I love investing in companies with recurring revenue streams.
One of the best examples of this is the old “razor blade” business model.
You sell customers on a great razor blade system that requires them to buy new razor blades when the old ones wear out – and you’ve got yourself a recurring revenue stream for years.
There are quite a few companies out there that have built successful empires off of similar business models. Doing so creates a profit stream that can last decades.
But what does this mean for dividend growth investors?
And one company in particular has built a very successful business model based on selling high-quality disposable products.
As such, it shouldn’t be a surprise that this company has increased its dividend to shareholders for decades.
That company is Becton, Dickinson and Co. (BDX).
Becton, Dickinson and Co. is a medical technology company that serves more than 190 countries, providing a wide range of medical supplies, devices, laboratory equipment, and diagnostic products.
They sell a number of medical products in the healthcare space that require frequent replacement, including needles, syringes, catheters, and disposable containers. In addition, they have successful product offerings in fluid collection systems, screening systems, and drug delivery systems.
The company was one of the first to sell US-made glass syringes. And they were also a pioneer in the production of hypodermic needles.
Now, the company has been built on that “razor blade” model (vis-à-vis needles). But they’ve made material efforts to increase the size, scale, breadth, and diversification of the business in recent years.
A notable move toward that end includes the 2015 acquisition of CareFusion for $12.2 billion, which brought a leader in medication management and patient safety solutions under the Becton, Dickinson and Co. umbrella.
Furthermore, Becton, Dickinson and Co. bolstered its move toward a more diverse and dynamic company via the 2017 acquisition of C.R. Bard, Inc. for $24 billion. This acquisition added a leader in the fields of vascular, urology, oncology, and surgical specialty products.
These major moves have reshaped the company as a whole, with that reshaping still actively and rapidly occurring (the latter acquisition closed at the very end of 2017).
The company operates in two segments: BD Medical (67% of fiscal year 2017 sales) and BD Life Sciences (33%).
Geographically, the United States accounts for 54% of revenue, while International sales accounts for the remaining 46%.
The healthcare sector is one of my favorite sectors to invest in. You have millions of baby boomers here in the US retiring and getting older every single day. And as these people get older, they increasingly need access to healthcare products and services.
Furthermore, countries around the world are seeing their economies develop further and mature, and citizens within many developing countries are gaining access to high-quality healthcare and medical products.
That’s where a company like Becton, Dickinson and Co. comes in.
Not only do they produce the products that hospitals, clinics, and health agencies around the world require, but many of their products are disposable in nature, thus creating a recurring source of profit.
The company’s growth over the last decade has been strong, although recent acquisitions have affected GAAP EPS.
Revenue increased from $7.075 billion in FY 2008 to $12.093 billion in FY 2017. That’s a compound annual growth rate of 6.14%.
This is brisk top-line growth, but a big jump after CareFusion became part of the company can be seen between 2015 and 2016.
Earnings per share was $4.46 in FY 2008. EPS came in at $4.60 for FY 2017. So we’re looking at a bottom line that’s essentially flat over this time frame.
This belies the true growth and earnings power of the company, which will be more accurately realized and reflected once these major acquisitions have been fully integrated.
Looking out over the next three years, CFRA predicts Becton, Dickinson and Co. will compound its EPS at an 11% annual rate. If you look back at their long-term operating history, adjusting for acquisitions, this appears to be an accurate take on the company’s growth potential.
As such, this is what I would base some of my long-term expectations upon.
Now, you would probably expect that a company selling high-quality, in-demand, and necessary products in a fast-growing area of the world’s economy to be doing well, but are they sharing some of that profit with shareholders?
You betcha.
The company has increased its dividend for the last 46 consecutive years.
That’s more than four decades of not just paying dividends, but increasing the dividend payment every single year. Talk about consistency.
Due to this, the stock is featured on David Fish’s Dividend Champions, Contenders, and Challengers list, which tracks over 800 stocks that have at least five consecutive years of dividend raises.
But Becton, Dickinson and Co. isn’t just increasing its dividend like clockwork; it’s increasing the dividend at a significant rate.
Over the last decade, the company has increased its dividend at an annual clip of 11.6%.
That’s obviously well in excess of inflation, meaning a shareholder is seeing their purchasing power increase year in and year out.
The only issue with the dividend growth is that it’s slowed quite a bit in recent years while the company has transformed itself. However, I suspect dividend growth will pick up again once things settle down.
And shareholders will want to see dividend growth really pick up again, considering the stock yields just 1.3% right now.
With that low yield, an investor needs to see strong dividend growth to make the income side of the investment equation reasonable and appealing.
