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Following the spin-off of the slower-growth Diabetes Care business, you can expect more rapid growth from undervalued Becton Dickinson (BDX). I caution you not to compare the current and historical BDX because the company is much different from recent prior years and its credit risk is much improved.
I last reviewed BDX in this August 7, 2022 post at which time BDX had recently released Q3 and YTD2022 results. We now have Q4 and FY2022 results and FY2023 guidance. I, therefore, take this opportunity to revisit BDX.
Business Overview
A business overview is provided in my previous post.
BD Alaris Pump Remediation
BDX continues to work with the US Food & Drug Administration (FDA) and is currently initiating remediation of existing Alaris system devices in the field. Details are accessible here.
Financials
Q4 and FY2022 Results
As I compose this post, BDX has yet to release its FY2022 Form 10-K. We do, however, have its Form 8-K and Earnings Presentation.
At BDX's November 2021 Investor Day, senior management outlined its plan to build sustained shareholder value creation in five key focus areas. The following summarizes the progress made to achieve this plan.
BDX continues to reshape its portfolio by advancing its innovation pipeline and M&A strategy toward higher-growth markets. In FY2022, it continued to transform the innovation pipeline with ~60% of new product development invested in three high-growth market spaces that are reshaping healthcare and helping to fuel our growth.
BDX also deployed over $2B in FY2022 toward 6 tuck-in acquisitions, all of which are allocated toward higher growth markets. This includes Parata Systems, BDX's largest acquisition since C.R. Bard. This acquisition is aligned with BDX's focus on smart, connected care and enabling new care settings. Parata makes BDX the global leader in the fast-growing pharmacy automation market and enables it to provide solutions to help pharmacies address rising costs and labour shortages.
BDX also made significant progress in FY2022 to simplify its operations. As a result, it was able to absorb significant increases in inflation during the year and improved its margin profile back toward pre-pandemic levels of 25% by FY2025.
The company paid down $0.5B in long-term debt and returned $1.6B in capital to shareholders through dividends and share repurchases. It also ended the year with a cash balance of ~$1B.
The following reflects BDX's FY2022 P&L highlights.
Source: BDX Q4 2022 Earnings Presentation - November 10, 2022
On the cash and capital allocation front, cash flows from operations totalled ~$2.5B in FY2022. Operating cash flow reflects a higher inventory balance of about $0.6B YoY. The increase reflects the impact of inflation, longer in-transit lead times, and strategic investments in raw materials to optimize product delivery to meet customer demand.
In FY2022, BDX made progress on organic innovation which is a key enabler to its growth strategy. The innovation pipeline was significantly enhanced with the launch of 25 key new products. This is in keeping with the company's plans to achieve new product revenue contribution and to increase the portfolio weighting in attractive, faster-growing markets.
Operating Cash Flow (OCF) and Free Cash Flow (FCF)
In FY2022, BDX generated ~$2.471B in net cash from continuing operations. It incurred ~$0.973B in CAPEX resulting in ~$1.5B of FCF.
As expected, FCF conversion was below BDX's long-term target. BDX continues to focus on cash flow conversion and actions are being taken to moderate inventory levels. In the short term, however, BDX felt it was a prudent trade-off to have higher inventory levels to ensure it could support its customers while delivering strong results.
FY2023 Guidance
BDX expects some persistent macro challenges and uncertainty. Inflation and supply chain challenges are going to persist but not escalate at least through 2023. While inflation could potentially start easing, management expects that it will remain well above historical levels. However, companies that have processes, systems and capabilities to navigate this environment will continue to thrive over the next couple of years.
Source: BDX Q4 2022 Earnings Presentation - November 10, 2022
Source: BDX Q4 2022 Earnings Presentation - November 10, 2022
Despite the impact of increased inflation, BDX is seeing a larger benefit from its offsetting initiatives.
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.
At FYE2022, BDX's net leverage ratio was 2.8x.
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
BDX’s dividend and stock split history is found here.
