BofA Upgrades Baxter International On 'Margin Story,' But Valuation Is Rich

In a report published Thursday, Bank of America Merrill Lynch analyst Bob Hopkins downgraded the rating on Baxter International Inc (NYSE: BAX) from Buy to Neutral, while lowering the price target from $78 to $40. Although the company is likely to be an interesting "margin story" following its recent spinoff, the stock valuation is rich at present.

Following the spin-off of Baxter's biopharmaceutical business into Baxalta Inc (NYSE: BXLT), the analyst believes that the former company is likely to see margin improvement in the medtech arena, with the potential for EPS growth of more than 20 percent in the near to intermediate term, as well as EPS growth in the double digits in the longer term.

However, even if Baxter manages to meaningfully exceed its own guidance, the stock appears fully valued already on almost all valuation metrics.

"Because BAX is under-earning today, we value BAX based on out-year earnings and cash flow. We do not add the value of BAX's stake in Baxalta to BAX's valuation because that equity stake in Baxalta will likely be gone within a year as it will be used to pay down debt and fund the pension," Hopkins said.

Baxter's stake in Baxalta is expected to drive the former company's out-year earnings. The analyst believes, therefore, that if one accounts for the Baxalta stake in Baxter's valuation, it would imply double counting.

"BAX looks less expensive on EV/EBITDA, but that metric does not capture the impact of BAX's high capex spending over the next few years. BAX will have $2-$3bln in balance sheet flexibility, which could be a source of potential upside, but we do not expect any moves near-term," the Bank of America report added.

The analyst expects Baxter's new dividend yield to be in the 1 percent range, based on the company's 35 percent payout target.