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Becton, Dickinson and Company (BDX) released Q1 2020 results on February 6th in which FY2020 guidance was lowered because of challenges experienced with its Alaris Infusion product.
Be patient...a broad market pullback is long overdue at which time I encourage you to look closely at BDX as a long-term investment.
Summary
- Investors with a long-term investment time horizon should welcome instances when great companies experience short-term challenges.
- BDX recently released Q1 results and lowered FY2020 guidance as a result of the Alaris pump issue.
- Embrace periods in which a great company’s share price gets hammered because of short-term challenges.
- BDX’s share price has jumped subsequent to the pullback following the release of Q1 results. I think investors can realistically expect another BDX share price pullback and would be wise to practice patience.
Introduction
I initiated a position in Becton, Dickinson and Company (BDX) in February 2009 in an account for which I do not disclose details. Over time I have been reinvesting the quarterly dividends and have occasionally added to my position on weakness.
I like BDX’s long-term prospects and in my November 6, 2019 article I indicated that I initiated a BDX position in one of the side accounts within the FFJ Portfolio at a cost of $248.655/share.
Following that purchase, BDX’s share price appreciated to ~$286 just prior to the release of Q1 2020 results on February 6th, the first day of our vacation in Costa Rica; BDX’s share price plunged to the ~$247 level when Q1 results were released.
I have a long-term positive outlook on BDX so my interest is piqued when I see a plunge in BDX’s share price. I, therefore, set aside some very valuable time from our vacation to delve into the Q1 analyst conference call.
While management readily admits it is experiencing short-term headwinds, the long-term outlook remains positive. As a result, I viewed the share price pullback as an opportunity to increase my exposure and acquired:
- an additional 200 shares for the FFJ Portfolio;
- additional shares in the account which has held BDX shares since 2009.
Full disclosure: the average purchase price of the recently acquired shares was ~$249; I will update the FFJ Portfolio at month end to reflect the acquisition of these additional 200 shares.
Regrettably, BDX’s share price has appreciated to $260.22 level as at the February 14, 2020 but this is earliest I could write/publish this article to disclose my most recent purchases.
Q1 FY2020 Results
BDX’s Q1 2020 results and guidance can be accessed here and here. A high level Infographic can be found here.
Investors seriously considering initiating a position/increasing exposure are encouraged to listen to the analyst call.
If you look at BDX’s financial ratios I would not be surprised if you were somewhat alarmed. The company did, after all, spend billions to acquire Carefusion and C.R. Bard a few years ago which totally threw the Balance Sheet out of whack.
The net value of the Goodwill, Developed Technology, Customer Relationships, Other Intangibles, and Other Assets reflected on the December 31, 2019 Balance Sheet totals ~$39.7B of the Total Assets of ~$52B. It is no wonder the major credit ratings agencies have accorded BDX the credit ratings I reflect further in this article.
Normally, I would shy away from a company with a Balance Sheet such as that sported by BDX. I have made an exception with BDX because I am confident that management is not just paying ‘lip service’ when it states it plans to deleverage the Balance Sheet by the end of 2020 so as to restore an investment grade credit rating.
Another reason why I am prepared to invest in BDX is that this is a company which generates significant Free Cash Flow.
In fiscal 2014, BDX generated ~$1B in Free Cash Flow. Fast forward to fiscal 2019 and it generated just under $2.4B in Free Cash Flow.
Many, many years ago I learned how critical Free Cash Flow is to a company. While Net Income is an important metric, I learned that Free Cash Flow is tantamount to oxygen for humans.
In the case of BDX, the importance of Free Cash Flow is clearly evidenced….
BDX has been experiencing challenges with its Alaris Pump Infusion Module to the extent where there has been a Class 1 recall by the FDA; a Class I recall is the most serious type of recall in that use of the Alaris Pump Infusion Module may cause serious injuries or death.
BDX is, obviously, very concerned about the well-being of patients so in November 2019, management communicated to the investment community that it was planning to make some improvements to the Alaris pump software, including upgrades to alarm prioritization and optimization; management indicated that it was in active discussions with the FDA about the timing and implementation of these improvements.
