Baxter Stock: I Don’t Like It; Better Opportunities Elsewhere (NYSE:BAX)

Baxter International (NYSE:BAX) is a diversified medical device and consumable supplier. Numerous BAX products and services are essential for medical care and patient health, and are critical for those with chronic health issues, such as dialysis therapies. Most of BAX revenues are from three operating units, Renal Care, Medication Delivery, and Pharmaceuticals. While the acquisition of Hill-Rom increases BAX hospital offering and could provide a boost to earnings, overall, I am unexcited with my current ownership of Baxter shares. For me, it’s time to move on.

Baxter operates in areas of the medical field where consumer prices are not always an overriding issue. While their industry is ultra-competitive with several suppliers of very similar products, generally consumers are less concerned about the cost of their dialysis machine than the cost of their COPD inhaler or their blood pressure medicine. Most of BAX products are not as susceptible to political pressures to reduce prices to the public. While BAX offers pharmaceuticals, which usually have the most exposure to political pressure, many of their offerings are generic and/or are infusion-based. In the current environment of increasing backlash against high medical costs, it seems medical device and generic drug manufacturers are flying under the radar. I find this to be a very attractive investment attribute.

Baxter business is separated into 11 global operating components, including three new operating units with the recent acquisition of Hill-Rom. The operating units are grouped by: Renal Care, Medication Delivery, Pharmaceuticals, Nutrition, Advanced Surgery, Acute Therapies, Biopharma Solutions, Patient Support Systems (new), Front Line Care (new), Surgical Solutions (new) and Other. The largest units are Renal Care with $3.9 billion 2021 revenue, Medication Delivery with $2.9 billion, and Pharmaceuticals with $2.3 billion. Combined, these three units comprised 71% of BAX’s 2021 revenues of $12.7 billion and 56% of estimated 2022 revenues of $16.1 billion, including $3 billion from the Hill-Rom Dec 2021 acquisition.

Renal Care includes sales of BAX’s various specialized dialysis machines as well as additional dialysis therapies and services. Medication Delivery includes sales of IV therapies, infusion pumps, administration sets, and drug reconstitution devices. The Pharmaceuticals unit offers a substantial exposure to generic drugs, premixed and oncology drug platforms, inhaled anesthesia, critical care products, and pharmacy compounding services.

Of interest to many investors is the strength of Baxter in non-hospital settings. Many applications of their renal care, medication delivery, and generic drug products are used in clinical setting, such as kidney dialysis centers, nursing homes, and rehabilitation centers. The addition of Hill-Rom’s products strengthens BAX’s exposure and opportunities in the hospital business. However, with the consolidation in the hospital sector continuing to be strong, competitive pressures are increasing as well. One of the justifications of hospital mergers and networking is the ability to negotiate better prices and terms from suppliers, such as BAX.

Although Baxter’s products are essential for medical care and patient health, many have similar alternatives, which can limit pricing power. Concerning business rivals, CFRA offers the following insight into medical device competition:

Competition is primarily focused on cost-effectiveness, price, service, product performance, and technological innovation. There has been increasing consolidation in the company’s customer base and by its competitors, which continues to result in pricing and market pressures; although, the company [BAX] certainly has the wherewithal to pursue a large transaction.

With the announcement of the Hill-Rom deal, Baxter has added some uncertainty to its ROIC prospects and has reduced its balance sheet flexibility in the intermediate term. According to Morningstar, over the previous 5-yrs, BAX’s return on invested capital, ROIC, has been quite a bit below their industry at an average of 8.75%. 2021 and TTM numbers are even worse at 6.77% and 6.08%, respectfully. The components of the iShares US Medical Devices ETF (IHI) averaged 11.09% ROIC in the past 12 months. BAX is portfolio position of IHI. I am in the camp that believes long term earnings growth usually does not exceed management’s ability to generate ROIC. Long-term debt has also ballooned from $5.8 billion in the end of 2020 to $17.1 billion as of March 2022. Goodwill assets jumped from $3.2 billion to $9.8 billion with the Hill-Rom acquisition.

From a recent investor presentation, management expects constant currency sales growth of 4% to 5% on a compounded annual basis from 2022 through 2025. The company also forecasts adjusted operating margin expansion of 350 to 400 basis points as compared to expected year-end 2022. However, broker consensus seems to be mixed, at best. According to thefly.com, several analysts have reduced their Baxter ratings from Overweight to Neutral and have reduced price targets from $90 to $72. While several believe BAX’s share price can retrace its high of $90, including Morningstar, JPMorgan (JPM) and Evercore, I side with those who have turned Neutral on the shares. The largest concerns focus on the uncertainly of integration of Hill-Rom, substantial inflationary pressures on operating costs, and the potential of revenue shortfalls over the short-and medium-term. According to SA, 7 brokers list BAX as a Strong Buy; 4 as a Buy; 2 as a Hold; and 1 as a Sell.

In Aug 2015, I re-established a position in BAX, which had been absent from my portfolio for a very long time. I made 3 buys between Aug and Dec 2015 in the $35 to $38 range. In the same time frame, I also bought Thermo-Fisher (TMO) between $118 and $138 and Hill-Rom between $52 and $54. Both TMO and Hill-Rom were covered by Guiding Mast Investments and rated in the higher side of Neutral at the time. At the end of 2019/early 2020, as part of a general reduction of equity exposure using stop loss triggers, I sold all TMO, all Hill-Rom, and half of BAX. Reviewing stock performance of these three using dividendchannel.com returns calculator, all three were pretty close in annual total returns at ~22% until early to mid 2020. During the past 2 years, BAX has greatly underperformed both TMO and IHI. I think it’s just time to take my 8.7% long term total return and move on as I believe there are better opportunities in the healthcare field.

I have entered a Good Til Canceled order to sell the remaining shares of Baxter at $66, which is 5% above its July 14 price. The proceeds will be split between cash, a nibble addition to IHI at 5% below 7/14 price at $47.50, and a nibble addition on Organon & Co. (OGN) (yes, I realize I said no drug makers above, but OGN is a vastly undervalued stock, especially at $30 and below) also at 5% below 7/14 price at $30.05.