One of BDX's shareholder value creation policies is to target a ~30% dividend payout ratio.
When I wrote my August 7 post, I expected BDX to announce a quarterly dividend increase of ~$0.03 - ~$0.04 at the same time as the release of FY2022 results in early November. On November 10, BDX declared a $0.91 quarterly dividend payable on December 30 payable to shareholders of record on December 9. This $0.04/share increase (~4.6%) from the prior $0.87 quarterly dividend marks the 51st consecutive year of dividend increases.
At the time of my August 7 post, BDX shares were trading ~$254.20 and the trailing dividend yield was ~1.37%.
Shares currently trade at ~$222 resulting in a forward dividend yield of ~1.64%.
I continue to expect BDX to be able to easily service this higher dividend from cash flow generated from normal business operations.
The weighted average number of outstanding shares in FY2011 - 2022 (in millions rounded) is 226, 209, 199, 198, 208, 218, 224, 265, 275, 282, 292, and 287.
The Q3 2022 Condensed Consolidated Statements of Cash Flows reflected no share repurchases. The FY2022 results, however, show that BDX repurchased $0.5B of outstanding shares. In comparison, BDX repurchased $1.75B of shares in FY2021.
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.
At the time of my August 7, 2022 post, shares were trading at ~$254.20 and the FY2022 adjusted diluted EPS guidance was $11.28 - $11.35. On this basis, the forward adjusted diluted PE range was ~22.45.
Using this share price and FY2022 - FY2024 guidance from the brokers which cover BDX, the following were 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.
BDX's FY2023 guidance now calls for adjusted diluted EPS of $11.85 - $12.10. Using the current ~$222.40 share price, the forward adjusted diluted PE range is ~18.4 - ~18.8.
Based on the current ~$222 share price and FY2023 - FY2025 guidance from the brokers which cover BDX, the following are the projected adjusted diluted PE levels:
- FY2023 - 12 brokers - mean of $11.93 and low/high of $11.80 - $12.00. Using the mean, the forward adjusted diluted PE was ~18.6.
- FY2024 - 13 brokers - mean of $13.31 and low/high of $12.69 - $13.61. Using the mean, the forward adjusted diluted PE was ~16.7.
- FY2025 - 7 brokers - mean of $14.76 and low/high of $14.46 - $15.15. Using the mean, the forward adjusted diluted PE was ~15.
With the spin-off of the Diabetes Care business and recent acquisitions, BDX has been transformed into a faster-growing and higher-margin company
Now that the net leverage ratio is 2.8x and BDX plans to continue its transformation, I would not be surprised if it were to make a major acquisition within the year. Such an acquisition would very likely change current earnings estimates. In my opinion, trying to gauge a company's valuation using earnings estimates beyond 1 - 2 years is a crapshoot.
Final Thoughts
I became a BDX shareholder in February 2009 at which time the company's credit risk was upper medium grade investment-grade. In March 2015, BDX acquired Carefusion and in December 2017 it acquired C.R. Bard. These acquisitions significantly transformed BDX but the credit risk increased significantly with the domestic senior unsecured long-term debt ratings falling 5 tiers to the highest non-investment grade (speculative or 'junk').
I seriously 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.
Most recently I have watched as BDX spun 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. I ended up receiving shares in Embecta (EMBC) (the newly created spin-off) but was not comfortable taking on that company's credit risk; Moody's and S&P Global assign ratings that are a few tiers below the lowest investment grade rating. I, therefore, exited my EMBC exposure.
In my opinion, investors can expect more rapid growth from undervalued Becton Dickinson. Its risk and growth profiles have improved and shares are slightly undervalued. Had I not recently deployed my liquidity toward the purchase of a second home, I would be adding to my BDX exposure.
I currently hold shares in one of the 'Side' accounts within the FFJ Portfolio. Shares were also held in a retirement account but as part of our registered retirement Savings Plan (RRSP) meltdown strategy, I had to liquidate some holdings; BDX happened to be one of the companies in which I sold shares.
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.
