CR Bard: Another Worthwhile Healthcare Play? (BCR)

Quick Background:

C.R. Bard, Inc (BCR) is a diversified healthcare supply company, based in Murray Hill, New Jersey, USA. Founded in 1907, the company went public in 1963 and moved to the NYSE in 1968. It is a Dividend Champion, having raised its dividend for 44 years straight. While the company is best known for introducing the Foley catheter in 1934, the company has expanded over the years, and now has four main business segments. The first, Vascular, is 28% of net sales, and consists of specialized intravenous balloons, endovascular stents, grafts, and filters. Urology is 25% of net sales, and includes stents, catheters, and incontinence products. Oncology focuses on implanted or long-term use catheters (27% of sales) and feeding devices, and Surgical Specialties offers various tools for things like hernia repair and breast reconstruction (17% of sales). Competitors include Johnson & Johnson (JNJ), Becton, Dickinson (BDX), and Boston Scientific (BSX).

For more basic information, check out the company’s website and the 2014 annual report.

An investment of $10,000 in December 1995 would be worth $149,694.76 today, all dividends reinvested. This yields an annual rate of return of 13.8%, which almost doubles the return of the S&P 500 during this time frame. (Source: FAST Graphs)

Sparknotes Analysis:

Let’s use our screening criteria on BCR to quickly judge BCR’s suitability as an investment.

• Pays a dividend: Yes
• Has 5+ years of dividend increases: Yes (44 years)
• Has not frozen dividend for over 8 quarters: Yes
• Has a Chowder number of 12 or more: No (5.4)
• Has am EPS payout ratio of less than 70%: Yes (26.37%)
• Pays a dividend monthly or quarterly: Yes (Quarterly; February, May, August, November)

• Has an S&P Quality Ranking of ‘A-‘ or better: Yes (A-)
• Has generally increasing earnings over the past 10+ years: Yes
• Is fairly valued/undervalued according to the Normal P/E ratio (blue line): No
• Is fairly valued/undervalued according to the Intrinsic P/E ratio (orange line): No

Other Ratings:

• S&P Capital IQ: 3-star hold
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 8 (optimized score of 6)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 1 for safety; 2 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst
• Morningstar:
  • Moat: Narrow
  • Stewardship: Standard

Financial Overview:

Although BCR is a Dividend Champion, it’s certainly not known for it’s dividend yield, which currently hovers around 0.50%. The quarterly payout per share is $0.24, which translates into $0.96 annually. Even more frustrating is the very low Chowder number. The dividend grows only slightly faster than inflation, growing an average of 4.8% annually over the past 5 years. Dividend increases average between 2% and 9% year-over-year, with the 19-year average dividend growth rate (DGR) at 5.4%. Recently, the DGR has been picking up; the most recent increase was a whopping 9%, from $0.22 to $0.24. But of course, one year does not a trend make.

Before we get into dividend sustainability, I want to share something from the most recent earnings call. From the CEO, Timothy Ring:

[W]e continue to be extremely active in the business development front. … And the share buyback would be the second use of cash and dividend third beyond that.

And the CFO, Christopher Holland:

[T]he priorities are clear. We’d love to be closing more. We’re certainly trying. And absent that and in conjunction with that, we’ll continue to return cash to shareholders in a pretty consistent basis between buybacks and obviously the slightly increased dividend.

From this, we see exactly what the company wants to do with the cash it generates. First, they want to reinvest back in the business. Historically, this means acquisitions (there have been 75 in the past 9 years), but also includes R&D and such. Second is buying back shares, and third is increase the dividend. This isn’t all bad, considering that BCR operates in a competitive and risky environment. They definitely need money to maintain competitive advantages and protect against lawsuits and recalls. Better to invest more into buybacks, which can be adjusted according to cash flow needs, rather than dividends, which can’t be cut without significant backlash.

With this in mind, we have two questions to answer: (a) is the dividend safe? and (b) are share buybacks effective enough to reward shareholders? Let’s tackle the first.

A company paying out such princely sums to shareholders should be certain that such sums are easily maintained, right? Thankfully, they are: The payout ratio is 26.37%. With free cash flow (FCF) per share of $2.53, the FCF payout ratio is still only 37.94%, which is perfectly fine. Total debt of $1.479 billion divided by shareholders’ equity of $1.8 billion gives us a debt/equity ratio of about 0.82. That’s a little high, but manageable. The interest coverage ratio is 10.95, and the company still has about $960.1 million in cash on its books. Therefore, I don’t consider debt to be much of an issue. And finally, in the FAST Graph above, we see that earnings are growing around 12.4% annualized. So we don’t have to worry about declining earnings impacting the dividend. Hence, I consider the dividend safe.

