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Becton, Dickinson and Company (BDX) released Q1 2021 results on February 4th in which FY2020 guidance was increased.
BDX has reduced its debt to the extent where Moody's has raised the company's senior unsecured long-term debt rating to an investment grade level after it had been downgraded following two major acquisitions in 2015 and 2017.
On the Q1 earnings call management indicated that a significant amount of the company's free cash flow in the last couple of years was dedicated to repaying debt. Going forward management expects the company will have greater flexibility to refocus cash deployment and growth opportunities, including tuck-in M&A and other capital deployment options.
Summary
- BDX has generated strong free cash flow in the last couple of years and in Q1 2021 thus enabling it to reduce its debt.
- Moody's has just recently upgraded BDX's senior unsecured long-term debt to investment grade level. All 3 major ratings agencies now rate BDX investment grade.
- Overall the company has fared well through the COVID-19 pandemic.
- The currently valuation is reasonable based on FY2021 adjusted diluted EPS guidance which has recently been revised upwards.
Introduction
In February 2009 I initiated a position in Becton, Dickinson and Company (BDX) in an account for which I do not disclose details. Subsequently, BDX has undergone a significant transformation with the completion of the ~$12.2B Carefusion acquisition in March 2015 and the ~$24B acquisition of C.R. Bard in December 2017. I was apprehensive about the debt taken on to fund these acquisitions especially given that the major ratings agencies had lowered BDX's long-term unsecured debt ratings to non-investment grade.
In recent years I have increased my holdings on the expectation that BDX would be a much stronger company in the future. In fact, when I ranked all my holdings by dollar value in August 2020 BDX was my 3rd largest holding.
With BDX having released Q1 2021 results on February 4th and having provided updated FY2021 guidance I now take this opportunity to review the company.
Q1 FY2021 Results
BDX’s Q1 2021 results and guidance can be accessed here. The Q1 earnings presentation and the January 26, 2021 AGM presentation can be accessed here.
Looking at the Consolidated Statements of Cash Flows in the FY2019 10-K (page 56 of 199), the FY2020 10-K (page 58 of 147), and the Q1 2021 10-Q (page 6 of 41) we see that BDX was a prolific user of cash in F2015 and FY2017 which are the years in which it made its significant acquisitions; under Financing Activities we see sizable 'Proceeds from long-term debt'.
Looking at the Consolidated Statements of Cash Flows in the FY2020 10-K we see that BDX raised ~$2.9B in 'Proceeds from issuance of equity securities'. This occurred in May 2020 and details can be found here. This resulted in an increase in the 'Average common and common equivalent shares outstanding' from 274,775 thousand in 2019 to 282,402 thousand in 2020 (refer page 66 of 147 in the FY2020 10-K) and a reduction in Treasury shares (refer page 57 of 147 in the FY2020 10-K).
If we look at page 28 of 41 in the Q1 2021 10-Q we see the financial covenants which stipulate the leverage coverage ratio conditions. Under the terms and conditions of the financing arrangements related to the acquisitions, BDX had to reduce its debt or risk being in default of a key term and condition of its financing agreement.
On the Q1 call with analysts, the company's CFO indicated:
'As we've been discussing, our BDX 2025 strategy includes a focus on driving cash flow and we were really pleased with the continued progress of these initiatives in our cash flow performance. We generated $1.5B in cash flow from operations in the quarter and $1.3B in free cash flows. We have also been focused on strengthening our balance sheet. As we previously communicated, we paid down $0.265B of debt in the first fiscal quarter. Our net leverage ratio declined to 2.5 times as of December 31, 2020 from 3.0 times at the end of September 2020.'
BDX's Non-GAAP Net Debt Leverage Reconciliation can be found on page 38 of 42 in this February 4th Q1 2021 Overview & Financial Supplement.
My FCF figure differs slightly from that presented by the company's CFO because I take 'Net Cash Provided by Operating Activities' and subtract 'Capital Expenditures' and 'Change in credit facility borrowings', 'Proceeds from long-term debt and term loan', 'Payments of debt and term loans'. This gives Q1 FCF of $1.02B which I calculate as follows: $1.533B - $0.246B - $0.267B.
On the Q1 earnings call management indicated:
'we believe we're approaching a turning point in our capital allocation. In the past, a significant amount of our cash was dedicated to repaying the debt. But looking ahead, we expect to have greater flexibility to refocus our cash deployment and growth opportunities, including tuck-in M&A and other capital deployment options.'
