Blue Chip with Solid Dividend Growth; BioScience spinoff Will Improve Resource Allocation, Growth Strategy and Core Businesses

Strong blue chip company with robust cash flow and steady dividend growth.

Impending Biosciences spinoff expected to add value, improve efficiencies.

28% operating income growth in Q4 2014 on strong sales growth.

Baxter International Inc (NYSE: BAX) is a global pharmaceutical and healthcare company that develops treatments for hemophilia, kidney disease, immune disorders and other acute medical conditions. The company operates two business segments: BioScience and Medical Products. Baxter International has operations in North America, South America, Europe, Africa and Asia, and manufacturing facilities in 27 countries.

As a leading blue chip company, Baxter International has several competitive advantages over competitors Medtronics (MDT), Becton, Dickson and Company (BDX) and CR Bard (BCR). Baxter has a large portfolio of patents, a strong research and development pipeline, diverse geographic locations, economies of scale and strong customer relationships, and uses strategic acquisitions and expansion into emerging markets as growth opportunities. Currently, the company gets only 20% of its sales from emerging markets and analysts expect this to climb to at least 30% over the next two years.

Recent Drop in Shares Offers Compelling Upside


As of 3/13/15, Baxter shares closed at $67.36, giving the pharmaceutical giant a market capitalization of $36.55 billion. Shares are trading near the lower end of the company’s 52-week range of $65.94-$77.31. Shares trade at 11.65x cash flow and the company has solid profit margins, with EBITDA margins of almost 26%.


Wall Street analysts have an average Baxter price target of $76 with a high price target of $84. At $67.36, shares offer 13% upside on average and 25% in the bullish scenario.

Solid and Steadily Increasing Dividends, 3.1% Dividend Yield

On February 17, 2015, Baxter announced a first quarter dividend of $0.52 per share, annualized at $2.08 per share, to be paid on April 1, 2015, to shareholders on record as of March 11, 2015. This represents a 6% year-over-year increase in quarterly dividends and a dividend yield of 3.09%. Over the past 3 years, Baxter has grown dividends by about 18%. Through dividends and share repurchases, the company returned over $1.6 billion to shareholders in 2014. As the graph below shows, the company is committed to dividends and dividend growth, and was part of the esteemed Dividend Aristocrats index until 1997 when an acquisition resulted in a temporary dip in dividends.


Baxter has a rich dividend payout ratio of 45% that is higher than most of its competitors.

Well Diversified Medical Products Business

The Medical Products business focuses on manufacturing IV solutions, premixed drugs, infusion pumps, inhalation anesthetics and other products used to deliver fluids and drugs to patients. The business also makes home-based therapies for patients with diseases that require constant, in-home treatment. The medical products business accounts for approximately 60% of Baxter’s revenue (as of 2014).


Spinoff of BioSciences Division Unleashes Hidden Value

In early 2014, Baxter announced plans to spinoff its BioSciences division into a publicly-traded company called Baxalta, Inc. (BXLT) for greater management focus, specialized product offerings, efficient resource allocation and tailored growth and investment strategies. Baxalta will focus solely on immune deficiencies and blood-related disorders, with current BioSciences’ President, Ludwig Hantson, running the new company as CEO. Biosciences accounts for approximately 40% of Baxter’s revenue and will have $6 billion in revenues after the separation.

The spinoff will be a tax-free distribution to shareholders through newly issued Baxalta stock and existing Baxter shareholders will own at least 80% of the new company. Baxalta headquarters will be located in Bannockburn, Illinois, in a 260,000 square foot facility, with its research and development center in a 200,000 square foot facility in Cambridge, Massachusetts.


In preparation for the spinoff, Baxter entered into a definitive agreement to sell its Vero cell platform and related assets to privately-held biopharmaceutical company Nanotherapeutics, Inc., for an undisclosed amount. The platform includes vaccines for H5N1, H1N1, seasonal influenza, Ross River virus, Chikungunya disease and West Nile virus. Baxter also divested its commercial vaccines business and assets to pharmaceutical company Pfizer (PFE). With the sales, Baxter BioSciences will be able to focus strictly on its core businesses in the areas of hematology, oncology and immunology.

Robust Product Portfolio & Pipeline

In September 2014, Baxter acquired the licensing and marketing rights to MM-398 for all markets (except the United States and Taiwan) from Merrimack Pharmaceuticals. MM-398 is an oral treatment for patients with metastatic pancreatic cancer. The company is currently preparing market authorization applications for Europe and other markets.

The company received Food and Drug Administration (FDA) approval on their PHOXILIUM treatment as a substitute for continuous renal replacement therapy for patients with acute kidney injuries. PHOXILIUM is the only approved premixed solution on the market that contains phosphate for electrolyte management.

