Baxalta: A Rare Undervalued Biopharmaceutical Company

Baxalta (BXLT) was created on July 1st 2015 when Baxter (BAX) spun-off its biopharmaceutical division.

Baxalta may be new, but it is no start-up company.  Baxalta has estimated annual revenues of around $6 billion, and 16,000 employees.

Around 50% of Baxalta’s sales come from the United States, with the other 50% from international markets. The company operates in 3 segments:

  • Hematology
  • Immunology
  • Oncology

The hematology segment currently accounts for about 60% of sales for Baxalta. The immunology segment makes up the other 40%. Where does that leave oncology?

The oncology segment will be operational when Baxalta acquires blockbuster leukemia drug treatment Oncaspar from Italian company Sigma-Tau Finanziaria S.p.A. for $900 million. The acquisition is expected to close in the 2nd half of fiscal 2015.

Onscapar currently generates around $100 million a year in revenue. Baxalta expects to grow the treatment to around $500 million a year in revenue by 2020.

Earnings Calculation & Valuation

As a spin-off, Baxalta does not have historical stand-alone financial reports.   The company’s pro-forma 2014 financial statements do give insight into the earnings power of the company.

Baxalta’s pro-forma 2014 financial statements shows adjusted pre-tax income of $2,073. Baxter had a tax rate of 22% last year. Baxalta’s tax rate should be similar to Baxter’s tax rate last year. Using a 22% tax rate, Baxalta had net profit of $1,617 billion in fiscal 2014.

Baxter distributed 80.5% of Baxalta to Baxter shareholders on July 1st, 2015. Baxter shareholders received 1 share of Baxalta for every share of Baxter. In total, there are approximately 544 million shares of Baxalta.

This works out to about $2.39 in earnings-per-share for Baxalta. The company currently trades for about $32.00 a share, for a price-to-earnings ratio of 13.4. The price-to-earnings ratios of other large biopharmaceutical companies are shown below:

  • Gilead Sciences (GILD) price-to-earnings ratio of 13.4
  • Amgen (AMGN) price-to-earnings ratio of 22.1
  • Biogen (BIIB) price-to-earnings ratio 29.6
  • Celgene (CELG) price-to-earnings ratio of 46.5

Baxalta’s price-to-earnings ratio is as low as Gilead Sciences’, and much lower than its other peers. Gilead Sciences is trading at a discount to fair value because of fears about price reductions for its flagship Hepatitis C drugs. There is no such controversy surrounding Baxalta. The only negative for Baxalta is that it is a ‘new’ company – and therefore isn’t as easy to analyze.

Growth Prospects & Competitive Advantage

Baxalta has especially high margins. The company is targeting an operating margin of around 30%. High margins are evidence of a strong competitive advantage.

Baxalta’s competitive advantage comes from its research and development department coupled with its ability to patent new discoveries. Patents allow Baxalta to protect its discoveries and charge high prices for its pharmaceutical products.

Baxalta is targeting annual research and development expenditures of around $600 million a year. The company has a robust product pipeline and is targeting 20 new product releases by 2020.

Baxalta is targeting sales growth of 6% to 8% a year, and operating earnings growth of 8%+ a year. The company will achieve this growth through a mix of new product releases, acquisitions, and organic growth in its current pharmaceutical portfolio.

Capital Allocation & Dividends

Baxalta’s management is targeting a 15% payout ratio. At current prices, this comes to a dividend yield of around 1.1%. Baxalta’s management will continue in the tradition of its parent company Baxter.

The company will very likely pay increasing dividends for years into the future. Baxter has paid steady or increasing dividends for 33 consecutive years. I expect Baxalta’s management to raise its payout ratio and grow dividends faster than earnings-per-share over the next several years.

Management will spend around 50% of its cash flows on organic growth.   The remaining 35% will be spent on potential (as yet unannounced) acquisitions to bolster the company’s pharmaceutical portfolio. If attractive acquisitions are not present, management will use these cash flows to repurchases shares – boosting earnings-per-share growth.

The Final Verdict

Baxalta shareholders should expect solid total returns going forward. Earnings-per-share should grow at over 10% a year for the next several years. This growth will come from:

  • Operating income growth of 8%+
  • Share repurchases of 1%+
  • Margin improvements of 1%+

As a new spin-off, Baxalta should have room to increase its margins by increasing efficiency. Earnings-per-share growth combined with Baxalta’s dividend yield gives investors expected annual total returns of over 11% a year.

Baxalta’s price-to-earnings ratio of just 13.4 seems far too low, especially considering the company’s 11%+ expected total returns. Investors will likely see even better total returns than 11% a year as the company’s valuation multiple slowly rises closer to that of its peers.

Baxalta ranks highly using The 8 Rules of Dividend Investing thanks to its solid expected total returns and low price-to-earnings ratio. Click here to see The 8 Rules of Dividend Investing. Baxalta is a buy for dividend growth investors looking for exposure to the biopharmaceutical industry.

Source: Baxalta: A Rare Undervalued Biopharmaceutical Company

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