Relying on its quality process within the infusion business and how the company has managed Alaris software updates over time, the team believed it could take a phased approach to releasing Alaris software updates and that these releases did not require a 510(k) clearance. BDX then issued phase 1 of its software updates in December 2019 and shipment of the Alaris pumps resumed.
Through management’s ongoing dialogue with the FDA, however, BDX learned that the FDA disagreed with BDX’s conclusion about the need for a new 510(k) clearance for these software upgrades.
The FDA has insisted that BDX combine all Alaris software enhancements, recall remediation updates, and changes made to the Alaris system over time into a single comprehensive 510(k) filing! This, however, will not occur until Q4 FY2020; BDX has a September 30th fiscal year end.
In the interim, BDX is actively continuing to collaborate with the FDA to ensure its meets their expectations for this upcoming regulatory submission.
Essentially, what happened is that BDX relied on its infusion quality process and system but subsequently realized the severity of the situation did not meet FDA's expectations.
Management has indicated that BDX continues to stand behind the safety and the clinical benefits of its product, which is used in the care of 70% of patients undergoing infusion therapy.
BDX has provided guidance to customers on how to mitigate potential risks until the software is fully remediated and:
- created a dedicated team of clinical consultants to support live training for healthcare providers;
- will continue to support existing customers to ensure they have access to the Alaris system under medical necessity.
As a result of the Alaris situation, the guidance range has been reduced by ~ $0.4B in revenue and $0.60 in adjusted EPS for fY2020.
While this is certainly not great news, BDX is not a ‘one trick pony’. There are several great things happening with BDX which gives me comfort that my investment in BDX will be beneficial over the long-term.
On the recent February 2020 Q1 conference call, management indicated that various segments of BDX’s business in China are expected to grow double digits during the year. There are also areas in which BDX is doing better than expected such as flu testing, drug-coated balloons, and FX.
In addition to the above, BDX reported Q1 results which were in line with the expectations management shared on the FY2019 analyst call in November. The businesses and the regions delivered solid performance, led by Life Sciences where BDX evidenced an incremental benefit from the flu and the Interventional segment where BDX saw growth from new products.
In Q1, BDX continued to make good progress on the BD-Bard integration. Management has reiterated that cost synergies of ~$0.1B are expected to be delivered this year thus bringing the total to ~$0.3B over the three-year deal period. BDX also continues to scale its commercial programs as part of its commitment to achieve $0.25B in revenue synergies by 2022.
Another strength in FY2020 is BDX’s ability to deliver on a robust pipeline of new products. It has already had 11 new launches in Q1 2020.
In addition to the above, and other initiatives, BDX is entering several new higher growth market spaces with its overall R&D pipeline focused in markets growing 1% to 2% faster than the existing product portfolio.
FY2020 Guidance
Looking at slide 16 of the Q1 2020 earnings presentation we can see a big drop in BDX’s FY2020 revenue and P&L guidance; this is specifically due to the Alaris situation and the revised range reflects several scenarios based on BDX’s ongoing conversations with the FDA. NOTE: the bottom end of the range assumes a very limited ability to ship Alaris pumps in FY2020.
On a segment basis for the full year, BDX now expects BD Medical revenue growth to be flat and BD Life Sciences and BD Interventional revenue growth to be at the high-end of previous guidance ranges of 6% - 7% and 5% - 6%, respectively.
The most recent FY2020 guidance now calls for revenue growth in Q2 of ~2% and EPS of $2.40 - $2.50 which includes a ~$20 million - $30 million headwind from the coronavirus.
Revised FY2020 adjusted EPS guidance (refer slide 17 of the Q1 2020 earnings presentation) now calls for $11.90 - $12.10 which reflects management’s latest view on FX and the impact of Alaris pumps.
Credit Ratings
BDX’s long-term unsecured debt credit ratings are:
- Ba1 (Moody’s) which is the upper tier of 3 tiers in the non-investment 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.
