Contents
Summary
- BDX released Q4 and FY2019 results on November 5th with adjusted EPS coming in at the low end of guidance.
- Company reduced gross leverage ratio to 3.5 times as of September 30 (down from 3.9 times as at FYE2018) and is on track to achieve commitment to delever below 3 times by December 2020.
- I expect non-investment grade speculative long-term credit rating assigned by 3 major credit rating agencies to be raised to lowest investment grade tier by early 2021.
- I envision a ~2.6% increase in the quarterly dividend to $0.79/share to be announced mid-November. Once investment grade credit rating restored we can realistically expect low double digit percentage increase in quarterly dividend to be restored. This rate of increase was common prior to CareFusion and C.R. Bard acquisitions.
- I have increased my exposure to BDX following recent share price pullback.
Introduction
Readers unfamiliar with Becton, Dickinson and Company (BDX) are encouraged to access the most recent 10-K (currently FY2018) in which a comprehensive overview of the business and risks (amongst other things) can be found.
I have previously written articles on this existing holding at Financial Freedom is a Journey with the most recent article entitled ‘Market Volatility Should Produce Buying Opportunities’ having been posted on August 6th.
I initiated a position in an account for which I do not disclose details in February 2009 and have periodically added to my position over the years.
After having owned BDX shares for several years and having made periodic additional share purchases it came to a point where I needed to look more closely at BDX’s financial statements. Readers familiar with BDX will know that BDX as a company changed significantly following the acquisition of CareFusion Corporation and the subsequent acquisition of C. R. Bard, Inc..
While these acquisitions made perfect sense from a strategic standpoint, I will not deny that (being the risk averse investor I am) the leveraged balance sheet following these two acquisitions had me thinking whether I should liquidate my position until the degree of risk was reduced to a level I deemed more acceptable for my purposes.
After delving further into the rationale for the acquisitions and listening to how management intended to deleverage the balance sheet in a reasonable period of time, I decided to retain my position. In fact, I have periodically acquired additional shares and for the first time, I have acquired shares for one of the Side Accounts within the FFJ Portfolio; I acquired 200 shares on November 6th @ $248.655 so I now hold shares in undisclosed accounts and in an account for which I publicly provide information.
Q4 and FY2019 Results
On November 5th, BDX released its Q4 and FY2019 results and provided FY2020 guidance (see here and here). A high level Infographic can be found here.
When Q3 results were released, full year guidance called for adjusted diluted EPS of $11.65 - $11.75 representing growth of ~12% on a currency-neutral basis over FY2018 adjusted diluted EPS of $11.01 (growth of ~ 6% - 7% including the estimated unfavorable impact of foreign currency).
With FY2019 adjusted diluted EPS having come in at $11.68 (the low end of the range provided when Q3 results were released) it is understandable why BDX’s share price has taken a hit following the release of FY2019 results.
If you look at the Q4 and FY2019 Earnings Release you will see multiple adjustments. Exclude all the adjustments and you get diluted EPS of $3.89 which is $7.79 less than adjusted results. I know some readers may find this alarming but some of these line items should disappear within the next 1 – 2 years (unless BDX decides to make another significant acquisition).
In my previous article I wrote that, as anticipated, BDX's results included a reduction of ~50% in planned Lutonix drug-coated balloons (DCB) related sales in Q3; BDX gained the Lutonix DCB business when it acquired C.R. Bard in 2018; DCBs represented an estimated $0.2B in sales and were among the company’s faster-growing product-lines.
Not everything always goes as planned!
DCB sales took a hit due to safety concerns that emerged in December 2018 and grew after the January and March FDA advisory letters.
In June 2019, the FDA released an update to its March 2019 Letter to Healthcare Providers on the subject matter of DCBs.
BDX followed up this FDA Press Release with the following Press Releases (see here, here, and here).
While this matter has yet to be fully resolved, I see that BDX has announced its plan to close in 2020 a Minnesota plant that makes its Lutonix drug-coated balloon. This does not mean BDX is getting out of this business entirely but rather that it is looking to consolidate its peripheral intervention business (aka improved efficiency and cost cutting so as to improve profitability).
The DCB business is a very small segment of BDX’s business so I encourage readers not to be alarmed.
I do, however, always have some concern when a healthcare company sells a product which has unintended consequences. I will continue to monitor this situation.
FY2020 Guidance
BDX’s FY2020 outlook and guidance is only provided on an adjusted basis; FY2020 adjusted diluted EPS guidance is $12.50 - $12.65.
Source: BDX – Q4 and FY2019 Earnings Presentation – November 5 2019
Credit Ratings
BDX’s credit ratings (BBB (S&P) BBB-(Fitch) Ba1 (Moody’s)) place it in the top tier of the non-investment grade speculative category.
Obviously I was not the only investor whose eyebrows were raised when the non-investment grade speculative ratings were assigned as BDX provides a quarterly update on its de-leveraging progress.
As at FYE2018 (September 30th), BDX’s gross leverage ratio was 3.9 times. When I wrote my August 6th article in which I touched upon BDX’s debt reduction progress, Q3 2019 gross leverage had been reduced to 3.7 times following a ~$0.45B debt reduction in the quarter.
