Dividend Aristocrats in Focus Parts 25 & 26: Becton Dickinson & C.R. Bard

Published by Bob Ciura on October 28th, 2017

Every year, we review each of the 51 Dividend Aristocrats, a group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
 

In this update, Becton Dickinson (BDX) and C.R. Bard (BCR) will be analyzed together, since Becton Dickinson is in the process of acquiring C.R. Bard.

The $24 billion acquisition brings together two giants in the medical supply industry. Once the deal closes, the combined entity has a long runway of growth up ahead.

The fundamentals of the medical supply industry remain very healthy. Aging global populations, growth of healthcare spending, and expansion in the emerging markets are attractive growth catalysts.

Shareholders have benefited from this growth for decades. Both companies have increased their dividends for more than 40 years in a row.

Going forward, the combined company should have no trouble continuing to increase its dividend each year.

Business Overview

Becton Dickinson has been in business for nearly 120 years. The company has annual revenue exceeding $12 billion, with 40,000 employees in over 50 countries.

Source: 2017 CEO Investor Forum, page 3

Approximately 55% of annual sales come from the U.S., with the remaining 45% derived from international markets.

Becton Dickinson’s sales are split 70-30, between Medical and Life Sciences supplies. It sells products in several categories within these businesses.

Some of its core product categories include diagnostics, infection prevention, surgical equipment, and diabetes management.

Source: 2016 Annual Report, page 5

C.R. Bard was founded in 1907 by Charles Russell Bard, an American importer of French silks, when he began importing Gomenol to New York City. At the time, Gomenol was commonly used in Europe, and Mr. Bard used it to treat his discomfort from tuberculosis.

By 1923, C.R. Bard was incorporated. Later, it developed the first balloon catheter, and slowly expanded its product portfolio. Today, the company is a leader in disposable medical supplies. C.R. Bard operates the following segments:

Vascular (28% of revenue) Urology (26% of revenue) Oncology (27% of revenue) Surgical Specialties (17% of revenue)

C.R. Bard also has an “other” product category, which accounts for just 2% of sales.

Both companies operate highly profitable and growing businesses.

In 2016, Becton Dickinson’s constant-currency revenue increased 4.3%. Cost controls and share repurchases fueled 20% growth of adjusted earnings-per-share for the year.

C.R. Bard also performed well last year. Constant-currency revenue increased 10%. The best-performing segments last year were Urology and Surgical Specialties, which grew revenue by 14% and 12%, respectively.

This is a good time for Becton Dickinson to make a significant acquisition, because its revenue growth has slowed down recently.

Source: Q3 Earnings Presentation, page 7

Constant-currency revenue increased 4.5% over the first three quarters of 2017, but growth was just 2.4% last quarter.

Medical supplies have been a notable laggard for Becton Dickinson so far this year.

Even adjusting for the effects of divestitures, comparable sales increased just 1.3% last quarter. This is particularly true in the U.S. where sales of medical products declined 1% last quarter.

Fortunately, Becton Dickinson has realized significant margin expansion through divestitures and cost cuts that drove 13% constant-currency revenue growth over the first three quarters.

Core operating margin is up 160 basis points over the first three quarters of 2017.

Source: Q3 Earnings Presentation, page 13

Still, cost cuts can only go so far. Becton Dickinson’s revenue growth could use a boost, which makes it easy to see why C.R. Bard is an attractive takeover target. C.R. Bard is off to a good start to 2017, and has continued its impressive growth streak.

C.R. Bard reported 7% growth in constant-currency sales, over the first nine months of 2017. Adjusted earnings-per-share rose 17% in that time, to $8.80.

The company is seeing strong growth rates across its four core product segments. Vascular product revenue increased 10% through the first three quarters, followed by 6% growth for oncology. Urology and Surgical Specialties supplies grew revenue by 5% each in that period.

For 2017, C.R. Bard had expected 5.5% to 6% net sales growth. Adjusted earnings-per-share were expected to increase 15% to 16% for the year. This indicates the potential C.R. Bard holds for Becton Dickinson.

