Baxter Expects More Weakness on Bottom Line in 2023

Senior Equity Analyst

Julie Utterback

Following the spinoff of Baxalta in mid-2015, Baxter's new management team has focused on increasing efficiencies and innovating in medical products. That focus has resulted in much-improved profitability and cash flow generation since then. At its 2022 investor, the company highlighted a goal for mid-single-digit sales growth primarily through new product launches and for double-digit adjusted earnings per share and free cash flow growth compounded annually. Acquisitions, like the recent combination with Hillrom (medical equipment like hospital beds with digital connection capabilities), could add to those prospects, if executed properly.

Baxter's renal and acute care technology supports patients with failing organs, most often kidneys. Baxter generates most of its revenue in these segments from at-home patients using its peritoneal dialysis, or PD, tools. However, it also sells hemodialysis products to dialysis clinics and continuous renal replacement therapy and other organ support equipment to intensive care units, which saw a boost in demand during the coronavirus pandemic. While some new product launches were delayed during the pandemic, this segment should continue to benefit from new hemo- and peritoneal-dialysis launches in the future. Additionally, increased demand for at-home dialysis tools should benefit Baxter in PD generally.

Baxter also provides many injectable therapies. In pharmaceuticals, Baxter is pursuing an ambitious growth strategy to roughly double the number of molecules its sells through a variety of delivery options, including premixes. In advanced surgery, Baxter sells wound closure and bleeding control products. New products aim to help clinicians save time in the operating room. In medication delivery and nutrition, management has turned around these operations after recent hurricane and regulatory concerns damaged Baxter's reputation as a reliable supplier of these critical therapies. New product launches, including several infusion pumps, may boost growth in these segments in a postpandemic environment, too.

Business Strategy & Outlook

Baxter has dug a narrow moat around providing dialysis and injectable therapies through complex delivery systems. It can claim top-tier positions in most of its product lines and typically competes with a concentrated group of peers. Overall, we think it would be difficult for new firms to enter these niches primarily due to the switching costs associated with some of its medical equipment and the intangible assets surrounding its proprietary technology and manufacturing processes. These factors form the basis of Baxter’s moat, and generally, we see a long runway for the company to generate economic profits with its existing technology and innovative pipeline of new products. We expect Baxter to generate returns on invested capital in the midteens, well in excess of capital costs, even after the Hillrom acquisition.

In its renal care segment, we believe Baxter benefits primarily from intangible assets associated with its proprietary technology and switching costs related to placed equipment. Baxter is the second-largest provider of dialysis equipment and related consumables, behind only Fresenius Medical Care. While both organizations offer a broad spectrum of dialysis products, their strengths largely lie in separate technologies and geographic footprints. Through its peritoneal dialysis products, Baxter thrives in the home setting with a strong presence in emerging markets. Baxter dominates the PD medical product market with market share around 70% versus Fresenius at 17%. Alternatively, Fresenius leads the way in hemodialysis technology, which is used in its own and other clinics with 39% hemodialysis patient share versus Baxter with around 10%. Baxter’s proprietary medical technology in PD and its ability to continually innovate create a moat source related to intangible assets, too. After its PD equipment is placed, Baxter structures payment for use of that equipment and related consumables as a monthly subscription with the consumables (tubing and solutions) delivered directly to each patient through Baxter’s own logistic network. In our opinion, if the treatments are working, patients have little incentive to switch due to inertia factors surrounding their own training around this self-administered treatment and the company’s business model, which creates a recurring revenue stream of consumables from placed equipment. 

Similar dynamics to the renal care business exist for Baxter’s acute therapy segment, which sells organ support tools to intensive care units of hospitals. Baxter clearly leads the continuous renal replacement therapy business. We believe its moat in acute therapy stems from differentiated technology (intangible assets) relative to peers that informs the initial purchase decision and also stems from switching costs related to caregiver training after that. 

While a relatively small percentage of Baxter’s total sales (estimated in the midsingle digits as a percentage of sales), infusion pumps contribute to Baxter’s maintainable competitive advantages and recurring revenue outside of renal care. Infusion pumps are a medical technology that help hospital staff, primarily nurses, automatically administer medical therapies and often lead to recurring consumable sales of administrative sets. Infusion pumps can be differentiated from a technology perspective from competitive pumps from the likes of Becton Dickinson and ICU Medical primarily in the U.S. Infusion pumps have a relatively a long life (over seven years), which gives them a long period to enjoy recurring sales after the pumps are placed. Some pumps offer networking software that helps these devices become embedded further in the workflow of caregivers, too. During replacement cycles, hospitals often stick with familiar technology to ensure smooth therapy administration by their caregiver, as well. Overall, once an infusion pump is placed at a hospital, we believe that facility is unlikely to create a workflow disruption by switching to a new pump provider.