On the Q4 and FY2019 Earnings Call, management indicated that in Q4 ~$0.675B of debt had been repaid and $2B for FY2019! As a result, the gross leverage ratio declined to 3.5 times as at FYE (September 30). Management also reiterated that it is on track with its commitment to delever below 3 times over the three years ending December 2020.
As a risk adverse investor I find it encouraging that BDX is on track to do what it indicated it would do when the C.R. Bard acquisition was announced. I continue to be of the opinion that we are long overdue for weaker economic conditions (and a broad market pullback) and BDX would be wise to have a strong balance sheet before times get tough.
I am also of the opinion that BDX may have been excluded as a potential investment by many because its debt is non-investment grade. I suspect the major credit ratings agencies will be revisiting the long-term credit rating assigned to BDX within the next 12 months and we will very likely see a one notch improvement in their respective rating (investment grade…finally!). Once this happens, I suspect the demand for BDX shares will increase.
Dividends and Dividend Yield
BDX’s dividend and stock split history can be found here.
Within the next couple of weeks I expect BDX will announce a dividend increase and am not expecting anything more than a $0.02/quarter/share increase as debt reduction is currently the focus ($0.77/share/quarter increasing to $0.79/share/quarter).
I encourage investors who focus heavily on a company’s dividend not to overlook BDX as a potential investment. I think that the magnitude of the dividend increases will improve once management has reached its deleveraging target.
Having acquired additional shares $248.655 and the current dividend being $0.77/share/quarter, we get a dividend yield of ~1.24%. The $0.02/share/quarter dividend increase I anticipate is nothing to write home about but….be patient. Look at BDX’s dividend history. Let time work in your favor. This company is very likely to continue to generate strong free cash flow and to continue to generate profits. The dividend will grow. Give it time.
Valuation
At the time of my January 10, 2018 article, a dozen analysts had projected FY2018 adjusted diluted EPS of $10.87. Based on the ~$223.7 closing stock price, the forward adjusted diluted PE was ~20.6.
When I wrote my January 30, 2018 article, BDX was trading at $246.28. Using the unchanged projected FY2018 adjusted diluted EPS for FY2018 I arrived at a forward adjusted diluted PE of ~22.66.
In my November 6, 2018 article I noted that BDX was trading at $240.69 and that FY2019 adjusted diluted EPS guidance of $12.05 - $12.15 had just been released. Using the $12.10 mid-point I arrived at a forward adjusted diluted PE of ~19.9.
When I wrote my February 6, 2019 article, Q1 2019 adjusted diluted EPS guidance reflected no change from the November 6th guidance. Shares were trading at ~$242.50 giving us a forward adjusted diluted PE of ~20.04.
When I wrote my May 12, 2019 article, BDX had just reported Q2 2019 and FY2019 results and had lowered adjusted diluted EPS guidance to $11.65 - $11.75 ($11.70 mid-point). With shares trading at $225.40 I arrived at a forward adjusted diluted PE of ~19.26.
At the time of my August 6, 2019 article, BDX was trading at $242.14 and adjusted diluted EPS guidance was $11.65 - $11.75 ($11.70 mid-point) giving us a forward adjusted diluted PE of ~20.7.
FY2020 adjusted diluted EPS guidance is $12.50 - $12.65 ($12.575 mid-point) and I just acquired shares at $248.655 so the forward adjusted diluted PE is ~19.77. I view this as an attractive level.
Option Strategy
With the volatility in BDX’s share price I have previously taken the opportunity to write covered calls on my underlying BDX shares.
In my March 21st article I wrote how I lucked out on a few March 15th $250 covered call contracts on which I received $1.90/share. In a nutshell, BDX closed slightly above this strike price and I let the shares get called away. As luck would have it, the Lutonix issue hit the news and BDX’s share price took a nosedive. This provided me with the opportunity to collect $250/share under the terms of the option contract and to turn right around and to acquire the same number of shares on the open market at $243.81. I essentially came out ahead $6.19/share by being wrong. Pure luck!
I am open to writing more covered calls but with the recent share price pullback, I do not view this as an opportune time to do so. I will continue to monitor BDX and should an opportunity present itself for me to write more covered calls then I will revisit this short-term income producing strategy.
Final Thoughts
I strongly suspect a great number of investors have never experienced a significant broad market downturn and will be in for a rude awakening should one occur. It is not for me to tell what one should do but from a personal standpoint….losing money is a harder pill to swallow than to make money slowly (patiently?).
Having lived through prolonged major market downturns I find it is far easier to sleep well at night if you are invested in high quality companies which provide products/services people TRULY need. Personally, I am far more inclined to spend money on products/services that will improve my health than products which are non-essential. As a result, BDX is the type of company which appeals to me.
I readily admit I am not wild about BDX’s non-investment grade credit rating. I am, however, encouraged that management is keeping to its commitment to deleverage the balance sheet and I fully expect an investment grade will be assigned to BDX’s unsecured long-term debt no later than early 2021.
Since I view BDX as a high quality company I have been willing to stick by it as it integrates the two companies is acquired a few years ago. I fully expect BDX will be a much stronger company in the not too distant future and that investors will be rewarded with a company with a better credit rating and with dividend increases that are superior to those evidenced in the timeframe during which debt reduction has been a priority.
Given the above, I continue to be long BDX in undisclosed accounts and, as previously noted, I have initiated a BDX position in the FFJ Portfolio.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long BDX.
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.
