Contents
When I last reviewed Becton Dickinson (BDX) in this May 10, 2024 post, I expressed cautious optimism that after a tumultuous few years the company was back on track; I have touched upon BDX's BD Alaris Pump issues in previous posts.
I concluded that post stating that exiting my position was a consideration. After some deliberation, however, I felt it would be imprudent to exit my position just when the company is on the path to improved returns.
Subsequently, BDX:
- announced on June 3 its intent to acquire Edwards Lifesciences Critical Care Product Group for $4.2B in cash; and
- issued its Q3 and YTD2024 results, revised FY2024 outlook, and preliminary FY2025 outlook.
thus prompting me to revisit this holding.
Business Overview
The best sources of information to learn about BDX are its website and its FY2023 Annual Report/Form 10-K.
Edwards Lifesciences Critical Care Product Group Acquisition
The Press Release and Presentation provide BDX's rationale for the acquisition and the negotiated terms.
Financials
Q3 and YTD2024 Results
BDX's Q2 and YTD2024 results are accessible here.
Net leverage (Net Debt/Adjusted EBITDA) improved to 2.4x at the end of Q3 from 2.6x, 2.8x, 2.6x, and 2.6x at FYE2021, FYE2022, FYE2023, and the end of Q2 2024.
Cash and short-term investments of ~$5.3B includes ~$3.4B in proceeds from the February debt refinancing and the Critical Care acquisition financing in June. Once BDX disburses the cash for the impending acquisition, the net leverage level is forecast to increase to 3x. Management's expectation, however, is to reduce this to 2.5x within 12 - 18 months.
Operating Cash Flow (OCF), Free Cash Flow (FCF), and CAPEX
BDX has delivered strong cash flow in the first half of FY2024 thus giving management the confidence that FY2024 will be another year of double-digit FCF growth.
In the FY2014 - FY2023 time frame, BDX's:
- OCF was (in B$) 1.744, 1.729, 2.559, 2.550, 2.865, 3.330, 3.539, 4.648, 2.634, 2.989, and 2.666 in the first 3 quarters of FY2024.
- CAPEX was (in B$) 0.653, 0.596, 0.693, 0.727, 0.895, 0.957, 0.769, 1.94, 0.973, 0.874, and 0.429 in the first 3 quarters of FY2024.
- FCF was (in B$) 1.091, 1.133, 1.866, 1.823, 1.970, 2.373, 2.770, 3.454, 1.661, 2.115, and 2.237 in the first 3 quarters of FY2024.
YTD FCF increased ~$1.2B YoY to ~$2.2B. This improvement is a reflection of continued improvement in working capital, including continued inventory optimization, planned phasing of certain cash flow items, and the ability to leverage CAPEX.
BDX remains focused on FCF conversion and is on track to deliver a double-digit FCF improvement in FY2024 with an 82% YTD FCF conversion at the end of 3 quarters.
Return On Invested Capital (ROIC)
High quality companies often generate a high ROIC. If a company generates a high ROIC, it needs to invest less to achieve a certain growth rate thus reducing the need for external capital.
When a company consistently generates a high ROIC over the long term and it is growing its revenue, it can reinvest a portion of its profits under favorable conditions thereby leading to a compounding effect. I would much rather invest in a growing company that can reinvest to create greater shareholder value than to invest in a company that has limited growth opportunities and thus chooses to distribute a growing dividend.
A company that generates $0.15/profit for every $1 invested, for example, achieves a ROIC of 15%. I consider a ~15%+ ROIC to be a reasonable minimum threshold because most of the time, a company's cost of capital will be lower than this level. BDX's ROIC in recent years has not come remotely close to 15%!
When I initiated a position on February 11, 2009, my decision was partially based on historical double digit ROIC performance. In FY2009 - FY2014, BDX's ROIC (%) results were 18.85, 18.76, 17.73, 15.56, 15.84, and 13.91.
In 2015, however, BDX acquired. It then acquired C.R. Bard in December 2017. Following these acquisitions, BDX's ROIC (%) plummeted in FY2015 - FY2023 to 7.1, 6.69, 5.09, 1.69, 3.71, 2.99, 5.86, 4.94, and 4.32.
FY2024 Guidance
The following reflects how BDX's FY2024 guidance has changed over the course of the year.
Preliminary FY2025 Outlook
BDX is currently in its FY2025 planning process but has offered the following.
Despite a dynamic environment, management remains confident in BDX's ability to exceed its 25% adjusted operating margin goal and to deliver double-digit EPS growth. The current thought is to model ~10% adjusted diluted EPS growth.
Using the current FY2024 $13.05 - $13.15 range this suggests BDX will forecast ~$14.35 - ~$14.46 when it provides its FY2025 outlook in the next few months.
Risk Assessment
BDX's net leverage ratio (Net Debt/Adjusted EBITDA) at FYE2021, FYE2022, and FYE2023 was 2.6x, 2.8x, and 2.6x. At the end of Q2 and Q3 2024 it was 2.6x and 2.4x. These levels are within BDX's 3.0x target.
There are no changes to BDX's domestic senior unsecured debt ratings from the time of my May 10, 2024 post.
Moody's, Fitch, and S&P Global affirmed their ratings on June 13, 2022, Jun3, 2024, and March 25, 2024, respectively.
