Ultimate Stock-Pickers' Top New Money Purchases
Digging deeper into Becton, Dickinson and other new money purchases by our top managers.
By Bradley Meeks | Stock Analyst
As you may recall, during our recent breakdown of the top purchases and sales by our Ultimate Stock-Pickers, we highlighted the fact that Becton, Dickinson and Company (BDX) stood out from the other top purchases not only because it was bought with conviction but because it was a new money purchase for three of the four managers buying the stock. We believe that portfolio managers send signals about how they feel about a particular stock by the amount of money they're willing to commit to it at any given time, which is why we focus on both purchases and sales by our top managers. Much as we assess the relative attractiveness of an individual security by how many funds hold it, whether or not their managers have been adding to or subtracting from their positions, and the percentage each security makes up of a portfolio, we also like to look at new money purchases and outright sales, which we feel offer additional insight into the thinking of managers about their holdings.
Sifting through the most recent holdings and transactions of the top managers in our Investment Manager Roster we've put together a list of new money purchases by our managers.
In each case, more than one manager was putting new money to work, which is probably the reason why five of these names--Becton, Dickinson, BHP Billiton (BHP), Corning (GLW), Oracle (ORCL), and Visa (V)--also showed up on our list of Ultimate Stock-Pickers' Top Purchases.
Given the greater level of conviction we saw from our managers purchasing Becton, Dickinson (versus the two other 5-star names on the list, Medtronic (MDT) and Mueller Water Products (MWA)), we decided to sit down with the analyst who covers the firm, Alex Morozov, the associate director for the Morningstar health-care team, in order to get his perspective on the medical products firm.
|Ultimate Stock-Pickers' New Money Purchases|
|No. of Fund|
|Becton, Dickinson and Company (BDX)||Low||Narrow||69.08||0.74||4|
|BHP Billiton Limited (BHP)||Medium||Narrow||55.39||0.85||3|
|Coca-Cola Company (KO)||Low||Wide||48.99||0.89||9|
|Corning Inc. (GLW)||High||Narrow||15.31||1.28||4|
|Medtronic, Inc. (MDT)||Low||Wide||33.22||0.69||8|
|Mueller Water Products, Inc. (MWA)||High||None||4.05||0.41||2|
|Oracle Corporation (ORCL)||Medium||Wide||20.29||0.97||6|
|Parker Hannifin Corporation (PH)||Medium||Narrow||42.82||0.73||3|
|Siemens AG (SI)||Medium||Narrow||70.77||0.97||3|
|Visa, Inc. (V)||High||Wide||61.93||0.81||4|
|Wal-Mart Stores, Inc. (WMT)||Low||Wide||48.70||0.81||15|
Stock price data and Morningstar ratings as of 06-18-09.
Alex, can you please give us a brief overview of Becton, Dickinson's business?
Becton Dickinson is the world's largest manufacturer and distributor of medical surgical products, such as needles, syringes, and sharps-disposal units. The company also manufactures diagnostic instruments and reagents, as well as flow cytometry and cell imaging systems.
Becton has made a name for itself manufacturing basic surgical instruments: needles, syringes, and scalpels, among others. The company is an innovator in its field--being the first to launch safety-engineered products (SEPs) designed to prevent needlestick injuries; these products are now mandatory in most of the hospitals across the United States.
We estimate that the company's market share in this subsegment of the needle industry is somewhere around 40% and steadily increasing as it continues to convert international markets, particularly emerging third-world countries, to the usage of SEPs. Becton also has a sizable presence in the diagnostics and scientific instruments fields, which represent growth pockets within Becton's otherwise mature operations.
What is the basis for the company's narrow economic moat rating?
The primary source of Becton's moat is the company's unparalleled economies of scale. Traditional sharps lack significant differentiation qualities, with cost being the biggest factor in the decision-making process. The firm's manufacturing capacity dwarfs its competitors', giving it some maneuvering room on price. That said, Becton is not entirely a price-setter as the sharps business is commoditylike, which limits price increases to enhancements and changes in product mix.
Becton is also the largest supplier of drug-prefilled syringes, where its low-cost/heavy-volume approach makes it a preferred vendor for bottom-line-oriented drug manufacturers. The company is not at the mercy of any one drug company either, with the firm contracted to manufacture syringes for more than 200 different drugmakers. Aiding Becton's competitive position is the essential but routine nature of its products.