We believe Baxter's therapeutic offerings—IV solutions, nutritionals, and generic pharmaceuticals—contain elements of cost advantages and intangible assets as well, although we do not consider cost advantage as a moat source for Baxter overall. Baxter enjoys the top position in IV solutions in the U.S., stands in a leading position in parenteral nutrition, and excels in difficult to manufacture generic pharmaceuticals, such as anesthesia and aseptic premixes. Baxter typically faces limited competition in these target markets where top-tier competitors include Fresenius SE, B. Braun, and the former Hospira assets (now at ICU Medical and Pfizer). Overall, we see significant barriers to entry around these businesses, which keeps most of the injectable markets that Baxter participates in concentrated from a competitive perspective. Specifically, key peer ICU Medical has estimated that it would take about $300 million and three years to build a manufacturing facility that would allow a new entrant to gain enough scale to compete effectively in the IV solutions business. We estimate that similarly large and time-consuming investments would be required in the nutritionals and generic pharmaceutical businesses. Beyond these up-front costs, the ongoing costs associated with ensuring compliance due to stringent regulatory standards remain high. These factors contribute to significant entry barriers for new competitors, which has been highlighted by recent shortages in IV solutions and nutritionals where market share shifts have occurred primarily between existing players rather than inviting significant new competition. Also, as shortage conditions are alleviated, the cost leader can often recapture its leadership position. For example, Baxter dominates the IV solutions market in the U.S. due to cost advantages even relative to its key peers in this niche. After some hospital customers jumped ship for a short time after Hurricane Maria knocked out some of Baxter's production capacity in Puerto Rico in 2017, Baxter has largely regained its market share due to its significant scale-related advantages in this business that allowed it to win back customers in this price-sensitive end market. 

Beyond the scale required to compete successfully in the IV solution, nutrition, and pharmaceutical businesses, we see some intangible assets in them, too, related primarily to the difficult manufacturing processes, unique delivery systems that can provide mix benefits, and the reputational requirements to be considered a long-term supplier of hospitals in these niches. Even in generic pharmaceuticals, Baxter primarily participates in markets with complex manufacturing and administration requirements. In both its inhaled anesthetics and injectable therapy franchises, Baxter typically faces competition from only a few competitors primarily due to manufacturing complexity, which is much higher than in oral generics for example where competition and pricing pressure is more pervasive. Beyond the general manufacturing requirements, Baxter also excels in aseptic premix product manufacturing, which is required to keep some molecules stable and helps ensure safety through product administration. Offering ready-to-use injectables in the care setting can improve patient safety and reduce the time associated with administration tasks, which creates a valuable tool for nurses and doctors on the front lines of care and helps Baxter generate some mix benefits in these otherwise commodified markets. In its nutrition products, Baxter benefits from intangibles through its differentiated formulations and delivery systems. Adding to those intangible assets, we see some reputation-related advantages in these therapeutic offerings, as well, particularly around the ability to be a reliable supplier of these essential therapies to hospitals in the GPO negotiating process.

In advanced surgery, we think the firm benefits primarily from intangible assets with its proprietary products to control bleeding and close wounds during surgical procedures. Baxter occupies the second position in this market behind Johnson & Johnson, and in advanced hemostats and sealants, its flagship Tisseel and Floseal products remain differentiated. Baxter continues to innovate in this area too with new launches aimed at significantly reducing valuable operating room time, including a reduced preparation time for Floseal and reduced suturing time through its Flow Coupler product. Ongoing innovation should add to the maintainability of this segment’s proprietary technology-related advantages. 

The other segment consists primarily of contract manufacturing for other pharmaceutical companies, which contributes to Baxter’s scale. However, we do not view contract manufacturing as an advantaged business on its own.

Narrow

Economic Moat

Baxter

Baxter International, Inc. engages in the provision of a portfolio of essential renal and hospital products, including acute and chronic dialysis, sterile IV solutions, infusion systems and devices, parenteral nutrition therapies, premixed and oncolytic injectable, bio surgery products and anesthetics, drug reconstitution systems and pharmacy automation, software, and services. It operates through the following segment: Americas, Europe, Middle East and Africa (EMEA), Asia-Pacific (APAC), and Hillrom. The Americas, EMEA, and APAC segments offer a portfolio of essential healthcare products. The Hillrom segment provides digital and connected care solutions and collaboration tools, including smart bed systems, patient monitoring and diagnostic technologies, respiratory health devices and advanced equipment for the surgical space. The company was founded by Davis Baxter in 1931 and is headquartered in Deerfield, IL.

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Baxter International, Inc. engages in the provision of a portfolio of essential healthcare products including acute and chronic dialysis therapies, sterile intravenous (IV) solutions, infusion systems and devices, parenteral nutrition therapies, inhaled anesthetics, generic injectable pharmaceuticals, surgical hemostat and sealant products, surgical equipment, smart bed systems, patient monitoring and diagnostic technologies, and respiratory health devices. It operates through the following segments: Americas, Europe, Middle East and Africa (EMEA), Asia-Pacific (APAC), and Hillrom. The Americas, EMEA, and APAC segments offer a portfolio of essential healthcare products. The Hillrom segment provides digital and connected care solutions and collaboration tools, including smart bed systems, patient monitoring and diagnostic technologies, respiratory health devices, and equipment for the surgical space. The company was founded by Davis Baxter in 1931 and is headquartered in Deerfield, IL.

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