Act Now While this Healthcare Giant is Still Cheap

An easy way to make money in the market is to buy a stock that has been beaten down due to short-term worries. Of course the rub is discerning whether the problem is indeed temporary. But there is considerable upside to identifying a setback that will not permanently impair a company’s fortunes over the long haul.

In the healthcare space, anytime you hear talk about product recalls or manufacturing woes, it’s worth investigating. These setbacks tend to kill positive investor sentiment. Product sales can also become weak for short-lived reasons, be it a temporary oversupply issue or a weak pricing environment. The key is finding a stock that’s likely to overcome these short-term hurdles.

Baxter International (NYSE: BAX) is suffering from a lot of these issues, but the stock could rise at least +50% as the market realizes the company’s appealing growth prospects across the globe.

Back in May the FDA ordered Baxter to recall its Colleague infusion pumps. The pumps don’t account for much of the company’s revenue and the company has already reserved nearly $100 million for recall expenses, but this could open the door to future product liability litigation and has resulted in quite a bit of negative publicity. Baxter is also suffering from weak demand for products related to its plasma franchise, which is used to treat hemophilia and related blood disorders, leading to falling prices.

It wasn’t that long ago that the Chicago-based company was regularly beset by manufacturing issues and the wrath of FDA inquiries into its facilities. In fact, the frequent occurrence, or recurrence of these issues qualified as a big competitive disadvantage.

Conditions have stabilized in recent years; stemming from the appointment of Robert Parkinson as CEO in 2004. Parkinson is credited with instilling a more shareholder friendly culture at Baxter, which he learned as chief operating officer at in-town archrival Abbott Labs (NYSE: ABT).

The proof of his success is in the performance figures. Despite industry headwinds during the past five years, not to mention the cloud left by healthcare reform, Baxter’s share price is up nearly +20%, compared to Abbott’s single digit performance and negative returns from many competing healthcare providers — and the overall market — during this time frame. The stock has largely followed fundamentals, as management has leveraged mid single digit annual sales growth into earnings growth exceeding +40% each year.

Given the steady trends of the recent past, current production issues can be written off as a short-term blip. Baxter even has a couple of years to take care of the recall and replace any faulty pumps and issue refunds to affected owners. This will allow the company to minimize short-term disruptions to its business and profitability as it spreads out any costs over a longer time period.

The plasma-based franchise, could take longer to work out its issues, but the business is stable. Patients need treatment no matter the economic climate. Plus, sales have grown double-digits in each of the last two full years and further illustrates the growth potential in this business.

In its most recent financial release, Baxter said it expected +1% to +3% sales growth and diluted earnings between $3.93 and $3.98 per share, equating to year-over-year growth of about +10%. That places the forward P/E at just over 11 times earnings. The valuation hasn’t been this low since 1994 — the same year the Clinton administration failed to implement its major healthcare overhaul. And just for the record: Baxter’s share price has more than tripled since then.

It may have taken decades, but the Democrats finally succeeded in their quest for a major healthcare overhaul. The fact that the reforms were enacted this time around is somewhat of a negative weighing on the industry, but it should inevitably help Baxter as millions more patients enter the system.

Action to Take —> Coupled with the other temporary setbacks, Baxter’s shares are significantly undervalued and could rise at least +50% as Baxter’s earnings multiple expands and profits continue to grow at an impressive clip. Short-term pain could easily turn into long-term gain when it comes to this compelling healthcare play.