For the year to date shares, of Baxter International (BAX) - Get Report , at $47, are up 28%. The medical products company reports third-quarter results on Tuesday. Can management inject more growth into the top line?
Last year, Baxter spun off its biopharma division, called Baxalta. Baxalta was later purchased by Shire (SHPG) - Get Report . for $32 billion. Freed from Baxalta, Baxter can now pay down debt, buy back shares and pay down pension liabilities. The company ended the first quarter with $3.4 billion of gross debt, a reduction of $6 billion. Net debt fell from $4.4 billion to end the quarter at $1.2 billion.
Baxter now operates two divisions: Hospital Products and Renal Products. The Hospital Product division consists of Pharmacy Solutions, Surgical Care and Fluid Systems and has sales of about $6.5 billion. Renal Care consists of chronic renal care and acute renal care and has sales of $4.2 billion.
Refocused, Baxter is working hard to jump-start its growth and improve margins. At the May analyst meeting the company outlined its plans to improve margins. Management believes it can deliver 300 basis points of incremental margin to the bottom line by the year 2020. The additional operating margin comes through cost savings initiatives and aggressive product management. Management is trying to lift operating margins from about 14% in 2015 to 17%-18% by 2020.
The company has starting raising prices on some of their saline solutions and on the company's peritoneal dialysis fluid.
In late July, Baxter reported second-quarter fiscal 2016 earnings of $0.46 per share, $0.06 better than the consensus estimate. Revenue rose 4.4% to $2.59 billion. Furthermore, the company raised guidance for the third quarter. Management sees earnings per share between $0.43 and $0.45 and expects sales growth of 2% to 3% or on a constant currency basis 3%-4%.
In addition, the company increased full year guidance. Management now forecasts earnings of $1.69 to $1.74 and sales growth of 1%-2% (or 3%-4% on a constant currency basis).
That's my problem with the stock. While there is plenty of opportunity to increase operating margins, there doesn't seem much room for revenue growth. In fact, if you study the company's presentation, the only real growth is coming from acute renal care business. Management believes that market can grow 10%-11% annually. But it's a tiny business. In 2015 acute renal care was only a $400 million business, out of $4 billion for total renal care.
The rest of the company, pharmacy, fluid systems, surgical care, biopharma, and hospital products are all projected to grow between 3% and 4% through 2020.
The stock already trades at a premium to its growth rate. Historically, the shares trade between 19 and 22 times forward estimates. At the current quote, the stock is trading around 24 times fiscal 2017 estimates of $1.97; that $1.97 contains really optimistic stock buyback and margin assumption.
While Baxter is a very well-run company, it's hard for me to see the stock moving much higher unless management can find a new way to inject some revenue growth.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.