But what about share buybacks? BCR explicitly prioritizes them over dividends. Thankfully, they mean it. 5 years ago, there were 95.9 million shares outstanding. Today, there’s 74.2 million. That’s a reduction of 22.63%, which is definitely impressive. Josh Arnold wrote a good article analyzing the buyback in detail, and he rates it as effective. However, this may not happen at the current rate, due to BCR wanting to conserve cash for acquisitions and expansion (priority #1). But since management has guided that they want to, at minimum, counter any dilution and slightly lower the share count year-over-year, I don’t think the trend will reverse itself in time.

Shares have split 5 times since going public; the last time was in 2004.

The current P/E ratio is 24.8, and Morningstar calculates the one-year forward P/E as 19.8. With 7.37% earnings growth projected by analysts in the coming year, this implies growth over share price decreases.

BCR’s gross (62.29%), operating (19.15%), and net profit (10.38%) margins all trail the peer group’s averages (65.75%, 23.25%, and 18.10% respectively). This further serves to illustrate how competitive the markets that BCR operates in actually are, and why BCR needs the cash for reinvestment instead of dividend increases. As a caveat: BCR may look worse here because many of the companies in BCR’s peer group also have much higher margins due to divisions that don’t directly compete with BCR. For example, JNJ has the pharmaceutical division, and BDX has high-margin diagnostic equipment and ventilators product lines.

Although it’s hard to say how a given company’s stock will perform in the future, especially several years out, we can still use analyst estimates to try. By 2018, BCR will have increased earnings by 10.0% annualized, and given the current share price, will translate into an annual rate of return (AROR) of -9.51%, indicating some decent losses. But this assumes a reversion to the standard P/E ratio of 15. GuruFocus indicates that the historical average P/E ratio is actually 22.27. If we assume this will also be the future P/E ratio, we get an AROR of 6.70%, not terrible. For JNJ, the AROR is 10.70%, for BDX, 6.17%, and for BSX, 2.49%.

Valuation: 

Most research services consider BCR to be overvalued. Morningstar has a fair value of $152.00, while S&P Capital IQ has one at $183.10. FAST Graphs has a fair value range of $120.14 – $162.59. Since these numbers are reasonably close to each other, and all of them show that BCR is mildly to moderately overvalued at the current price of $192.95, I won’t do a dividend discount model calculation of my own to verify.

Risk Factors:

The first risk is low switching costs. BCR makes products that are mostly one-time-use, which is good because it provides a recurring revenue stream. The flip side of that is most products can be replaced with another vendor’s products without excessive struggle. It’s certainly not like a pacemaker or joint replacement, where surgeons have to have significant training in the use of each tool or product. BCR is counteracting this with value-add products like drug-coated balloons (Lutonix) and acquisitions of companies with novel technology, but it can’t change the fact that most of the products BCR offers are essentially commoditized. Another risk includes lawsuits, recalls, and fines. In 2013, BCR was fined $48.26 million for illegal kickbacks, and the company is currently dealing with lawsuits over a defective vaginal mesh product. It comes with the territory – if you are in a competitive market and you make products that go inside someone’s body, something will go wrong eventually. Thankfully, BCR has a solid cash hoard, as mentioned above, which helps in those kinds of situations. Finally is an interesting company-specific risk. From Morningstar:

In the case of its litigation with W.L. Gore, Bard ended up hitting the jackpot–landing a substantial ruling against Gore. After much delay, Gore finally ponied up approximately $1 billion in damages, royalties, penalties, and legal expenses. Gore remains on the hook for royalty payments to Bard as Gore continues to sell its infringing vascular graft.

Basically, W.L. Gore made and sold a vascular graft that infringed on BCR’s patents. BCR sued and won, and now gets royalty payments for the offending product. Someday, this no-effort stream of cash will stop, and BCR will make that much less money.

Final Conclusion:

According to my criteria, BCR isn’t a buy at this time. The dividend is low, the dividend growth rate is equally low, and the company is just plain overvalued. However, after looking at the company, I understand it a lot better, especially why the dividend policy is the way it is. And because of that, I’m a bit more tolerant of the first two. Not to mention that I’m usually more of a growth-oriented/capital-gains-focused dividend growth investor than most, so BCR wouldn’t be a bad fit for me. On the positive side, the buyback is strong, and earnings are and will be growing nicely.

I’m really just neutral on the company overall. Margins are pretty low, and the dividend policy won’t change due to the high-competition, high-risk fields BCR operates in. But it’s not really a bad company in and of itself. That’s really it. It would make a pretty good growth-focused play at lower valuations, but not now.

Eventually, I do want another healthcare company in my portfolio. Maybe I’ll take a look at Medtronic (MDT) or St Jude Medical (STJ) eventually, and if I don’t see anything exciting there, I’ll pick up a few shares of BCR. Until then, BCR earns a full-throated “meh” from me, and I’ll hold off on buying.

Does BCR make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: Long BDX, JNJ

All data is accurate as of market close, 07/28/2015. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo is copyright of the company. Data source is FAST Graphs, Scottrade Research, David Fish’s US Dividend Champions List, or company materials, unless otherwise indicated.

Tags: BCR, C.R. Bard Inc, dividend-stock-analysis