Becton Dickinson (BDX): Valuation Analysis

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Becton Dickinson (BDX): Valuation Analysis

Warren Buffett once said, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

In other words, a company with a highly predictable business model, durable competitive advantages, a shareholder-friendly corporate culture, and numerous opportunities for long-term growth.

Of course finding such companies isn’t always that easy, but you can take a look at all of Warren Buffett’s dividend stocks here for a few examples.

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There is also another group of dividend growth stocks known as dividend aristocrats, which pretty much define the kind of “buy and hold forever” mentality that Buffett looks for.

Let’s take a closer look at dividend aristocrat Becton Dickinson (BDX) which, with 45 straight years of dividend growth, has proven to be one of the most dependable income investments on Wall Street.

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Business Overview

Founded 120 years ago in 1897, Becton Dickinson is one of the world’s largest medical supplies, devices, laboratory equipment, and diagnostic products manufacturers. In fact, its 40,000 employees help the company sell in over 50 countries through two main business segments.

Medical (69% of 2016 sales): makes and markets drug delivery systems including syringes, pen needles, IV sets for diabetics, IV catheters, and anesthesia and surgical equipment.

Life Sciences (31% of 2016 sales): specimen collection and diagnostics systems including blood collection and microorganism culturing and diagnosis equipment. Also produces molecular analysis systems for detecting cancer and testing for bacterial drug resistance

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Source: Becton Dickinson Presentation

By geography, the majority of Becton Dickinson’s sales are from outside of the U.S., and the company generates around 20% of its total sales from developing markets.

Business Analysis

There are two important things to consider when buying any company, especially if your focus is on long-term dividend growth.

The first is the stability of a company’s business model, including its growth in sales, earnings, and free cash flow (FCF). Part of this involves whether or not a company has a long runway for future growth.

Becton Dickinson, thanks to its dominant position in the medical devices industry, benefits from several factors including a growing and aging world population. This is especially true in the developed world, such as the U.S. and Europe, which both have aging populations that will need greater amounts of drug delivery equipment in the coming years.

That being said, up until recently Becton Dickinson was hardly a fast-growing company. That’s because it generally avoided large-scale acquisitions and instead delivered steady but moderate growth.

However, recently this changed in a major way.

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More specifically, Becton Dickinson underwent a corporate strategy shift starting in 2015. That’s when it made its largest acquisition by far (20 times larger than its previous biggest purchase) – the $12.2 billion buyout of CareFusion, a provider of medical devices and diagnostic products to hospitals and physicians.

This purchase doubled the size of the company’s addressable medical products market and set the company up for faster growth thanks to its extensive distribution channels (60% of BDX’s sales were abroad, but 75% of CareFusion’s business was in the U.S.).

As a result of this acquisition and some of the accounting noise that came with it, Becton Dickinson’s margins became temporarily depressed. The good news is that the company’s apparently below-average profitability is likely to prove transitory as management extracts synergistic cost savings and larger of economies of scale.

Source: Morningstar, Gurufocus

In fact, the most important thing to note when comparing Becton Dickinson’s profitability relative to its industry peers is its very strong FCF margin, which shows that management is very good at generating strong cash flow from its fast growing sales. Even better is that Becton’s larger acquisition-focused growth strategy, part of a larger consolidation of the medical devices industry, continues to accelerate.

That’s because Becton recently announced an even larger purchase of C.R Bard for $24 billion in cash and stock. This deal will be a major game-changer, increasing Becton’s workforce to 65,000, adding $20 billion to the company’s addressable market, and giving it a presence in almost every country on earth. The acquisition will also be immediately accretive to the company’s bottom line and boosts revenue by nearly 30%.

Even more important is that the C.R. Bard deal will significantly grow Becton Dickinson’s exposure to key medical device markets, especially in fast-growing emerging markets.

Source: Becton Dickinson Investor Presentation

For example, in Q1 of 2017 Becton’s sales, adjusted for currency fluctuations, grew a decent 4.5% in developed markets, which make up 85% of the company’s overall revenue.