Finally, about a quarter of the firm's business is in diagnostics/instrumentation where it benefits from long replacement cycles, intensive training required to operate the machinery, and a steady stream of consumables following the large up-front installation cost. Such advantages are particularly exemplified by the steady, double-digit returns on capital in every year since the late 1990s.
You believe Becton will be able to sustain and grow its operations despite the widespread financial crisis and economic slowdown. What is the basis of your confidence in its business model?
We view the bulk of Becton's products as recession-resistant, primarily due to the essential nature of their use. Sharps, even slightly costlier SEPs, would be the last resort for any hospital cuts, as the risk of being unable to perform basic surgical procedures outweighs any financial considerations. That said, we saw some very modest indications of destocking in the past few quarters, but, in our opinion, the slight bleeding down of inventory has already ceased, and the next few quarters should see a more normalized demand for surgical instruments. Further, despite significant foreign currency weaknesses, the company continues to advance its safety-engineered products overseas--sales grew at a robust 20% clip over the past few quarters--underscoring strong unfulfilled demand for safety products.
The company's other two segments face tougher head winds given the element of capital spending inherent in their operations. Nonetheless, our forecast calls for moderate growth in both diagnostics and biosciences areas. We anticipate several positive factors will impact the performance of these two units for the remainder of 2009: advancement of Becton's rapid test for MRSA (staph infection) and a $950 million expected increase in spending by the National Institute of Health.
How would you characterize the firm's financial health?
At the end of the last quarter, the company was sitting on $730 million in cash and equivalents, a very comfortable position given its total debt of under $1.2 billion and annual free cash flow in excess of $1 billion. The company's interest coverage ratio is more than 40 times EBIT, and I would argue that its predictable and robust cash flows make Becton a perfect candidate for additional leverage. Unfortunately, in the current environment taking on additional debt isn't viewed favorably by investors, so the company has been steadily reducing its debt position. Becton has also stuck to its share repurchase activity--a prudent strategy, in our opinion, given its underpriced stock.
How do you view Becton's management team?
We view the firm's executives in a very favorable light primarily as a result of its wise capital allocation decisions and the avoidance of major operational mishaps throughout the company's history. Becton's management has historically resisted immediate growth through acquisitions, instead relying on smaller targeted acquisitions with a focus on promising technologies. The most recent example is its 2006 purchase of GeneOhm, which yielded the first FDA-approved rapid staph infection test. In light of its prudent investment strategies, Becton's returns on invested capital (ROIC) have consistently exceeded our estimate of its cost of capital, with returns reaching 24% last year. Becton's corporate governance policies are by and large shareholder friendly and top management's personal wealth is closely aligned with the firm's performance--Becton's CEO alone holds nearly $60 million worth of the company's stock.
Why do you believe the stock is undervalued?
Despite Becton's relative resistance to the economic turbulence, its stock has still been impacted by the overall decline in the equity markets. While its valuation may not be as attractive as several of its peers' in the medical device space, the company has only limited exposure to capital spending cycles, which helps set a floor for more risk-averse investors. At current prices, Becton's stock trades at an attractive enterprise value/earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) multiple of 8 times, and its trailing price/earnings (P/E) ratio of 15 is well below its 10-year average of 22. In addition, the company's stock yields 2%; while not a yield that many investors would salivate over, the firm's dividend has grown at a four-year compounded annual growth rate of 17%. Our fair value estimate for Becton, Dickinson is $93 per share.
What do you consider to be the key risks for investors?
It is not unfathomable that the current economic downturn persists well beyond 2009, delaying the recovery in sales of Becton's relatively expensive scientific and diagnostic platforms. We could also see tight hospital budgets resulting in tough contract renegotiations even for basic surgical instruments. The pricing squeeze could be exacerbated by upward movement in raw material prices. Finally, given the company's substantial foreign operations, any movement toward curbing foreign income deferrals for tax purposes would adversely affect the company's effective tax rate and its competitive position.
Despite some of the risks involved, Alex believes that Becton, Dickinson is undervalued and is well-positioned to reward investors longer term. His opinion is borne out by the fact that three of our top managers made significant new money purchases in the stock during the most recent period, with a fourth manager increasing his stake in the name. As such, we'd encourage investors to take a much deeper look at Becton, Dickinson, as well as some of the other new money purchases we've highlighted above, to see if one of them might offer up the right medicine for their portfolios.
Disclosure: Bradley Meeks doesn't own shares in any of the companies mentioned above.
The Morningstar Ultimate Stock-Pickers Team does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.