2023-04-11 14:43:35 ET
Summary
- H1-23 is likely to be challenging, but drastic adjustments have already been made to forward estimates, with valuations now looking attractive.
- FCF could double in FY23 as working capital dynamics pick up, and the potential sale of BPS could also help reduce debt levels.
- The risk-reward on the charts looks attractive, and BAX could benefit from mean-reversion momentum within the medical devices space.
Introduction
Baxter International Inc. ( BAX ) manufactures and supplies a broad portfolio of medical instruments and healthcare products that are sold in over 100 countries. BAX's products are primarily utilized by dialysis centers, hospitals, nursing homes, and patients at home under physical supervision. The company currently reports under four broad segments namely, Americas, APAC, EMEA, and global Hillrom (this existing segmentation is due to change soon under a new transformational structure that will be implemented from H2-23 ).
BAX's stock has been a source of wealth destruction for a while now (down by almost 50% over the past 12 months), but we feel things could potentially change for the better. Here are a few reasons why we think investors may consider building small positions in the stock.
De-rating has already largely played out, with forward valuations looking attractive now
BAX faced a difficult FY22 and by the looks of it, H1-23 could continue to remain challenged. The top line could be reduced by some product and geography exits (worth $100m ), whilst $140m of one-off benefits seen in FY22 will not be repeated this year either.
On the cost front, management expects supply constraints and higher costs of goods to weigh adversely on operating margins. Despite these lingering challenges, it is worth asking if a lot of these risks have already been priced in by the sell-side community?
Data from Seeking Alpha show that over the past three months, there have only been downward revisions (15 in total) with no upward revisions whatsoever, something that doesn't happen too often.
Meanwhile, if we take a look at the forward estimates, the EPS already looks poised to decline by 18% this year, coming in at $2.85. In the following year, in FY24, the EPS should increase by 17% YoY, but the chart below shows us that it will still be lower than what was seen in FY22.
That is certainly not ideal and should result in steep forward P/E multiples, but such has been the ferocity of selling pressure over the past year, that the P/E actually looks quite attractive now, relative to history.
Taking the FY24 EPS estimates into consideration, the stock now trades at only 12.6x forward P/E, an attractive 40% discount to the stock's long-term P/E of 21.34x .
Granted, given that BAX will be looking to divest and spin off certain businesses, one shouldn't expect a quick re-rating to the old 22 P/E levels, but the current discount feels far too wide, in our opinion. Investors should also consider that despite all the operating challenges, BAX still looks set to bring through over $300m of cost savings this year, which may drive up EPS estimates.
Amidst all the transformation mayhem, investors shouldn't also forget that this is a business that has been paying dividends for 21 years now and intends to do so going forward as well. Well, considering the dividend facet, it's fair to say that getting in at this juncture could prove to be quite a steal, as the current dividend yield works out to 2.75%, a good 150bps higher than what you normally get with this stock.
FCF poised to double
Another encouraging facet of pursuing BAX at this point is that you're likely to witness a manifold improvement in free cash flow. Whilst operating pressures may linger, the company's working capital position is likely to witness a drastic turnaround which could potentially see the FCF more than double in 2023 (for context, last year's FCF stood at $532m ).
Two key drivers here will be a lower inventory position and a lower level of receivables. Last year, production was impacted by longer lead times, missing components, longer shipping lanes, etc which resulted in a bloated inventory position. In effect, the company was not very productive in converting its inventory to sales, which had dropped to its lowest point in five years.
Meanwhile, December 2022 proved to be a very strong month leading to an overdose of credit sales, so much so that the receivables turnover ratio too dropped to its lowest point in five years. This is not sustainable and should reverse, boosting the overall operating cash flow.
With over $1bn of FCF next year, BAX will benefit from additional elbow room to not only cover its dividend bill (which is likely to be around $0.6bn , given the recent trend in annual dividend cash outlay), but to also kickstart higher threshold of share buybacks (this could be very useful in supporting the share price at these lowly levels) which appear to have petered out in recent periods, despite the company having the authorization to carry out another $1.3bn worth of buybacks.
Granted, the immediate priority should be towards debt reduction (debt on the books has tripled since the pre-pandemic era, primarily on account of the Hillrom acquisition), but this could also be curtailed by the potential stake sale proceeds of BAX's BioPharma Solutions (BPS) product category. BPS should receive considerable attention as it generates over $600m of sales and it also offers contract manufacturing capabilities.
All in all, it does look like BAX's cash-gen and cash management position in FY23 should look a lot more enticing.
Good risk-reward on the charts
As a rotational play in the Medical Devices space, the Baxter International stock is likely to be one of the most attractive options, as the current relative strength ratio of BAX to the iShares US Medical Devices ETF ( IHI ) is at record lows and almost 70% away from the mid-point of its long-term range.
Finally, if one switches focus to the long-term standalone chart of BAX, we can see that since February 2022, the stock has been on a relentless downtrend with no support in sight, until recently. Recently we've seen the stock drop to the $32-$42 terrain, an area that had served as a congestion zone for three years from 2013-2016. A drop to this old congestion zone has now prompted a few bargain hunters to come on board and support the stock. This is exemplified by the bullish hammer candle seen last month.
The next objective for the stock will be to break past the descending channel boundary. Even if it fails to negate its descending channel, I still feel this looks like a decent zone to build positions, given how long the stock spent chopping around in this zone around a decade ago.
For further details see:
3 Reasons To Consider A Nibble On Baxter