Contents
Rating upgrades and recent acquisitions and divestiture mean Becton Dickinson (BDX) has a lower risk profile and superior growth prospects.
I last reviewed Becton Dickinson (BDX) in this November 13, 2021 post. At the time, BDX had announced its intent to spin off its Diabetes Care business as part of its 2025 Strategy - Grow, Simplify, and Empower strategy; details of the spin-off completed on April 1, 2022 are found here.
As a BDX shareholder, I received 1 common share in the newly formed entity Embecta Corp (EMBC) for every 5 BDX shares I held. Once I had an opportunity to analyze this new stand-alone entity, however, I exited my position and disclosed this in my June 7, 2022 post.
The Diabetes Care business only represented ~6% of BDX's total annual revenue. Nevertheless, the present BDX differs from the BDX in recent prior years so we can not merely compare historical results to BDX's current results and guidance. Fortunately, the Q3 and YTD performance and FY2022 guidance reflect BDX’s results on a continuing operations basis; the business spun-off into EMBC is excluded.
Following the spin-off, BDX has completed a couple of acquisitions to grow, improve margins and profitability, and enhance shareholder returns during FY2022 - FY2025. It also released Q3 and YTD 2022 results and FY2022 guidance on August 4, 2022. This is, therefore, a good opportunity to revisit BDX.
Business Overview
BDX is a global medical technology company engaged in the development, manufacture and sale of a broad range of medical supplies, devices, laboratory equipment and diagnostic products used by healthcare institutions, physicians, life science researchers, clinical laboratories, the pharmaceutical industry and the general public. Its organizational structure is based upon three principal business segments:
- BD Medical;
- BD Life Sciences; and
- BD Interventional.
A description of each segment is accessible here.
A good overview of the company is found in the Q3 Form 10-Q commencing on page 25 of 50.
BDX 2025 Strategy - Grow, Simplify, and Empower
A high-level overview of BDX's 2025 strategy is included in this comprehensive 2021 Investor Day Presentation.
In FY2022, BDX has continued to execute its tuck-in M&A strategy and has committed over $2B to the completion of 6 acquisitions. The following are the most 2 recent acquisitions.
Parata Systems Acquisition
Shortly after the end of Q3, BDX announced the completion of the acquisition of Parata Systems for $1.525B in cash from Frazier Healthcare Partners, a leading private equity firm focused exclusively on the healthcare sector.
BDX is seeing the acceleration of macro trends across the industry and the growing demand for pharmacy automation solutions which Parata's portfolio addresses. These macro trends include the centralization of pharmacy services in large fulfillment centers and increased clinical demands on pharmacists and hospital and retail settings. In addition, there is increased wage inflation, labour attrition and a large percentage of pharmacists reporting burnout.
This acquisition advances BDX's 2025 strategy by expanding its transformative solutions to provide new pharmacy automation technologies for hospitals, retail pharmacies, long-term care and home settings. Parata Systems provides BDX with access to a new $0.6B pharmacy automation market segment. Expectations are for ~10% annual growth to $1.5B in the US alone over 10 years.
Parata's portfolio of innovative pharmacy automation solutions powers a growing network of pharmacies to:
- reduce costs;
- enhance patient safety; and
- improve the patient experience.
By automating the more routine work within a pharmacy and implementing intelligent workflow solutions, pharmacists can focus on higher-value clinical work to improve medication adherence, patient safety and outcomes.
MedKeeper Acquisition
On July 28, BDX announced the acquisition of MedKeeper, a provider of modern, cloud-based pharmacy management applications. MedKeeper is a relatively small private company that has created solutions in compounding, logistics workflow, controlled substance management and inventory optimization.
Terms of the acquisition are unavailable. My sources, however, suggest its annual revenue is ~$15 - $20 million so the purchase price is likely far less than that paid to acquire Parata Systems.
BD Alaris Pump Remediation
As noted in previous posts, BDX is working with the US Food & Drug Administration (FDA) and is currently initiating remediation of existing Alaris system devices in the field.
The most current information on this matter is on page 37 of 50 in BDX's Q3 Form 10-Q.
Financials
Q3 and YTD2022 Results
On August 4, 2022, BDX released Q3 and YTD results and revised FY2022 guidance. Material related to this earnings release is accessible here.
BDX's R&D focus is on:
Over 60% of BDX's R&D investments are now in high-growth areas.
Several medical industry participants have indicated there is evidence of constrained capital spending amidst recessionary concerns. BDX, however, is not impacted to the same extent in that its revenue base is 85% recurring. It is well positioned with only a small percentage of revenues attributed to capital placements or instruments.
The following images provide a high-level overview of the breakdown of BDX's Q3 revenue.
