Becton, Dickinson: Business Should Beat H2 2023 Expectations

Recommendation

Becton, Dickinson and Company (NYSE:BDX) continues to execute on its path to margin expansion. BDX had a strong recent quarter, growing organically by 7% thanks to strength across the board in their Medical and Interventional businesses. Even though the flu's contribution to LifeSciences was weaker than expected, supply chain pressures and macro environment recovered slightly which benefited new product launches. In my opinion, the reason why BDX did not perform as well as expected is because of the weak guidance that implies a slowdown in 2FH23 relative to 1FH23. This seems to be a common theme this year among companies that are embedding the uncertain macro environment into their guidance, despite performing better than expected at the start of the year. While I do value management's efforts to err on the side of caution, I am slightly disappointed that they have not increased their guidance, which, in my opinion, would have led to a rise in the stock price. However, what is done is done, and the positive takeaway is that consensus is following management's guide, and if any outperformance in 3Q23 would lead to consensus revising their estimates. In a nutshell, BDX should have an easier time exceeding guidance and estimates for 2H23 due to the significantly reduced expectations. My recommendation is a buy (reiterated) as I expect BDX to beat 2H23 estimates and the share price would re rate.

P&L movements

Margin improvements have been made since I last wrote about BDX. For instance, there has been a 270bps increase in both gross margin and operating profit margin. Looking ahead, management is now guiding for EBIT margin to further expand by 100bps in FY23. In spite of the fact that macro headwinds will continue, I think BDX may have passed the worst of it. Inflation stabilization, falling prices for key inputs like resin, and enhanced supply chain accessibility are all factors that should prove beneficial to profit margins in the not-too-distant future. These previously formidable headwinds are now formidable tailwinds, so there should be no problem with BDX regaining its pre-recession >35% EBIT margin levels. Furthermore, the management has reported that they have accomplished half of their intended SKU rationalizations. They have also made a concerted effort to enhance effectiveness and streamline the company by reducing their workforce by 2% in FY23. In my opinion, these initiatives should drive structural improvements in BDX margin profile. With regards to revenue growth, I am less concerned now as management noted the operating environment remains stable, with procedure volume recovery and hospital capital spending appetites remaining unchanged, both of which bode well for revenue growth. However, the pressure from China should not be ignored. The most recent numbers suggest that China will continue to feel moderate pressure from COVID admissions well into 2Q23.

Guidance

BDX has revised its sales projections for FY23, increasing the range to $19.2 billion to $19.3 billion. They anticipate a base sales growth of 6.5% to 7% in constant currency terms and 5.25% to 5.75% organically. It's worth noting that the organic growth guidance incorporates a 100bps setback from a discontinued business unit, which is being offset by a 50bps increase in organic growth contribution from acquired tuck-ins. Initially, one might expect the EPS guidance to follow suit and increase as well. However, this is not the case, which likely explains the stock's failure to reflect the improved guidance. BDX has only adjusted the lower end of its EPS guidance, raising it to $12.10 from the previous $12.07. Consequently, the new EPS guidance stands at $12.10 to $12.32. While it may not generate significant momentum, I perceive this slight increase as a positive indication, as it reflects an improved outlook for the core business with growth projected at 14.0% to 15.5% in constant currency terms, compared to the previous range of 12.5% to 14.5%. All in all, I view the guidance as something positive and BDX should be well positioned to beat this "low expectation guidance" easily.

Valuation & model

BDX is currently trading at 18.5x its 10-year average forward PE ratio. As previously stated, I believe the consensus is following management's lead in remaining conservative for the remainder of FY23, and no beat and raise actions are expected. According to my model, BDX will outperform guidance and estimates in FY23 because the bar for 2FH23 is low given how 1FH23 has performed thus far. This should boost the stock's momentum and valuation. I estimated a 0.5x increase in PE to reflect this momentum, but this could be higher depending on the size of the beat. As BDX improves its margin profile structurally through internal initiatives, these valuations should become the new "average" and norm.

Summary

BDX has shown progress in improving margin. The stock's underperformance can be attributed to the weak guidance indicating a slowdown in the second half of FY23 compared to the first half. However, I believe the reduced expectations present an opportunity for BDX to exceed guidance and consensus estimates. With margin improvements, SKU rationalizations, and workforce reduction, BDX is working towards enhancing its structural margin profile. The stable operating environment, procedure volume recovery, and hospital capital spending appetite support revenue growth.