The merger of the two companies means 2017 is a landmark year. Becton Dickinson has reached a definitive agreement to acquire CR Bard in a $24 billion deal, with a mix of cash and stock.

The deal will allow Becton Dickinson to expand on its own core competencies, as well as diversify the company into new businesses.

Becton Dickinson is no stranger to mega-deals. In 2014, it acquired CareFusion for $12.2 billion. CareFusion boosted Becton Dickinson’s medical segment, particularly in drug management and patient safety services.

This acquisition follows a similar strategy. Becton Dickinson is pursuing a high-quality business, which can leverage its existing capabilities, and give it a presence in new areas.

Becton Dickinson expects the acquisition to close in the fourth quarter of calendar 2017. Once completed, it should help accelerate Becton Dickinson’s future growth.

Growth Prospects

Going forward, the merger presents even more growth opportunities for Becton Dickinson. The combined company will have annual revenue of approximately $16 billion. And, adding C.R. Bard expands Becton Dickinson’s total addressable market in medication management by $20 billion.

Source: Acquisition Presentation, page 9

Becton Dickinson will be able to enter several new growth categories with C.R. Bard in tow. First, there are healthcare associated infections, which Becton Dickinson estimates costs patients nearly $10 billion every year.

According to Becton Dickinson, one out of every 15 patients acquires an infection during care. The combined company will be able to treat these unaddressed conditions, specifically in surgical site infections, blood stream infections, and urinary tract infections caused by catheters.

Next, C.R. Bard will help expand Becton Dickinson’s oncology and surgery products, in biopsies, meshes, biosurgery, and infection prevention devices. Once the merger closes, Becton Dickinson will have an oncology and surgery business generating annual sales of $1.5 billion.

Lastly, the acquisition boosts Becton Dickinson’s international presence, particularly in medical technology. The company already generates nearly half of its annual sales from outside the U.S.

Over the long-term, the acquisition provides Becton Dickinson the opportunity to expand its reach in new therapeutic areas.

Source: Acquisition Presentation, page 11

The company is targeting investment in diabetes, peripheral vascular disease, and chronic kidney disease.

C.R. Bard opens up channel expansion opportunities, in China, and other emerging markets. Last quarter, sales outside the U.S. rose 10% in constant currency.

Becton, Dickinson expects the deal will be immediately accretive to earnings-per-share, with accelerating growth once the deal closes.

Source: Acquisition Presentation, page 14

Along with organic growth, the acquisition should boost Becton Dickinson’s earnings. In its third-quarter financial report, the company raised its guidance for the full year. It now expects adjusted earnings-per-share growth of 10% for 2017.

From 2018-2020, management expects earnings growth in the mid-teens, thanks to revenue growth and operating margin expansion.

Competitive Advantages & Recession Performance

Becton Dickinson and C.R. Bard have significant competitive advantages, including scale and vast patent portfolios. These competitive advantages are due to high levels of investment spending.

Becton Dickinson’s research and development spending in the past three years is as follows:

2014 research-and-development expense of $550 million 2015 research-and-development expense of $632 million 2016 research-and-development expense of $828 million

For its part, C.R. Bard is coming off a multi-year period of elevated research and development spending.

Source: 2016 Analyst Day Presentation, page 23

This spending has certainly paid off, with strong revenue and earnings growth in 2016 and 2017. Both companies have obtained leadership positions in their respective categories because of product innovation, a direct result of R&D investments.

The two companies’ competitive advantages provide them with consistent growth, even during economic downturns.

Both companies grew their earnings in each year of the Great Recession. Becton Dickinson’s earnings-per-share during the recession are as follows:

2007 earnings-per-share of $3.84 2008 earnings-per-share of $4.46 (16% increase) 2009 earnings-per-share of $4.95 (11% increase) 2010 earnings-per-share of $4.94 (0.2% decline)

Becton Dickinson generated double-digit earnings growth in 2008 and 2009, during the depths of the recession. It took a small step back in 2010, but continued to grow along with the economic recovery.

