I'm considering Becton, Dickinson (NYSE: BDX), a maker of a broad array of medical supplies and the dominant maker of medical sharps in the world, for the Rule Maker Portfolio.
I wrote extensively about Becton, Dickinson (BD) in the March 2002 edition of The Motley Fool Select. I came away deeply impressed with the company but a wee bit concerned that there was no discount offered with the share price. Still, even then, it was priced at multiples below the mean of the S&P 500. Some of the data I'm using here actually comes from our Fool Community members, including sean1arch, TMFWallstgal, madmarv, and gdholm100, who have been doing some heavy lifting on this company on the Rule Maker Strategy discussion board.
It's about 25% cheaper per share now than when I wrote about it for Select, so let's take a look at BD using the Rule Maker Criteria, shall we? We're trying to buy great companies at good prices. Does BD fit the bill?
1. Sustainable competitive advantage
BD is one of a few market leaders in branded commodities. In its case, BD is far and away the largest producer of medical sharps in the world. In 2001, it produced 12 billion of them, which seems all the more amazing when you recognize that since these are medical instruments, the level of tolerance for defective products is just north of none. This is a solid company in a stable business with significant growth prospects.
As we will see later, BD does have competition, particularly in the realm of safe needle technology, and it has upstream competition from Johnson & Johnson (NYSE: JNJ), among others. BD has some advantages in other markets (for example, the ACE bandage is a BD product), but its center of gravity is definitively in sharps, and its moat in this domain is deep.
Sharps are surprisingly high tech. BD's Integra model of safe-sharp technology, for example, allows for needle retraction after it has been withdrawn from the patient, which decreases the amount of drug waste by as much as 90%. This could equal an additional dose per vial, and with drugs costing upwards of thousands of dollars, that has a deep impact on a company's bottom line.
2. Must show industry dominance
This one is a definite -- BD is the industry leader, by far.
Still, BD's stock was blitzed in July of this year when a New York Times article detailed a $1 million upfront fee paid by the company to one of the largest medical purchasing groups in the country in exchange for product exclusivity. Prosecutors have looked into whether this payment to Novation fits the definition of a "kickback," and rival companies such as Retractable Technologies (AMEX: RVP) have cried foul. Novation pointed out that this payment was similar to one it received from more than a dozen different medical technology and drug companies. What makes this particularly interesting is that Retractable and other small companies are trying to make inroads into BD's massive business with new safe-sharp technologies they claim to be superior to those offered by BD.
It's the latter part of that statement that concerns me the most. Former President Clinton signed into law the Needlestick Safety Prevention Act, which calls for safer technology, including retractable needles, to protect health-care workers. Are these pretenders offering better technology that will erode BD's stranglehold? Tough to say, but it bears more investigation.
What's nice is that the unit cost for retractable needles is much higher, up from less than a dime per unit to more than a quarter. This means BD could see an enormous increase in revenues as a result. This, coupled with its delays in releasing new diabetic glucose monitoring products, have cast doubt on BD's market position. I believe these concerns are overblown. Still, any real assault on the company's leadership position will have to come with some help from BD itself.
3. Dominant for more than a decade.
Uh-huh. Again, companies have made inroads, but BD has been the king of the sharps for at least 40 years, perhaps more. The company is so well-established that one of its founders has a college named after him, Fairleigh Dickinson University.
4. Cash King Margin exceeding 10%.
With very few reservations, given the above, I'm confident we've found a Rule Maker in BD. But is it a good investment? Let's begin to get into the meat of the issue. Cash King Margin measures the company's ability to turn revenues into cash. We want to see free cash flow of at least 10% of revenues, or, at a minimum, know why the company isn't generating such returns.
BD (in US$ millions)
2001 2000 1999 1998 1997 1996
Revenues 3754 3618 3418 3116 2810 2769
Free Cash Flow 407 239 120 319 272 315
Cash King Margin 10.8% 6.6% 3.5% 10.0% 9.6% 11.3%
In the past six years, we've had three yeas, three nays. The worst year seemed to be 1999, in which BD was socked with an additional $131 million in inventories -- not a good performance, generally. I get the feeling BD's current inventory levels may come back to bite it as we run the company through the paces.
That's about all the time we have this week, but we'll continue probing BD. If you're a member of the Fool Community, please discuss this company or others on the Rule Maker boards. Or start specific BD discussions on the Becton, Dickinson board. It tends to be quiet, but I get the feeling we're not done with our interest in this company, by a long shot.
Finally, I've been blown away by the number of responses to my article in this space last week, What Matters Most. I'm trying to answer each one personally, but it will take a while. For those of you who wrote in, thank you very much.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
The irony is Bill Mann hates shots. At time of publishing, Bill held none of the companies mentioned in this article. The Motley Fool is investors writing for investors.
The Rule Maker Portfolio has had a cumulative investment of $42,500. As of Sept. 16, 2002, its current value of all cash and equities is $27,009.22. This equals an internal rate of return of -14.8% since the launch of the portfolio in February 1998.