Source: BDX - Q3 2022 Earnings Presentation - August 4, 2022
Source: BDX - Q3 2022 Earnings Presentation - August 4, 2022
Headwinds
The entire medical industry continues to face supply chain constraints and increased inflationary pressure. However, BDX has over the past 2+ years, made investments to institutionalize improvements in supply chain resilience. These investments are having a positive impact on its overall cost-effectiveness, responsiveness, and sustainability.
It has, for example, continued its long-standing investments to systematically validate secondary suppliers for the most critical products. BDX has also made additional investments to increase inventory to secure the availability of critical raw materials and componentry. This includes chips that have allowed it to deliver strong growth in areas such as BDB instruments.
Furthermore, BDX is contracting directly with shippers to ensure continuity of supply for its customers.
China
The impact of restrictions has lasted longer than anticipated but BDX's recovery has been faster than projected with a strong rebound in June.
Beyond the recovery of hospital patient flow, BDX initiated several actions to continue manufacturing and keep warehousing largely operational. It has worked closely with its stakeholders in China to help secure key logistics capacity for itself and its suppliers.
Continued strength in China in Q4 is expected. Assuming no additional COVID waves occur, BDX is on track to deliver double-digit revenue growth.
Operating Cash Flow (OCF) and Free Cash Flow (FCF)
BDX has generated YTD OCF of $1.498B and has incurred YTD CAPEX of $0.658B resulting in ~$0.840B of YTD FCF.
BDX's Q3 cash flow from operations reflects a ~$0.4B higher-than-normal inventory balance. This is because BDX purposely continued with its strategic investments in raw materials, such as electronic components. This higher inventory level is part of the company's actions to optimize product delivery to meet customer demand in this uncertain environment.
FY2022 Guidance
Despite the impact of increased inflation, BDX is seeing a larger benefit from its offsetting initiatives.
The updated guidance reflected below assumes share repurchases will, at minimum, offset any dilution from share-based compensation; guidance assumes no material change in shares outstanding.
The Parata acquisition has an accretive margin profile but guidance calls for this accretion to be offset by one-time deal-related costs.
Source: BDX - Q3 2022 Earnings Presentation - August 4, 2022
Source: BDX - Q3 2022 Earnings Presentation - August 4, 2022
On the Q3 earnings call, management indicated it is premature to provide FY2023 guidance given the uncertain macro environment. However, expectations are that the challenges will not worsen. Secondly, there may be some modest relief from some of the current supply chain complexity toward the second half of the fiscal year. Guidance will be provided in November when FY2022 results are released.
For now, the assumption is that the COVID-only testing revenues and related earnings will be significantly below FY2022 levels. BDX, however, will have a positive contribution from the full-year benefit of revenue and income from Parata Systems that will partially offset the reduced COVID testing revenue and earnings. Therefore, despite the anticipated reduction in COVID-only testing earnings, adjusted EPS growth is expected to be in the double-digits.
Credit Ratings
In April 2017, BDX announced its proposed acquisition of C.R. Bard. A the time of the announcement this acquisition implied that BDX's Pro forma leverage ratio would be ~4.7x the last 12 months' adjusted EBITDA. The commitment, however, was to deleverage to below 3x over 3 years; the acquisition closed in December 2017.
We now see that in Q3, BDX repaid ~$0.5B in debt and it ended the quarter with a strong cash balance of $2.6B and a net leverage ratio of 2.7x.
This significant improvement in BDX's financial position has restored BDX's domestic senior unsecured debt ratings to investment grade levels.
- Baa2 (Moody’s) is the middle tier within the lower medium grade category - upgrade from Baa3 on June 13, 2022;
- BBB (S&P) is the middle tier within the lower medium grade category;
- BBB (Fitch) is the middle tier within the lower medium grade category - upgrade from BBB- on June 17, 2022.
These ratings 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
One of BDX's shareholder value creation policies is to target a ~30% dividend payout ratio.
BDX’s dividend and stock split history can be found here. The distribution of the 4th consecutive $0.87 quarterly dividend will be on September 30, 2022. With shares trading at ~$254.20, the current dividend yield is ~1.37%.
When I wrote my prior post, BDX had recently announced a $0.04 increase in its quarterly dividend ($0.83 to $0.87) effective with the dividend payable on December 31. This dividend increase marked the 50th consecutive year in which BDX increased its dividend. With shares trading at ~$244, the forward dividend yield was ~1.4%.
BDX's fiscal year end is September 30 and I expect a ~$0.03 - $0.04 dividend increase in the quarterly dividend when BDX releases its FY2022 results in early November.
BDX should be able to service this higher dividend from cash flow generated from normal business operations.
The weighted average number of outstanding shares in FY2011 - 2021 (in millions rounded) is 226, 209, 199, 198, 208, 218, 224, 265, 275, 282, and 292. The average common and common equivalent shares outstanding for the 9 months ending June 30 is ~287.4.
