Informal Thoughts on BDXA

Investments

As with everything that I will post to the investing section of this blog, the following should not be construed as investment advice.  It is simply meant to be the ramblings of a now-retired individual with some time on his hands.  I am not affiliated with any organization and have no interest in publishing other than for the intellectual exercise.  While I make an effort to be accurate with my facts, I do not assert that any of the following information is 100% reliable.  If I own a stock upon which I comment, I will always say so.  In  this case, I own BD Depository Shares Representing the Mandatory Convertible Preferred Stock (BDXA) in a personal account.

 

The Mouthful:  Becton Dickinson Depository Shares Representing 1/20th of One Share of 6.125% Mandatory Convertible Preferred Stock, Series A

Thoughts on Becton Dickinson

For those who don’t know that much about the company, Becton Dickinson is essentially a medical products supermarket. The company manufactures and distributes a wide variety of products, including the Vacutainer tubes technicians and nurses use when drawing blood, sharps (e.g. pen and safety needles), catheters (e.g. urological catheters for drainage, therapeutic catheters, etc.), diagnostic reagents and instrumentation, infusion pumps, surgical materials, medication management products and others. The company’s operations are well diversified from a geographic point of view, with roughly 44% of revenues generated overseas. Finally, I believe it’s important to recognize that, while BD operates in highly regulated markets, 1) its products don’t typically rise to the level where customers feel the need to “do something” about their costs, and 2) BD is somewhat insulated from the economic cycle, given the amount of business that is reimbursed under fee schedules comprising both medical devices and medical professionals’ reimbursement. While analysts get worked up over whether the company grows its top line 4%, 5%, or 6% in a given year, I think that the ability to grow reliably is more important for long-term, income-oriented investors. In this regard, BD is hard to beat.

Over the years, it appears that BD’s strategy has been to move up the value chain and become more important to its primary customer base – hospitals and clinics. While the organization spends about 6% of net revenues on R&D, its principle method for doing so has been by making acquisitions. Every few years, it seems, BD makes a significant acquisition. Most recently, the company closed the $24bn acquisition of C.R. Bard, in late 2017, bringing the company a host of interventional and surgical products. Before that, it was the infusion pump company, Carefusion, which BD bought in 2015 for $13bn. Given that BD is about a half-turn away from its leverage target post the acquisition of Bard, I think it is reasonable to expect BD to begin shopping for its next target.

Not surprisingly, BD’s willingness to return cash to shareholders ties to its M&A strategy. As debt comes down as a multiple of EBITDA, the company raises its dividend more aggressively. In the early periods post an acquisition, dividend increases are more modest. Most recently, the company announced a 2.6% increase to its quarterly dividend (to $0.79/sh.), suggesting the company is still in debt pay-down mode. The forward yield on common equity is only 1.2%. Over the longer-term, BD ought to be able to grow earnings in the high single digits, organically, and its dividend growth ought to match. This is certainly consistent with the company’s history. Capital intensity has been coming down, and capital expenditures clocked in at 5.5% of net revenues in BD’s Fiscal Year ending 9/30/19.

An Investment in BD

BD’s shares trade at roughly 20x forward earnings. That’s not cheap in an absolute sense, but it’s cheaper on a relative basis than they’ve been in a while. This valuation is also arguably attractive when you consider where “defensive” stocks typically trade and the shrinking list of investable companies that are truly defensive. Consequently, I’m O.K. owning BD common at these levels.

However, when it comes to what I actually own, it’s the Becton Dickinson 6.125% Mandatory Convertible Preferred Stock depository shares (BDXA). Becton Dickinson issued these securities in conjunction with the financing it did in order to complete the C.R. Bard acquisition. The key features of this issue are that the Preferred shares 1) sit higher in the capital structure (not an issue for BD), 2) pay a higher dividend and 3) convert into common according to specified terms. On this latter point, the Preferred converts into BD common according to a fixed ratio when the common trades above $211.80 and below $176.50, but along a sliding scale between these two prices. In other words, as BD common approaches $211.80, the Preferred stock ought to start offering better downside protection.

Today, BD common trades at roughly $257/sh., or roughly 21% above the Threshold Appreciation Price of $211.80. Thus, we’d have to undergo a rather violent correction between now and May 2020, by which date the Preferred shares must be converted into common, for the Preferred shares to stand out. In other words, BD Preferred share receipts really aren’t much more interesting than BD common right here, right now. Still, I bring this security and its feature up in consideration of what I outlined earlier. Specifically, should BD engage in another acquisition of size, this form of the financing might be included and offer total return investors a solid investment opportunity that fits their objectives. If it informs the potential timing of such an event, BD should be at 3.0x D/EBITDA by the third quarter of calendar 2020, at which time significant M&A again becomes a possibility; BD did the financing for Bard roughly a month after having announced the proposed deal.

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