Why You Should Not Be Buying Becton Dickinson Just Yet

Becton Dickinson is a great company with a strong management team and solid competitive advantage but not a great investment opportunity yet

Author's Avatar
Oct 07, 2015
Article's Main Image

Becton Dickinson (BDX, Financial) is a company with which I have done well in the past. I subsequently sold it but keep tabs on it for the irrational reason of having done well with it before.

That goes to show how much I have to fear from the rational detached supercomputer investor taking over my job and doing it much better. Recently, the share price fell back some amid the greater market selloff, and I decided to take a closer look.

Becton Dickinson is the largest player in the industry of making and distributing medical surgical products such as needles and syringes. As these disposables can be used only once, there is great and ongoing demand for them. Because these items are not protected by patents like most drugs, anyone can enter this market. Consequently the industry behaves much like any commoditized industry. Industries of scale win out. Becton is the one with the scale. The most recent move by the company is a $12 billion acquisition of Carefusion (CFN, Financial).

Management

In commoditized industries management teams are very important. The reason is that the business is under constant threat from competition. This environment requires strong management teams to constantly stay ahead of the pack. With a strong competitive advantage (like Wynn Resorts [WYNN] enjoys in Macau) it becomes much easier to stay ahead of the competition if it exists at all.

Becton Dickinson has that strong management team its industry requires. Both its RoE and RoIC are way above market averages. If you view the total return the management team has generated over the past 10 years it is 2x that of the S&P 500. Given that there is a certain amount of risk-free return to be obtained, this achievement is not just twice as good but even better than that.

2Y6NAcfdFGJps-8_rjhbx1rViPmAefJVSrqeGp1GE5V0dGj6UVroxNlzI9wS2txc069nciHRu8gz_nVwOxpwFwsCpsblYK3eYexryE4ABhFesxEK-cW0TJRKsi6t7axRTLQaqFGp

BDX Total Return Price data by YCharts

Risks

The company is not conservative in the way it is financed. The $26 billion market cap is burdened with $13 billion in debt. The EBITDA of $2.4 billion is fairly robust. The company is not swinging between huge profits and losses but is fairly consistent instead. The company’s earnings are not easily threatened due to its economies of scale and hospitals are unlikely to require fewer syringes. It may be a result of great management that it uses an appropriate amount of leverage to boost RoE when cash flows are quite predictable.

The Carefusion acquisition was done at a price reflecting near 3x sales. It could prove to be real challenging to achieve the company’s historic RoIC. Integration issues may prop up as they often do and synergies may not materialize in the way management is currently expecting (at least $250 million worth).

Valuation

The company expects to reap the full benefit of the acquisition in 2018, and that is where I concentrated my efforts to predict revenue and expenses.

Becton & Dickinson   2018 Scenario
$ million   Â
   Â
Revenue 11000 Â
EBITDA 2750 25% EBITDA margin Authors estimate of future EBITDA based on historical data.
Less: interest expense -500 Â Â
Less: Capital Expenditures -750 Â Based on historical CapEx pattern which is very stable.
Less: taxes -350 Â estimate based on recent average tax rate.
Free cash flow 1150 Â Â
   Â
Shares outstanding 210 Â Â
   Â
Free cash flow per share $5.5 Â Â
   Â
   Â
FCF Multiple   Â
15 $82.5 Â Lower bound of the FCF multiple the company traded at
22.5 $123.75 Â Conservative average FCF multiple the company traded at over the past 10 years
30 $165 Â Ceiling of the multiple the company sometimes traded at during the past 15 years
   Â
   Â
Current price $136.2.20 Â Upside potential:
   Â
   Â

After putting in my assumptions it just does not look like Becton Dickinson is that great of an investment. In my opinion shares are slightly overvalued. How much depends on your discount rates. If your time horizon is long, six to 10 years and over, it can still make a fine investment on the basis of the strong management team and the company’s competitive advantage. It seems like a terrible investment to buy and flip in 2018 when the acquisition is fully integrated.

Outlook

The outlook for Becton has become a little bit less certain with the acquisition of CareFusion thrown in there. Is the combined firm going to be able to generate similar rates of return going forward? The plan is to provide a greater range of supplies and tools for medical facilities to deal with insurers. With insurers playing an increasing role policing budgets hospitals are under increased pressure to reduce spending. One platform that can help with that was developed by CareFusion; it tracks hospitals' use of drugs and inventories of drugs. The software helps to reduce inefficiencies. The supplies CareFusion offers are a good fit with Becton Dickinson’s range of products. Becton makes catheters to put drugs into patients and CareFusion makes machines that pump drugs into catheters. The sales reps of the companies can now represent a greater range of complimentary products. This should save on sales cost and ultimately achieve in greater efficiency to the benefit of the firm and patients. Geographically the companies are also a great fit with Becton making most of its sales outside the U.S. and CareFusion making the majority of its sales in the U.S. There is a good chance the Becton reps outside of the U.S. are able to sell CareFusion products. Becton executives are not exactly promotional saying they think the deal will add to earnings in 2018. I will be staying on the sidelines for now but remain fond of of this highly robust company.