In a recent Phase III study, Baxter’s BAX 855 treatment for Hemophilia A showed a reduction of 95% in median annualized bleed rate for a control group. BAX 855 essentially extends the interval between infusions. The results meet the company’s primary endpoint and support previous data included in an application to the FDA for approval.

The company recently announced positive top-line results for a Phase III trial on its PERSIST-1 treatment, a therapy for patients with myelofibrosis that was jointly developed with CTI BioPharma Corporation (CTIC). The results meet the company’s endpoint of reducing spleen volume by at least 35% and confirm previous results from Phase II trials.

Lastly, Baxter announced positive results for a Phase III trial on its BAX 817 treatment for Hemophilia A or B. The trial was used to evaluate the safety and efficacy of the treatment which achieved bleeding control in 89% of patients just 24 hours after infusion.


Portfolio Expansion through Acquisitions

On March 4, 2015, Baxter announced that its BioSciences business will acquire German biopharmaceutical company, Suppremol, for approximately $225 million. Baxter will add Suppremol’s early-stage development portfolio of biologic immunoregulatory therapies for autoimmune diseases to its portfolio of autoimmune treatments. In particular, Baxter added SM101 – a Phase 2a treatment for idiopathic thrombocytopenic purpura and systemic lupus erythematosus – to its portfolio. Baxter has successfully grown its portfolio through six acquisitions over the past five years.

Defensive Litigation Protects Sales

In November 2014, Baxter filed a lawsuit against specialty pharmaceutical company Mylan (MYL) for filing an Abbreviated New Drug Application (ANDA) with the FDA for a generic version of Baxter’s Brevibloc treatment for tachycardia and hypertension. Brevibloc had $49 million in sales for the twelve months ended September 30, 2014.

Executive Officers Have Strong Global Pharmaceutical Expertise

Robert Parkinson Jr. serves as Chairman and Chief Executive Officer. He joined the company in April 2004. Prior to working at Baxter, Parkinson held senior leadership positions at pharmaceutical company Abbot Laboratories (ABT). He has over 29 years of domestic and international pharmaceutical and hospital industry experience.


Robert Hombach joined the company in 1989 and is now Corporate VP and Chief Financial Officer. Mr. Hombach previously served as Treasurer, VP – Finance and VP – Corporate Planning at Baxter. He has been an integral part of Baxter’s strategy team and oversees all finance related decisions.

Paul Martin joined the company in 2011 as Corporate VP and Chief Information Officer. Mr. Martin is responsible for information technology strategy, operations and processes on a global scale for the company. Previously he held the same position with British consumer packaging company REXAM PLC for 11 years.

Q4 Operating Income Up 28%, Net Income Up 192%, Beat Expectations

For the three months ended December 31, 2014, Baxter International had net sales of $4.47 billion (up 4%), gross margin of $2.22 billion (up 11%), income from continuing operations of $524 million (up a solid 28%), or $0.96 per share, and net income of $953 million (up 192%), or $1.74 per share. Its earnings were driven by stronger-than-expected 9% growth in Biosciences’ sales on robust demand for Hemophilia and BioTherapeutics franchises.


As of December 31, 2014, Baxter had $2.93 billion in cash and cash equivalents, $7.61 billion in long-term debt and $8.12 billion in total stockholders’ equity. The company has a solid balance sheet and strong cash flow, with $3.2 billion in operating cash flow in fiscal 2014 (ended 12/31/14).


Conservative Guidance for Q1 2015

Baxter management expects Q1 2015 earnings from continuing operations of $0.85-$0.90 per share on sales growth of about 2%-3% excluding the impact of foreign currency. The decrease in earnings is attributable to traditional seasonality and is not an anomaly. With projected intangible amortization expense of $0.09 per share, GAAP earnings are expected to be $0.76-$0.81 per share for the first quarter of 2015. Management expects headwinds in early 2015 on the stronger dollar (which was up nearly 10% recently), ramping up competition from cheaper generic drugs and an uptick in manufacturing costs. These headwinds should abate by the second quarter and stabilize earnings over the rest of the year.

Summary

Baxter is a global leader in its space, a blue chip company with a steadfast investor base, less-than-market risk (with a beta of 0.71) and a solid commitment to dividend growth. In addition, the company continues to innovate through in-house R&D, strategic expansions and divestitures. Its latest move to spinoff Biosciences is a clear indication of management’s ongoing commitment to maximizing resources and staying nimble in a highly competitive space. Shares are currently off recent highs and offer solid long-term upside, with valuations well below analyst projections.

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