Meanwhile, C.R. Bard’s earnings-per-share during the Great Recession are below:

2007 earnings-per-share of $3.84 2008 earnings-per-share of $4.44 (16% increase) 2009 earnings-per-share of $5.09 (15% increase) 2010 earnings-per-share of $5.60 (10% increase)

C.R. Bard did even better than Becton Dickinson. C.R. Bard managed double-digit earnings growth from 2007 to 2010. It sailed through the Great Recession unscathed.

The ability to consistently grow earnings each year of the Great Recession, arguably the worst economic downturn in decades, is extremely impressive.

The reason for their strong financial performance, is that health care patients need medical supplies. Patients cannot choose to forego necessary healthcare supplies. This keeps demand steady from year to year, regardless of the condition of the economy.

Becton Dickinson and C.R. Bard have a unique ability to withstand recessions extremely well, which explains their 40+ year histories of consecutive dividend increases.

Valuation & Expected Returns

According to ValueLine, Becton Dickinson shares trade for a trailing price-to-earnings ratio of 18.4 based on 2016 earnings.

Becton Dickinson trades above its average valuation over the past 10 years. In that time, Becton Dickinson held an average price-to-earnings ratio of 16.7.

Source: Value Line

That said, the stock trades below the valuation of the broader market indexes. The S&P 500 Index has an average price-to-earnings ratio of 25.7. Becton Dickinson is valued at a discount of approximately 14% to the S&P 500.

Given Becton Dickinson’s strong earnings growth potential, it could be deserving of a slightly higher valuation multiple. For example, if Becton Dickinson trades for the market multiple of 25.7, the expanding valuation would generate returns of approximately 16%.

However, investors cannot be assured that the valuation multiple will increase.

Aside from an expanding valuation multiple, Becton Dickinson stock will generate returns from earnings growth and dividends.

Source: 2017 CEO Investor Forum, page 10

Capital investments have fueled Becton Dickinson’s historical returns, and should continue to do so. The company is in the enviable position of generating enough cash flow for capital expenditures, dividends, debt reduction, with cash left over.

Becton Dickinson grew earnings by 8% compounded annually, over the past 10 years. Analysts with ValueLine expect earnings growth of 10% in 2017, and 8% next year.

To err on the side of caution, investors might want to expect slightly below the company’s guidance of mid-teens earnings growth through the end of the decade.

A potential breakdown of total returns is as follows:

6%-9% revenue growth 1%-3% margin expansion 1% dividend yield

Based on this fairly conservative outlook, Becton Dickinson would generate 8%-13% compound annual returns, including dividends.

Plus, the stock could earn additional returns, if the price-to-earnings ratio expands from the current level of 22.2.

As far as dividends, Becton Dickinson remains a quality dividend growth stock. It has a very secure payout, with room for growth.

The company currently pays an annual dividend of $2.92 per share. Based on 2017 earnings guidance, Becton Dickinson will likely have a dividend payout of approximately 31% for the current year.

This is a very low payout ratio. It leaves plenty of room for sustained double-digit dividend growth moving forward, particularly since earnings will continue to grow.

In the past five years, Becton Dickinson has increased its dividend by 10% compounded annually. Its most recent dividend increase was also 10%, and came on November 21st, 2016. As a result, shareholders could be in line for another double-digit dividend increase during the next few weeks.

Becton Dickinson provides a low dividend yield, which is roughly half the 2% average yield of the S&P 500 Index. This might make the stock unattractive for retirees, or investors who prefer higher levels of income today. However, its dividends will add up over the long term.

If Becton Dickinson raises its dividend by 10% per year, its dividend will double roughly every 7.2 years.

Final Thoughts

Becton Dickinson and C.R. Bard are both strong companies on their own. They have both demonstrated strong growth over many years, even during recessions. In turn, both companies have rewarded shareholders with more than 40 years of dividend increases.

Together, they should be even stronger. They have complementary business models, with the potential for Becton Dickinson to gain access to attractive new growth categories.

The C.R. Bard acquisition brings significant revenue growth potential to Becton Dickinson, in new product and geographic markets. There is also the opportunity for cost synergies, which could lead to 10% annual earnings growth moving forward.

Becton Dickinson’s future growth and expected returns are enhanced by the acquisition. Investors can continue to count on Becton Dickinson for strong dividend increases each year.