The Q3 2022 Condensed Consolidated Statements of Cash Flows reflect no YTD share repurchases. The reason the number of shares outstanding as of June 30 is lower than the figure for FY2021 is that these figures are weighted averages. BDX repurchased $1.75B of shares in FY2021 ($1B in Q3 and $0.75B in Q4).
Valuation
When I wrote my February 5, 2021 post, adjusted diluted EPS guidance had been raised to $12.75 - $12.85. In addition, FY2021 adjusted diluted EPS guidance from 18 brokers was a mean of $12.77 and a low/high range of $12.40 - $13.01.
BDX was trading at ~$254.70 thus giving us a forward adjusted diluted PE of ~20 using the mid-point of management's guidance and ~19.6 if we used the high end of analyst guidance.
When I published my August 6, 2021 review, BDX was trading at ~$241. Using the $12.90 mid-point of management's $12.85 - $12.95 guidance, the forward adjusted diluted PE was ~18.7.
Using this share price and FY2021 - FY2023 guidance from the brokers which cover BDX resulted in the following projected adjusted diluted PE levels:
- FY2021 - 19 brokers - mean of $12.87 and low/high of $12.80 - $13.00. Using the mean, the forward adjusted diluted PE was ~18.7.
- FY2022 - 19 brokers - mean of $12.64 and low/high of $12.00 - $13.60. Using the mean, the forward adjusted diluted PE was ~19.1.
- FY2023 - 13 brokers - mean of $13.83 and low/high of $13.40 - $14.71. Using the mean, the forward adjusted diluted PE was ~17.4.
When I published my November 13, 2021 post, management's FY2022 adjusted diluted EPS guidance was $12.30 - $12.50. Using the $12.40 mid-point and the current ~$244 share price, the forward adjusted diluted PE was ~19.7.
The following were the projected adjusted diluted PE levels based on current FY2022 - FY2023 broker guidance:
- FY2022 - 12 brokers - mean of $12.38 and low/high of $12.10 - $12.44. Using the mean, the forward adjusted diluted PE was ~19.7.
- FY2023 - 11 brokers - mean of $13.68 and low/high of $13.43 - $14.00. Using the mean, the forward adjusted diluted PE was ~17.8.
Shares are now trading at ~$254.20 and the FY2022 adjusted diluted EPS guidance is $11.28 - $11.35. On this basis, the forward adjusted diluted PE range is ~22.45.
Using this share price and FY2022 - FY2024 guidance from the brokers which cover BDX, the following are the projected adjusted diluted PE levels:
- FY2022 - 12 brokers - mean of $11.50 and low/high of $11.17 - $12.90. Using the mean, the forward adjusted diluted PE was ~22.1.
- FY2023 - 15 brokers - mean of $12.28 and low/high of $12.08 - $12.86. Using the mean, the forward adjusted diluted PE was ~20.7.
- FY2024 - 9 brokers - mean of $13.62 and low/high of $13.32 - $13.91. Using the mean, the forward adjusted diluted PE was ~18.7.
In the coming days, I expect marginal reductions in these ranges that will lead to a slight increase in BDX's valuation.
The rationale for the spin-off of the Diabetes Care business spin-off was to transform BDX into a faster-growing and higher-margin company. We, therefore, should not expect BDX's valuation based on forward-adjusted earnings estimates to be similar to historical levels.
Final Thoughts
I started acquiring BDX shares in one of our retirement accounts in February 2009 and have added to my position over the years. In addition, I initiated a position in November 2019 in one of the 'Side' accounts within the FFJ Portfolio.
BDX was my 5th largest position at the time of my Mid-2022 Investment Holdings Review. It was also my 5th largest holding when I completed a similar review at the beginning of January 2022 and mid-April 2021. It was my 3rd largest holding when I completed my mid-August 2020 review.
Following BDX's March 2015 acquisition of Carefusion and the December 2017 acquisition of C.R. Bard, BDX's total investment return with the reinvestment of dividends has lagged the broad S&P500 index by ~2%. In addition, following these acquisitions, BDX's credit ratings were lowered to 'non-investment grade'. I debated on whether to exit my position but decided to give management the benefit of the doubt; management lay out a game plan as to how it was going to improve investor returns and its credit ratings.
I am grateful I did not exit my position because what management communicated to the investment community has transpired. The company's credit ratings are now investment grade and expectations are for BDX to generate higher growth and higher margins.
I like BDX's long-term outlook, however, shares appear to be fairly valued. The plan is to increase my exposure through the automatic reinvestment of quarterly dividends and to increase my exposure to companies that are temporarily out of favour.
I wish you much success on your journey to financial freedom!
Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long BDX.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