Looking at pages 93 and 94 of 147 of the FY2020 10-K we see that BDX has $0.701B of debt due June 4, 2021 and $1.008B due November 28, 2021. In 2022 debt totalling $2.88B is due. If BDX can continue to generate free cash flow to the magnitude generated in Q1 2021 I envision this debt being retired...a step in the right direction to returning to the Baa2 rating Moody's had assigned prior to the major acquisitions; this debt reduction would be in addition to the deployment of funds toward growth opportunities.
FY2021 Guidance
BDX's revised FY2021 guidance can be found here.
FY2021 adjusted diluted EPS is now expected to be $12.75 - $12.85 compared to prior $12.40 - $12.60 guidance. This represents growth of approximately 25% - 26% over FY2020 adjusted diluted EPS of $10.20, and includes a contribution of ~100 basis points from foreign currency compared to prior guidance of ~50 basis points. On a currency-neutral basis, adjusted diluted EPS are expected to grow 24% - 25%.
Credit Ratings
Recently, Moody's upgraded BDX's long-term debt credit rating from Ba1 to Baa3 so now the 3 major ratings agencies rate BDX's debt as investment grade.
- Baa3 (Moody’s) which is the lowest tier within the lower medium grade category;
- BBB (S&P) which is the middle tier of 3 tiers within the lower medium grade category;
- BBB- (Fitch) which is the lowest of 3 tiers in the lower medium grade category.
On the Q1 earnings call, management indicated that the company is committed to maintaining a full investment grade credit rating across the major credit rating agencies.
Dividends and Dividend Yield
BDX’s dividend and stock split history can be found here. We can expect 3 more quarterly $0.83/share dividend payments and with the improvement made in BDX's debt and liquidity positions I envision that dividend increases may return to the $0.05 - $0.06/share/quarter range as opposed to $0.02/share/quarter we have witnessed in recent years. If BDX's share price remains relatively constant (eg. ~$255) come December and the quarterly dividend is increased to $0.89/share/quarter, the dividend yield would be ~1.4% versus the current ~1.3%. This will certainly not excite dividend yield hungry investors but an investment in BDX should not be viewed primarily from a dividend income perspective. Capital appreciation is more likely to be the manner in which long-term investors will be rewarded from an investment in BDX.
Valuation
In Q1 2021 BDX generated $3.35 in diluted EPS but management specifically stated on its Q1 earnings call that investors should NOT extrapolate Q1 revenue margin and EPS performance going forward. Q1 revenues, operating margins and adjusted EPS, are likely to be the highest absolute levels for the year for various reasons.
So, while we should not expect similar results in the remaining quarters, we should not expect the low EPS levels reported in the most recent fiscal years to be replicated in FY2021.
Were we to make our investment decision on the basis of FY2020 diluted EPS of $2.71 and the current ~$254.70 share price we would get a PE of ~94. We need to, however, account for various adjustments to FY2020's earnings as found at the bottom of BDX's Q1 2021 earnings release.
Since BDX only provides adjusted diluted EPS guidance and BDX has increased this guidance to $12.75 - $12.85 and guidance from 18 brokers calls for an adjusted mean diluted EPS of $12.77 and a $12.40 - $13.01 range I estimate that BDX's current PE based on adjusted earnings is ~20 if I use the current ~$254.70 share price and $12.75 in earnings; this level is relatively similar to when I acquired BDX shares in the past. I continue to have a positive long-term outlook on BDX and view the current valuation based on FY2021 guidance to be sufficiently reasonable to recommend the acquisition of shares if you are a long-term buy and hold investor looking for capital gains potential and dividend income is not a priority.
Final Thoughts
I currently hold BDX shares in two accounts. One account is a retirement account for which I do not disclose details. I am not adding funds to this account because I need to commence a Registered Retirement Savings Plan (RRSP) meltdown strategy shortly. If I do not start withdrawing funds before I must convert this account to a Registered Retirement Income Funds in another decade I will find myself being forced to withdraw funds at the highest tax bracket.
The other account which holds BDX shares is one of the 'Side' accounts within the FFJ Portfolio. At the moment I do not currently have any meaningful amount of money in this account to add to my BDX position.
I am looking to increase existing positions in other high quality companies in the accounts which currently hold cash so while I like BDX's current valuation and recommend you consider this potential investment, I will not be acquiring additional BDX shares at this time. Having said this, BDX is one of my top 10 holdings so I stand to benefit from what I think will be a bright future.
Stay safe. Stay focused.
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 individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own 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.
