Wall Street can be surprisingly stubborn at times. Right now, for instance, it appears that there's a deep commitment to like Abbott Labs as a recovery play in 2014, but an equal commitment to dump on Baxter (NYSE: BAX ) and predict significant market share loss to Biogen Idec (NASDAQ: BIIB ) in hemophilia coupled with other imagined disappointments.
To be sure, Baxter is not my favorite stock today, and the company did not provide a perfectly clean fourth quarter on Thursday morning. What Baxter did offer, however, was good enough; I think investors who can be patient with a pretty understated company can do well over the long term with Baxter.
A somewhat messy start to 2014
Baxter didn't deliver the sort of hands-down great quarter that would silence critics, but I believe it was a solid quarter overall.
Revenue rose 16% as reported, or about 6% on an organic constant currency basis, good for a roughly 3% beat. BioScience revenue was up 6%, with a surprisingly strong 11% improvement in hemophilia sales. Baxter did get some benefit from large orders (particularly to Hemobras), but management indicated that label extensions also were supportive of the company's growth. BioTherapeutics sales were weak (down 2%), but that was basically expected. More importantly, management indicated that supply constraints of IVIG have been fixed.
The Medical side also did well, with 7% growth excluding Gambro. Fluid systems revenue rose 6%, while Specialty Pharmaceuticals rose 8%. Renal was up 66% as reported due to the Gambro acquisition, while underlying sales were up 5% as the company saw respectable growth in peritoneal dialysis.
As has been the case with seemingly every med-tech company to report so far, margins were "mixed". Gross margin was three points lower than last year and about a point lower than expected due to foreign currency and geographic mix issues. Operating income rose about 3% on an adjusted operating basis, with a one-point miss on margins, and Baxter needed a lower-than-expected sharecount to make the estimate for the quarter.
The biggest questions won't get answered for a while
The biggest question for Baxter today is the extent to which Biogen's long-acting Factor VIII product for hemophilia displaces Baxter in the market. I believe the market is pricing in a market share loss of nearly 50%, while I approximate the real loss will likely be closer to 20% to 25%. With that, I expect the quarter-to-quarter reports of both Baxter and Biogen to be influential on the stock price of Baxter this year.
Baxter also needs its long-acting rFVIII candidate BAX 855 to come through. Management maintained its guidance with respect to finishing the study this year and filing before year end. Were this product to fail, it would be a significant setback to Baxter.
Time for blocking and tackling
Outside of the Biogen hemophilia competitive threat, Baxter basically just needs to do what good companies are supposed to do – execute on the opportunities in front of them. Gambro sales were a little weaker than expected, likely due to the extended review process that delayed the deal close, and Baxter could generate some upside here if management can reaccelerate growth into the mid-single digits or higher.
As mentioned before, the supply improvements for IVIG should allow Baxter to regain some share from Grifols and push growth from this $1 billion-plus product back into the mid-to-high single digits. Baxter also needs to hit its marks in the Fluid Systems business (pumps and infusion products) – I believe the opportunity to gain share from CareFusion or Hospira is there and would help margins.
The bottom line
Baxter could probably juice its stock price by publicly entertaining the idea of splitting the company, but I think the underlying fundamentals still support a positive slant. I'm looking for long-term growth of between 4% and 5%, with long-term free cash flow growth of roughly double that on higher margins and improved free cash flow generating efficiency. Discounting that back, Baxter still seems underpriced below the high $70's. Baxter is not at all a get-rich-quick stock, but for investors who want a story that could get better one quarter at a time, this may fit the bill.
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