Medical Device Industry Faces a Rising Demand Curve

In the midst of an aging population, the United States remains the market leader for medical devices, accounting for about one-third of the worldwide market. An aging population is one of the biggest problems the U.S. is currently facing.

This leads to a bright future outlook for medical device manufacturing companies. In fact, the global medical device, technology, and equipment market is forecast to be worth more than $440.5 billion by 2018.

In the medical device and supplies industry, I have picked up Baxter International (NYSE: BAX  ) , as the company's high ROE instigated my interest in the stock. I wanted to analyze this company as to how it was managing to register such high returns in a staggering economy and would it continue to report such high returns for its shareholders.

Historic company performance

Source: Baxter International 10-K. 

DuPont analysis breaks down ROE in a way that provides a clear insight into the whole company, the income statement, and the balance sheet -- in just three ratios.

Net profit is consistently improving, from 11.06% in 2010 to 16.39% in 2012, partly due to the rising revenue. Renal product sales have increased due to the continued growth in the number of peritoneal dialysis patients in Asia, Latin America, and the United States. In 2012 and 2011, the company's top line benefited from improved sales in the pharmaceutical partnering and pharmacy compounding businesses, in addition to the favorable contribution from the fourth quarter 2011 acquisition of Baxa.

IV Therapies sales growth in both years was driven by increased demand for IV solutions and strong sales of nutrition products. Within the anesthesia product category, sales growth in both years was primarily driven by improved international growth from increased penetration of Suprane (desflurane) and generic sevoflurane.

Asset turnover was slightly lower in 2012 as the acquisitions and capital expenditures to acquire assets were higher than the increase in sales turnover. When the expected synergies materialize, this ratio will rise.

Financial leverage has gone up by 13.62%. This can be alarming for the shareholders as it indicates higher financial risk and endangers their portion of return. The company's debt rating was also downgraded by one notch from A+ to A, and its outlook was changed from stable to negative when the company decided to finance the acquisition of Gambro by raising a minimum of $3 million in debt. As a result, the company's debt-to-equity ratio rose to 0.8 in 2012 from 0.66 in 2010. 

Innovation, internal growth and acquisitions have contributed to the company's long-term growth. In 2012, the company spent $1.16 billion, or 8.1% of revenue, on research and development to enhance its existing product pipeline and to come up with new innovative medical devices. Through an active acquisition program, the company has invested billions to acquire a number of companies, products, and technologies to further drive growth.

The acquisition of Gambro
Joining hands with Gambro further strengthens Baxter's position as a global provider of dialysis products for remedying kidney disease. The company perfectly fits in with Baxter's existing global home dialysis offerings.

The takeover of Gambro places Baxter in a better position now to meet the ever increasing needs of the large and growing dialysis market. According to the US Renal Data System, the incidence of end-stage renal disease has increased at an average annual rate of 1.5% over the past five years. At present, globally more than 2 million people are undergoing some form of dialysis treatment, and patients are expected to increase every year due to the increasingly aging population. Comprehensive dialysis offerings are facing a steepening demand curve as the population ages, and this is what makes this acquisition a sensible move by Baxter at the right time.

Comparison with competitors
Where Baxter is busy in equipping itself to be able to cater to the rising demand for dialysis, its competitor Fresenius Medical Care (NYSE: FMS  ) also plans to achieve organic growth through expansion of its dialysis clinic network, initiation of innovative dialysis products, and making acquisitions. It will focus on particularly attractive regions, horizontal expansion, and a boosted activity in home therapies. The company intends to spend approximately $1.2 billion in 2013 on acquisitions and capital expenditures.

Despite having a higher debt profile, with a debt-to-equity ratio of 0.88, Fresenius's net profit margin was lower at 8.6% in 2012 as compared to 16.4% of Baxter's. The results were inconsistent with the phenomenon of high risk, high return.

Conclusion
Although Baxter's leverage level may seem to have increased, it is still below the industry average of 2.7. Also, the company has proven that it is utilizing the funds efficiently. With the prevailing low interest rate environment, it may be better to finance the company's expansion programs with debt as the cost of raising equity can be quite high.

To sum up, in the light of the rising demand for dialysis, I foresee a bright future for Baxter.

Another health care investing opportunity
Rising health care costs continue to be a hotly debated topic, and even legendary investor Warren Buffett called this trend "the tapeworm that's eating at American competitiveness." To learn more about what’s happening to the health care system -- and how to potentially profit from this trend -- click here for free, immediate access.

 


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9/12/2014 4:00 PM
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