Morningstar Magazine - February/March 2014 - (Page 74)

Best Ideas Baxter Has a Positive Prognosis By Karen Andersen A strong pipeline should help the health-care firm fend off competitive threats. Diversified health-care firm Baxter BAX has earned a wide economic moat, stemming from efficient scale in its hemophilia franchise and economies of scale in plasma processing, injectable therapies, and dialysis products. Intangible assets-like Baxter's strong brands, patent protection, and pipeline productivity -also allow the firm to remain remarkably profitable in tough industries. More than 70% of Baxter's sales come from products with market-leading positions, and the safety and quality of its biologic therapies allow it to charge a premium compared to competitors. While the company is a global health-care leader, it does face fierce competition on several fronts. For example, Advate is the firm's highly profitable hemophilia A product that helps control bleeding. It dominates the U.S. market and is a major part of the firm's BioScience division, which we estimate will comprise more than 40% of the company's sales in 2013 (and a higher proportion of profits). But rival Biogen Idec plans to launch a longacting product in 2014 that could support a once-weekly dosing schedule (Advate can be given every three days) and Novo Nordisk has a long-acting version in late-stage development as well. Those new drugs could eat into Advate's sales. Despite that, we think the firm's competitive advantages remain strong. Baxter's pipeline 74 Morningstar February/March 2014 investments should help insulate it from some of the challenges from rivals. Baxter has accelerated development of long-acting factor VIII protein BAX855, aiming for a 2015 launch. In addition, HyQvia, a long-acting version of Baxter's immunoglobulin product Gammagard, recently received regulatory approval in Europe and should launch in the U.S. in 2014. HyQvia's improved convenience should translate into market share gains and better pricing power. Baxter's medical products segment should also be a steady performer for the firm. In addition to supplying items such as intravenous solutions, infusion pumps, injectables, and anesthesia gases to hospitals and their pharmacies, Baxter offers contract manufacturing services to drug firms and is a leading provider of at-home dialysis solutions outside the United States. With the acquisition of Swedish dialysis firm Gambro, which was announced in late 2012, medical products are likely to remain Baxter's largest overall business for the foreseeable future. We think Baxter will now achieve critical mass in its renal disease offerings, and recent reimbursement changes in the U.S. and new product offerings through 2015 will accelerate growth. Synergies with Gambro will also prevent low gross margins in the renal market from weighing on the bottom line. Valuation, Growth and Profitability Our fair value estimate for Baxter stands at $80 per share. Overall, following the acquisition of Gambro, we think Baxter is capable of 7% top-line growth and 9% bottom-line growth through 2017. While near-term headwinds like the device tax in 2013 (a 1% earnings per share impact, by our estimates) as well as continued capacity constraints on plasma processing going into 2014 will weigh on growth, we think a return to strong Gammagard supply and the launch of new pipeline products will lead to higher growth in 2015-16, despite competition from branded (hemophilia) and generic (Suprane and cyclophosphamide) entrants. Following the Gambro acquisition, we expect gross margins to slightly deteriorate but return to 2012 levels in five years, as the slightly lower medical products segment margins are countered by manufacturing synergies. Thanks to commercial synergies on the marketing and administrative expense line over this period, we still expect Baxter's operating margin to climb to 24% by 2017. We assign Baxter an 8% cost of equity and assume roughly $300 million in annual share repurchases in the near term in our earnings per share forecast. Scenario Analysis Baxter's pipeline offers new opportunities, but competitors could also weaken market share of its established products. That said, we don't

Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2014

Morningstar Magazine - February/March 2014
Contents
Contributors
Letter From the Editor
Preparing for the Next 50 Years
Morningstar Managers of the Year
Fixing the Trust Deficit
Rethinking the Path to Retirement
Trends
Same Old, Same Old
Global Briefs
The Economic Implications of an Older World
Banking on Performance
Is the Affordable Care Act Healing Health Care’s Woes?70
Baxter Has a Positive Prognosis
Leading Fidelity’s Charge for RIAs
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Moving the Goal Post

Morningstar Magazine - February/March 2014