Biotech Values

[DewDiligence]

Baxter: The Next Dark Horse for Alzheimer’s?

[BAX is IMO a solid core healthcare holding at a reasonable valuation, and it’s a clear beneficiary of The Global Demographic Tailwind. Any upside from the Alzheimer’s program is icing on the cake.]

http://online.barrons.com/article/SB126756889605254729.html

›Baxter International Has Room to Run

MARCH 3, 2010
By JOHANNA BENNETT

With almost two dozen new products in development that could generate annual sales of $6 billion, Baxter International (ticker: BAX) should deliver bloody good returns.

Unfortunately, the stock has been pretty anemic, gaining just 4% over the last 12 months.

Profits last quarter failed to beat expectations for the first time since 2004. Slowing sales in the biosciences division that makes life-saving drugs from human plasma, have stoked concerns about Baxter's future prospects.

But Wall Street underestimates the medical-product giant's ability to grow its earnings and beat estimates.

With steadily growing cash flow funding stock repurchases and dividend hikes, the shares -- at less than 14 times forward earnings -- offer a compelling opportunity.

"This is a company that delivers steady double-digit earnings growth through any economic environment, and on top of that, the Street isn't giving them credit for the extent of their pipeline," says Ruairi O'Neill, a portfolio manager for PNC Capital Advisors. "I see upside potential for earnings expectations."

Or as Lawrence Keusch, an analyst at Morgan Keegan puts it, "It's a free call option on their pipeline."

Others share equally bullish sentiments.

In late January, analysts at UBS and Piper Jaffray hiked their price targets 12% to the low $70s. The stock now trades at $59 a share.

And during the three-month period that ended Dec. 31, 2009, hedge fund Lone Pine Capital, managed by noted stockpicker Steve Mandel, initiated a large position in the stock.

Founded in 1931, Baxter pioneered the process of separating plasma into component parts [i.e. plasma fractionation]. And today, its biosciences division uses those proteins --and an increasing amount of artificial (also called recombinant) proteins -- to manufacture treatments for hemophilia and autoimmune disorders.

Gammagard and other antibody replacement therapies for malfunctioning immune systems generate roughly 10% of Baxter's yearly revenue. And sales of recombinant Factor VIII (a genetically engineered form of the component that helps human blood clot) totaled roughly $1.3 billion last year.

But with total sales of $12.5 billion in 2009, Baxter is more than a drug maker.

Drug sales generated 44% of revenue last year, or $5.6 billion. Baxter got 37% from equipment that administers intravenous medications and $2.3 billion came from products used to treat kidney disease.

That diversity, and because many of its products treat chronic, life-threatening conditions, helped Baxter weather the recession and led Barron's to weigh in favorably on the stock last year.

Earnings almost doubled between 2005 and 2009 to $3.80 a share. The company sees gains of 11% to 13% this year.

Baxter, meanwhile, is a cash machine. Free cash flow could double to $4 billion by 2014, according to Morgan's Keusch. Over the next five years, the company plans to spend 35% to 40% of its capital on share purchases and dividend payments.

But overseas markets and new products position Baxter for sizable growth in the years to come.

Baxter now gets 57% of its sales from outside the U.S. It's well positioned to benefit from fast-growing emerging markets such as China, Brazil and Eastern Europe.

The Street sees profit growing roughly 12% annually over the next three to five years.

But Baxter has roughly 25 drugs and devices in development that could each generate peak annual sales of roughly $250 million. Last year, the company started 14 late-stage clinical trials.

A new version of Gammagard that patients can inject subcutaneously -- like a flu shot -- could reach the Food and Drug Administration early next year.

And further afield: treatments that regenerate hearts derived from adult stem cells.

But high hopes are being pinned on Baxter's efforts to develop Gammagard to treat Alzheimer's disease. Though not expected before 2014, it could open the door to a $3 billion market for the decades-old drug. A Phase III clinical trial is underway. But results from an earlier study due to be released in April could prove compelling, says Morgan's Keusch.

Investors don't have to pay too much for the stock. At 13.9 times forward earnings, Baxter trades at a 10% discount to the Standard & Poor's 500.

In 12 months, Morgan's Keusch sees the stock climbing 19% to $69 a share, or 16 times his earnings estimates for 2010.

A lot is riding on Baxter's ability to deliver new drugs. Sales will falter if the economy or currency trends take a turn for the worse.

Meanwhile, Baxter is laboring to fix problems at a Belgium manufacturing plant and investigating the source of problems that led to a recall in January of some HomeChoice dialysis machines.

Still, Baxter remains a good defensive play.

And with earnings poised to exceed projections, lots of cash and a growing dividend, Baxter may be just the right therapy to cure lackluster portfolios.‹