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Advancing Health, Not Performance (NYSE:BDX) –

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Het hoofdkantoor van BD Canada in Mississauga, On, Canada.

JHVEPhoto/iStock Editorial via Getty Images

1t has been five years ago since I last looked at Becton, Dickinson (NYSE:BDX) which acquired C. R. Bard at the time in a huge $24 billion deal. While the deal made strategic sense, I was fearful about high valuations and leverage, leaving me on the sidelines.

A Quick Recap

Becton, Dickinson announced a huge $24 billion deal for C. R. Bard five years ago as the valuation included a near $5 billion premium in order to rejuvenate top line sales growth, grow margins, and increase earnings per share, aided by the usage of a lot of cheap debt.

The deal allowed Becton to expand its position in medication management and infection prevention, creating synergies through the opportunity to offer a wider range of products, including key vascular access drug delivery products. The quicker pace of growth of Bard and higher margins, as well as greater overseas opportunities for Bard provided huge opportunities to the pro forma business.

The $24 billion deal for Bard valued those operations at 6.5 times sales of $3.7 billion. With reported EBITDA coming in at $930 million, that revealed a steep multiple, as adjusted EBITDA of $1.09 billion still worked down to a demanding 22 times multiple. These achievements compare to a $12.5 billion revenue base of Becton, Dickinson which posted adjusted earnings of $1.9 billion.

Becton earned close to $9 per share on a standalone basis and traded at a lower valuation of 4 times sales and 13 times EBITDA, as the Bard deal came at a huge valuation. Furthermore, net debt would jump to $22 billion, working down to a leverage ratio of around 4.5 times, even after factoring in that part of the deal would be paid for in shares.

The 217 million shares outstanding traded at $185 at the time, and with earnings power of $9 per share, we saw a full valuation at 20 times, certainly with leverage so high and many uncertainties being around. At $180, valuation was a bit too demanding for my taste, as I concluded to get involved around the $150 mark, levels which we have not seen anymore.

The Great Stagnation

Following the deal in 2017 and shares trading at $180 at the time, shares of Becton have been trading range-bound for many years, in fact, the lack of volatility has been certainly noteworthy with shares trading in a relatively tight $200-$280 range in the five years ever since, now trading hands at $250 per share.

Forwarding to November 2021, Becton posted its 2021 results with revenues surpassing the $20 billion mark, with revenues coming in at $20.2 billion. GAAP operating earnings came in at $2.8 billion as net earnings of $2.0 billion worked down to earnings of $6.50 per share based on 290 million shares outstanding. These are the GAAP earnings as adjusted earnings of $13.08 per share came in twice as high, with the difference stemming mostly from amortization charges following the Bard deal.

Net debt stood at $15.2 billion, down quite a bit from the pro forma situation upon the Bard deal, and very manageable with EBITDA trending around $5 billion a year. Following these results, the company issued a large buyback program which entailed the purchase of 10 million shares, with the annual dividend being hiked to $3.48 per share, still translating into a rather modest dividend yield.

In the meantime, there are some moving parts as well, as Becton announced its intention to spin off its diabetes care business to improve focus on innovation and growth. Momentum in this process really accelerated with regards to the spin-off at the start of the year as the diabetes business was set to be called Embecta (EMBC), with investors in Becton received one share in Embecta for every five shares they hold in Becton. The deal sounds larger than it is, as Embecta only trades at $25 now, indicating that about $5 per share in the valuation of Becton has been spun off, as that transaction has been completed by now.

In May, the company posted second quarter results as results are a bit uneven, similar to the first quarter, with some Covid-19 testing revenues being on the retreat with the pandemic fading (note that Covid-19-related revenues came in at nearly $2 billion in 2021). Given a 2% fall in sales for the six-month period to $10 billion, and adjusted earnings actually being down by $0.92 per share to $6.82 per share, it can easily be understood why investors are a bit cautious with net debt flattish around the $15 billion mark.

While earnings power around $13 per share is far higher than it was in 2017, the reality is that outside the pandemic test revenues, Becton posts revenues of just around $18 billion, or $17 billion if we factor in the spin-off of Embecta. This reveals hardly any growth from a pro forma basis in 2017. While the business is set to earn close to $13 a share on an adjusted basis this year, it will lose over $1.50 per share in earnings power from the Embecta divestment.

What Now?

The truth is that Becton has been underperforming a bit in my book. The 287 million shares value equity at $72 billion, for an $87 billion enterprise valuation, indicating the size of the business and its valuation of course. Reality is that growth has been a bit underwhelming, and given the continued stagnation in the share price, while margins have been improving, valuations have become a bit more compelling. With shares trading at $250, the realistic earnings multiple now comes in around 20 times, while leverage ratios have fallen from more than 4 times to around 3 times here.

To ignite some growth and imagination, Becton announced a $1.52 billion deal for Parata Systems, an innovative provider of pharmacy automation solutions in June. With $220 million in revenues, the deal come at a big price, at nearly 7 times sales while the overall business trades at just over 4 times sales. On the positive side, Becton claims that the deal will be accretive to growth, margins, and earnings per share, but with a 1% revenue contribution to the pro forma business, it is just a smaller deal.

Final Thought

Despite multi-year stagnation, I can only conclude that I agree with the market here. Leverage has fallen a bit, but in general, Becton has been underperforming versus its positioning and the market, as this performance does not anatomically create appeal at 20 times earnings with leverage around 3 times, certainly in a world in which interest rates tick higher, leaving me cautious on the sidelines.

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