However, in emerging markets (15% of business) its sales rose a much faster 8.7%. Meanwhile, China, which accounts for 6% of its overall top line, saw business boom 11.9%, nearly three times faster than its developed market sales growth.

The C.R Bard acquisition will open up even larger markets for Becton’s large global supply chains and help the company achieve even stronger long-term top and bottom line growth, which bodes well for future dividend growth.

That’s not just because of the immediate benefit of 27% higher revenue, but also thanks to the $300 million in annual synergistic cost savings that are anticipated.

Management expects that this, combined with ongoing organic cost savings projects, should boost the company’s overall long-term operating margin by several hundred basis points and result in mid-teens annual earnings growth.

Key Risks

While Becton Dickinson has some great growth catalysts at its back, there are nonetheless several risks to keep in mind.

The first of these is the fact that Becton’s debt levels have been steadily rising in recent years, a trend that has only accelerated now that management is pursuing ever-larger acquisitions.

And keep in mind that the C.R Bard purchase hasn’t closed yet, meaning that the $10.5 billion in new debt that will result from the purchase will only further increase the company’s leverage. That in turn could have several negative effects on the company.

Now in fairness to management, the company’s growing debt levels occurred during a period of record-low interest rates, which provided BDX with an average weighted interest rate of just 4.1%. However, in a rising interest rate environment, shareholders will want to be aware that refinancing the company’s growing debt will likely mean higher interest costs and somewhat decreased financial flexibility.

Specifically, that means that more of the company’s growing cash flow will need to go to paying down debt, which could result in slower dividend growth.

Then of course there’s the fact that, as a medical devices company, Becton faces the ever-present threat of major regulatory changes. This includes the uncertainty regarding the potential repeal of Obamacare, which has resulted in slow growth in hospital consumables as that industry attempts to save as much cash as possible.

Also keep in mind that, though a major player in the industry, Becton still faces stiff competition from major rivals such as Abbott Labs (ABT) and Roche (RHHBY). This, combined with little pricing power in the commoditized surgical equipment divisions, could result in greater margin pressure going forward.

Finally, we can’t forget that Becton Dickinson has achieved its impressive growth record using a very different business strategy. Specifically, until 2015 the company was known for well executed but small bolt-on acquisitions.

However, now that management is pursuing large, needle-moving acquisitions, financed largely with cheap debt, there is a lot more execution risk. The company will have to prove that it hasn’t overpaid for CareFusion and C.R Bard and can achieve the synergistic cost savings that were part of the justification for those mega purchases.

And given that historically 87% of large corporate acquisitions have destroyed shareholder value, Becton Dickinson has its work cut out for it in proving that these were savvy purchases. Management deserves the benefit of the doubt for now, but such major capital allocation decisions deserve close scrutiny.

All things considered, Becton Dickinson’s diversified portfolio, recession-resistant products, strong business model, long operating history, and disciplined management team lower the company’s overall risk profile.

Becton Dickinson’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

BDX has a Dividend Safety Score of 92, indicating that its payout is one of the safest and most dependable on Wall Street. This shouldn’t come as a surprise given that it’s paid an annual dividend every year since 1909 and has raised its payout for 45 consecutive years.

The key to Becton’s impressive dividend growth streak (just six years away from becoming a dividend king) is its highly consistent cash flow. That’s courtesy of a recession-resistant business model created by selling consumable medical products that result in steady and recurring cash flow.

Then there’s management’s disciplined approach to dividend growth. Specifically Becton has taken the long-term, slow-but-steady view that dividend growth should never vastly outpace sales, earnings, and FCF growth. That has resulted in consistently safe EPS and FCF payout ratios generally between 20% and 40% that serve as large safety buffers protecting the payout.

In fact, because Becton’s dividend generally only pays out 20% to 40% of EPS and 30% to 40% of FCF, the company has been able to steadily increase its payout even during periods of intense economic uncertainty, such as the 2008-2009 financial crisis.