All 3 ratings are the middle tier within the lower medium grade category. They define BDX as having an ADEQUATE capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity for BDX to meet its financial commitments.
These ratings are satisfactory for my purposes.
Dividend and Dividend Yield
BDX’s dividend history is accessible here.
Some investors fixate on dividend metrics and may use BDX's track record of 52 consecutive years of dividend increases as a deciding factor to invest in the company.
On July 23, BDX declared its 4th consecutive $0.95 quarterly dividend for distribution on September 30. In early November, the dividend will likely be increased ~$0.04. If this does materialize, the 4 quarterly dividend distributions after the September dividend will total $3.96 (4 x $0.99). Using the ~$236 August 5 closing share price, the forward dividend yield is ~1.67%.
The weighted average number of diluted outstanding shares in FY2011 - 2023 (in millions rounded) is 226, 209, 199, 198, 208, 218, 224, 265, 275, 282, 292, 287, and 288.
The average common equivalent shares outstanding assuming dilution in the first 9 months of FY2024 it was ~291.
In Q1, BDX executed and settled accelerated share repurchase agreements for the repurchase of 2.118 million shares of its common stock for total consideration of ~$0.5B. The purchase was made pursuant to the repurchase program authorized by the Board on November 3, 2021, for 10 million shares for which there is no expiration date.
No shares were repurchased in Q2 and Q3 2024. I anticipate no share repurchases until such time as BDX's net leverage ratio is reduced to 2.5x following the impending acquisition; this is unlikely to be achieved until early/mid-2026.
Valuation
At the time of my May 10, 2024 post, BDX's share price was ~$235. Using adjusted diluted EPS broker estimates, BDX's forward adjusted diluted PE levels were:
- FY2024 - 12 brokers - mean of $13.04 and low/high of $12.98 - $13.09. Using the mean, the forward adjusted diluted PE is ~18.
- FY2025 - 12 brokers - mean of $14.25 and low/high of $14.05 - $14.43. Using the mean, the forward adjusted diluted PE is ~16.5.
- FY2026 - 8 brokers - mean of $15.70 and low/high of $15.34 - $15.97. Using the mean, the forward adjusted diluted PE is ~15.
In FY2023, BDX generated $2.115B of FCF and management was targeting double-digit growth in FY2024; I conservatively selected 11% growth giving me ~$2.348B. In the first half of FY2024, BDX generated $1.119B of FCF meaning it needed to generate ~$1.23B in the second half of FY2024. I thought this would be achievable.
The average common equivalent shares outstanding assuming dilution was 290.344 in Q2 2024. If this increased to ~291 million shares for the entire year, I anticipated BDX would generate ~$8.07 of FCF/share ($2.348B/291 million shares). Dividing the current ~$235 share price by $8.07 resulted in a P/FCF of ~29.1. In comparison, BDX's P/FCF in FY2022 and FY2023 was ~27.7 and ~23.5.
BDX's share price is now ~$236. Using adjusted diluted EPS broker estimates, BDX's forward adjusted diluted PE levels are:
- FY2024 - 15 brokers - mean of $13.08 and low/high of $13.00 - $13.15. Using the mean, the forward adjusted diluted PE is ~18.
- FY2025 - 15 brokers - mean of $14.27 and low/high of $14.02 - $14.45. Using the mean, the forward adjusted diluted PE is ~16.5.
- FY2026 - 11 brokers - mean of $15.59 and low/high of $15.01 - $15.90. Using the mean, the forward adjusted diluted PE is ~15.
Adjusted net income in the first 3 quarters of FY2024 is $2.718B. If BDX conservatively generates ~$0.80B in Q4, FY2024's adjusted net income will be ~$3.518B. An 82% FCF conversion rate is FY2024 FCF of ~$2.885B which is ~$0.537B greater than my prior estimate; BDX's FCF in the first 3 quarters of FY2024 is ~$2.237B so ~$2.885B for the year appears realistic.
The average common equivalent shares outstanding assuming dilution in the first 9 months of FY2024 was ~291 and is unlikely to change much between now and FYE2024. Dividing ~$3.518B of FCF by ~291 million shares is ~$12.10 FCF/share. Divide the current ~$236 share price by ~$12.10 and we get a P/FCF of ~19.50.
This is very different than my prior calculations. BDX now appears to be significantly undervalued.
Final Thoughts
My current exposure consists of 435 shares in a 'Core' account in the FFJ Portfolio.
BDX was my 27th largest holding when I completed my 2023 Year End FFJ Portfolio Review and my 24th largest holding when I completed my 2024 Mid Year FFJ Portfolio Review. When I completed the 2023 YE and 2024 Mid Year reviews, BDX's share price was ~$233 and ~$233, respectively.
As noted at the outset of this post, BDX has not generated a decent return over the past few years. I am not, however, giving up on it now that it is on the path of improved returns.
My desire is to acquire shares in great companies that have stumbled but are likely to recover. BDX is such a company.
I consider shares to be significantly undervalued. Before I increase my exposure, however, I want to analyze the:
- FY2024 results and FY2025 outlook; and
- be certain that the proposed acquisition of the Edwards Lifesciences Critical Care Product Group receives the required regulatory approvals.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long BDX.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