Looking at Moody’s website I see that the last review was conducted May 15, 2019. S&P last reviewed BDX’s rating January 9, 2020. The most recent Fitch rating review I can locate can be found here.
As at FYE2018 (September 30th), BDX’s gross leverage ratio was 3.9 times. On the FYE2019 Earnings Call management indicated that in Q4 ~$0.675B of debt had been repaid and $2B for FY2019! This lowered BDX’s gross leverage ratio to 3.5 times as at FYE (September 30).
In Q1 2020, BDX repaid ~$0.09B of debt; this amount is much less than in some of the more recent quarters.
The gross leverage ratio as at the end of Q1 2020 remained at 3.5 times but management has reaffirmed the company is on track to achieve the commitment to de-lever to below 3 times by December 31, 2020.
Should BDX reduce its leverage ratio below 3 times, I expect the ratings agencies will place BDX’s ratings under review with potentially positive implications.
Dividends and Dividend Yield
BDX’s dividend and stock split history can be found here.
In my previous BDX article I indicated that within the next couple of weeks I expected BDX would announce a dividend increase not greater than $0.02/quarter/share increase. My reasoning was that debt reduction is a greater priority than dividend increases.
Looking at BDX’s dividend history I see that BDX’s quarterly dividend rose from $0.77/share/quarter to $0.79/share/quarter effective with the dividend distributed December 31, 2019.
With BDX trading at $260.22, the $0.79/quarter ($3.16/annually) dividend only amounts to a ~1.2% dividend yield. Many investors will shy away from investing in BDX because of the low dividend yield but investors with a long-term investment time horizon would be wise not to get fixated on the low dividend yield. I continue to be of the opinion that the magnitude of BDX’s dividend increases will increase once BDX achieves a gross leverage ratio below 3 times.
Valuation
In my November 6, 2019 article I disclosed that having just acquired shares at $248.655 and FY2020 adjusted diluted EPS guidance of $12.50 - $12.65 ($12.575 mid-point) having been provided, the forward adjusted diluted PE was ~19.77.
We now see that adjusted EPS guidance for FY2020 has been lowered to $11.90 -$12.10 because of management’s latest view on FX and the impact of Alaris pumps.
I suspect I am much like anyone reading this article…it is wonderful to see a company’s share price get hammered because of short-term headwinds.
Following the release of Q1 2020 results which sent BDX’s shares down over 10%, I decided to acquire additional shares at ~$249. Based on my share purchase price and adjusted EPS guidance, BDX’s valuation range was ~20.58 - ~20.92…not as attractive as that of some of my previous purchases but good enough for a BDX investor with a long-term investment time horizon.
Unfortunately, BDX’s share price has surged to $260.22 subsequent to my most recent purchase and the forward adjusted PE range is ~21.51 - ~21.87.
Final Thoughts
I have stated in previous articles that I:
- look upon BDX as a solid long-term investment, and therefore, acquire additional shares when I view valuation as being at the very least…’fair’;
- increased my exposure to BDX after its long-term credit rating was lowered to non-investment grade as a result of the elevated leverage attributed to the use of debt to acquire Carefusion and C.R. Bard because I viewed these acquisitions as strategic and beneficial for BDX over the long-term.
While BDX’s long-term credit rating has not been revised by the ratings agencies despite the gross leverage ratio having been reduced to ~3.5 times from ~3.9 times as at FYE2018, I anticipate an investment grade will be assigned to BDX’s unsecured long-term debt no later than early 2021 if the balance sheet does get de-levered to below 3 times by December 31, 2020.
As evidence of my long-term positive outlook for in BDX, my total BDX exposure in all accounts is more than double than in the accounts for which I do disclose details.
Having said this, I am of the opinion investors should be cautious in this environment. Regrettably I was in no position to post an article on a timely basis disclosing my most recent purchase and BDX’s share price has surged in recent days.
I most certainly have no ‘crystal ball’ but am of the opinion another pullback in BDX’s share price will present investors with an opportunity to acquire shares at a slightly more attractive valuation than the current level.
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.