In addition to consistent, recurring cash flow and safe payout ratios, Becton Dickinson’s payout security is also helped by its historically strong balance sheet.

Despite steadily-rising debt levels in recent years, Becton’s strong cash flow still enables it to easily service its debt payments, and its current ratio of greater than one means its short-term assets easily cover its short-term obligations.

That being said, we can’t forget that Becton operates in a moderately capital intensive industry, and its recent mega deals have resulted in higher-than-average debt levels that could result in a reduced ability to further grow through acquisitions over the next few years.

Sources: Morningstar, Fast Graphs

For example, after the CareFusion acquisition the company’s leverage ratio and debt to capital ratio rose significantly higher than its industry peers. In addition, management projects that the $10.5 billion in additional debt required to close the acquisition of C.R Bard will result in a Debt/Adjusted EBITDA ratio of 4.7 and a credit downgrade from BBB+ to BBB.

While that investment-grade credit rating is still strong enough to likely allow Becton to access cheap debt in the future, especially given its larger size, going forward Becton will likely have to deleverage before attempting another large scale acquisition. Otherwise it risks another downgrade that would put it just one level above junk bond status and potentially increase its debt refinancing costs going forward.

Overall, BDX’s dividend appears very safe, even after the C.R. Bard acquisition closes and increases the company’s financial leverage. With a long operating history, a diversified portfolio of recession-resistant products, conservative payout ratios, and strong brand recognition, Becton Dickinson is a blue chip stock that should have no problem paying dividends for many years to come.

Becton Dickinson’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

BDX’s dividend Growth Score of 68 indicates that investors can probably expect better than market average (5.7% annually over the last 20 years) dividend growth in the years ahead.

That’s not surprising given that, in addition to an incredibly consistent long-term dividend growth record, Becton Dickinson’s rate of payout growth has been impressive, with double-digit growth across every time frame.

Source: Simply Safe Dividends

Going forward, assuming that management can execute well on the CareFusion and C.R. Bard purchases and achieve its long-term mid-teens earnings growth guidance, Becton’s dividend should be able to grow at a similar rate (about 8% to 12% annually).

Note that this is slightly lower than management’s stated earnings growth goal. However, it also accounts for the company’s future deleveraging efforts, which are necessary to strengthen its balance sheet and ensure maximum long-term financial flexibility.

Valuation

Over the past year, Becton Dickinson has nearly matched the S&P 500 during its strong rally. And given that the market is now in its 9th year of an epic bull run, naturally many investors are worried that valuations are getting dangerously high.

However, despite BDX’s strong performance its forward P/E ratio of 18.5 isn’t all that high. That’s especially true given that the S&P 500’s forward P/E ratio is 17.8 and the company’s 13-year median forward PE ratio is 19.5.

When we look at the dividend yield, we see something similar – shares trading about in line with their historic norms. That’s because the 1.5% yield is equal to the stock’s 22-year average yield of 1.5%.

Today’s share price, while not an obvious bargain, could be a reasonable entry point for long-term investors. That’s especially true if the company can deliver double-digit growth over the coming years, which creates potential for long-term annual total returns north of 10% (1.5% dividend yield plus 8% to 12% annual dividend growth).

Conclusion

Becton Dickinson is a high quality healthcare company with a number of long-term growth opportunities. Its acquisitions of CareFusion and C.R. Bard significantly expand its addressable market, and higher healthcare spending in developing countries, as well as the continued aging of the world population, bodes well for future growth.

The company’s dividend appears to remain on very solid ground, even after the C.R. Bard acquisition closes, and payout growth should remain strong given the company’s long-term outlook.

While Becton Dickinson may not be an obvious bargain at the moment, it’s hard to argue with one of the industry’s most proven management teams and the company’s shareholder-friendly corporate culture.

Investors seeking more yield should review the 30 high dividend stocks here.

Article by Simply Safe Dividned

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