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Stock Strategist

Baxter's Headwinds Mostly Temporary

The company faces near-term challenges after the split, but we still like its moat.

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 Baxter International (BAX) faces a particularly challenging year in 2015 following the spin-off of Baxalta (BXLT), and while growth should remain relatively stable going forward, management faces a considerable task ahead to boost profitability. Thanks to the company's competitive advantages in the dialysis and hospital markets, we give decent odds for margin expansion gains over the coming years.

A number of factors are depressing Baxter's near-term cash flows. Generic competition for branded oncology drug cyclophosphamide at the end of 2014, currency headwinds, dis-synergies from the Baxalta split, regulatory and manufacturing issues, and pension expense adjustments have cumulatively shaved about $1 off Baxter's earnings per share, by our estimate, and place 2015 operating margins in the high single digits, considerably lower than those of close peers like Fresenius (FRE), Hospira (acquired by Pfizer (PFE)), or CareFusion (acquired by Becton Dickinson (BDX)). Meanwhile, capital expenditures have been running high as management addresses regulatory issues and expands manufacturing capacity for solution products. Beyond these mostly temporary issues, we think gaining synergies from the Gambro acquisition, optimizing manufacturing and distribution operations, exiting unprofitable business lines, and refocusing on new product launches and higher-margin segments (nutrition, anesthetics, and biosurgery) can lead to long-term margin expansion.

Michael Waterhouse does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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