While the payout ratio looks high, at 65.2%, presupposing near-term weak dividend growth to persist indefinitely, this payout ratio is artificially higher than it really should be. This is because of the aforementioned acquisition charges negatively affected GAAP EPS.
If you’re looking for a growing dividend that’s almost bulletproof, this is it. However, I think one has to ask themselves if they’re okay with the low yield and near-term uncertainty regarding the size of dividend increases. Within a year or two, though, double-digit dividend increases are likely to resume.
The rest of the company’s fundamentals have long been solid, although the overall picture currently looks less attractive and more uncertain than what shareholders have typically come to expect.
The long-term debt/equity ratio is now sitting at 1.44, which is certainly much higher than it was just a few years ago. Meanwhile, the interest coverage ratio, at a bit over 3, is shockingly low.
This is just a snapshot in time, and I suspect the balance sheet will look much better within a few years’ time. The interest coverage ratio, for example, will jump and improve quite a bit once EBIT recovers and normalizes.
The same issue translates to the company’s profit. Long a source of strength (the company historically produced strong net margin that was well into the double digits), the more recent numbers have been temporarily and artificially clouded by the reshaping of the company.
Nonetheless, the company averaged annual net margin of 10.64% over the last five years, while return on equity averaged an annual rate of 17.24% over that period.
These are good numbers in absolute terms, but they’re far off from what the company has historically generated. And I suspect these numbers, too, will recover soon enough.
There’s just not much to dislike here in terms of the business model.
The historical, normalized growth is impressive. And the near-term forecast for EPS growth is likewise impressive. While there’s uncertainty in the near term regarding how this company will look when the dust clears, the truth is that the acquisitions, while sizable, are complementary in many ways. The company should come out of this period stronger for it.
I see no reason why this company can’t continue increasing its dividend for the next two or three decades – or longer.
Just imagine collecting more and more passive income every year, for decades.
That could quite literally change your life.
Their product offerings are pretty broad in scope. And the company’s scale and diversification is only increasing. Not only do they provide some of the products I listed above, but they also offer cell imaging systems, drug transfer devices, medication workflow solutions, rapid diagnostic assays, and reagent systems for life science research.
So they have a stable business providing disposable products to hospitals and clinics, while also providing a number of systems and devices that clients like reference laboratories, pharmaceutical companies, blood banks, and clinical laboratories require.
Of course, like any business, there are risks.
Primarily, they have to worry about competition. The healthcare space is relatively stable, but competition is fierce.
Furthermore, regulation and litigation is an omnipresent risk in healthcare.
In addition, new products are routinely introduced in the marketplace, meaning there’s always the risk of obsolescence for healthcare devices. Of course, the counterargument is that this just feeds into demand, strengthening companies with good product pipelines, diversification, and strong R&D departments.
The valuation of the stock is a bit hard to nail down right now, due to the way GAAP EPS isn’t properly reflecting the true earnings power of the company. For perspective, the company recorded $971 million in after-tax charges, which is a massive number against $1.1 billion in recorded net income.
While the current P/E ratio of 46.5 is thus not accurate, the stock still looks pretty expensive here.
The price-to-sales ratio is at 3.9 right now, compared to the stock’s five-year average P/S ratio of 3.0. This ratio bypasses the issue with earnings.
Moreover, the stock’s low yield looks even lower when you compare it to the 1.7% yield the stock has averaged over the last five years (an average which itself is low).
I think the stock is probably worth a premium to the market after looking at the quality, scale, diversification, and strength of the complementary businesses after this transition is complete. But the valuation still seems stretched, even after giving it the benefit of the doubt.
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 8%.
That DGR is on the high end of what I allow for (and is arguably aggressive when compared to the most recent dividend increase of 2.7%), but I think the company will be uniquely positioned and extremely competitive after this period of uncertainty is complete.
Dividend raises may be a bit small for the next year or two, but I think the potential for double-digit dividend growth returns sooner rather than later. And so things should work out and average out nicely for shareholders over the long run. Plus, as noted, I’m giving them the benefit of the doubt here.
The DDM analysis gives me a fair value of $162.00.
Bottom line: Becton, Dickinson and Co. (BDX) provides high-quality medical products and devices in the healthcare space, many of which are disposable and have to be replaced. This creates constant demand for their products, which means recurring profit. Recent acquisitions are reshaping the company into a stronger and more diverse company that will have the scale to compete for many years to come. They’ve increased their dividend for 46 consecutive years, and I think another 46 years of dividend increases is certainly possible. But with the stock appearing to be overvalued right now, waiting for a sizable pullback seems prudent for long-term dividend growth investors.
— Jason Fieber
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