of 5.31%. The stock's fair valuation is $17.96, as indicated by its GF Value.
Understanding the GF Value
The GF Value represents the current intrinsic value of a stock derived from our exclusive method. The GF Value Line on our summary page gives an overview of the fair value that the stock should be traded at. It is calculated based on three factors: historical multiples (PE Ratio, PS Ratio, PB Ratio and Price-to-Free-Cash-Flow) that the stock has traded at, GuruFocus adjustment factor based on the company's past returns and growth, and future estimates of the business performance.
We believe the GF Value Line is the fair value that the stock should be traded at. The stock price will most likely fluctuate around the GF Value Line. If the stock price is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher.
The Risk Factors of Bausch Health (NYSE:BHC)
However, investors need to consider a more in-depth analysis before making an investment decision. Despite its seemingly attractive valuation, certain risk factors associated with Bausch Health Companies Inc (NYSE:BHC) should not be ignored. These risks are primarily reflected through its low Piotroski F-score of 2, and Altman Z-score of 0.09. These indicators suggest that Bausch Health, despite its apparent undervaluation, might be a potential value trap. This complexity underlines the importance of thorough due diligence in investment decision-making.
Understanding the Piotroski F-score and Altman Z-score
The Piotroski F-score, created by accounting professor Joseph Piotroski, is a tool used to assess the strength of a company's financial health. The score is based on nine criteria that fall into three categories: profitability, leverage/liquidity/ source of funds, and operating efficiency. The overall score ranges from 0 to 9, with higher scores indicating healthier financials. Bausch Health's current Piotroski F-Score, however, falls in the lower end of this spectrum, indicating potential red flags for investors.
Before delving into the details, let's understand what the Altman Z-score entails. Invented by New York University Professor Edward I. Altman in 1968, the Z-Score is a financial model that predicts the probability of a company entering bankruptcy within a two-year time frame. The Altman Z-Score combines five different financial ratios, each weighted to create a final score. A score below 1.8 suggests a high likelihood of financial distress, while a score above 3 indicates a low risk.
A Snapshot of Bausch Health Companies Inc (NYSE:BHC)
Bausch Health Companies Inc is a global specialty pharmaceutical, consumer health, and medical device company with a focus on branded products for the dermatology, gastrointestinal, and ophthalmology markets. The company reports revenue in five segments: Salix; International; Solta Medical; Diversified Products and Bausch + Lomb. It generates maximum revenue from the Bausch + Lomb segment. The company's market cap is $2.80 billion with sales of $8.40 billion.
Analysis of Bausch Health's Profitability
Firstly, let's address profitability. One significant component of the F-Score is a positive return on assets (ROA). A closer look at Bausch Health's ROA reveals a worrying trend of negative returns. This indicates the company's inability to generate profit from its assets - a fundamental concern for any investor.
Observing the financials of Bausch Health, it's important to note that the cash flow from operations over the trailing twelve months (TTM) stands at $-428 million, whereas the net income in the same period is significantly higher at $-186 million. The Piotroski F-score considers this discrepancy as a potential red flag. The rationale behind this is that a company's operating cash flow is a more direct and less manipulated measure of its cash-generating ability than net income. Net income, while important, is susceptible to accounting treatments and non-cash items which can distort the true cash profitability of the company. If a company consistently shows lower cash flows from operations relative to its net income, it could indicate that the earnings quality is poor and the company might have difficulties sustaining its operations or financing its obligations, a fact which could negatively impact its financial stability and investor confidence.
Leverage, Liquidity and Source of Funds: A Worrying Trend
Assessing the aspect of leverage, liquidity, and sources of funds, Bausch Health demonstrates an alarming rise in its debt-to-total assets ratio over the past three years. The provided data shows 2021: 0.78; 2022: 0.77; 2023: 0.81, expressed as percentages. A higher debt ratio suggests that Bausch Health is increasingly financing its assets through debt, thereby escalating its financial risk. The Piotroski F-Score views this as a negative indicator, further cautioning investors about Bausch Health.
Operating Efficiency: A Darker Picture
Examining the data provided: 2021: 358.43; 2022: 362.20; 2023: 367.10, it becomes evident that Bausch Health has seen an increase in its Diluted Average Shares Outstanding over the past three years. This trend signals that the company has issued more shares. While issuing additional shares can provide immediate capital for the business, it can also lead to the dilution of existing shares' value. This dilution occurs because the earnings of the company now have to be divided among a larger pool of shares, which could decrease Earnings Per Share (EPS). Consequently, if the company's earnings don't grow at a pace that matches or exceeds this share increase, it could lead to a reduction in the value perceived by existing shareholders, potentially impacting their investment returns. Hence, while additional share issuance may provide necessary capital, it is important to monitor its impact on shareholder value carefully.
Lastly, concerning operating efficiency, the Piotroski F-score examines changes in gross margin and asset turnover. Regrettably, Bausch Health follows a discouraging trajectory with a decrease in gross margin percentage over the past three years, as demonstrated by the data provided: 2021: 71.44; 2022: 71.48; 2023: 70.46 (expressed in percentages). This contraction in gross margin suggests that Bausch Health is grappling with either an escalation in the cost of goods sold or dwindling prices - both of which are inauspicious indicators for profitability.
Conclusion
While the Piotroski F-score is not the only lens through which to view a potential investment, it is a robust and comprehensive tool for evaluating a company's financial health. Unfortunately for Bausch Health, its current score suggests potential troubles. The low Piotroski F-score, coupled with the high debt-to-asset ratio and decreasing gross margin, paint a picture of a company that could be a potential value trap. Therefore, despite the seemingly undervalued stock price, investors should tread carefully and conduct thorough due diligence before investing in Bausch Health.
GuruFocus Premium members can find stocks with high Piotroski F-score using the following Screener: Piotroski F-score screener .
GuruFocus Premium members can find stocks with high Altman Z-Score using the following Screener: Walter Schloss Screen .
This article first appeared on GuruFocus.
