Baxter International: Dividend Cut Because of Restructuring

Baxter International (BAX) cut its dividend because of the upcoming sale of the Kidney Care business, high debt and leverage, lower earnings per share, and free cash flow. It had a seven-year streak of increases before the reduction. 

Moreover, the share price has decreased considerably since late 2021 and is near a 52-week low. The share price fell as investors exited this dividend stock because of concerns about leverage, a weakening renal business, and a potential dividend cut as safety decreased. We do not anticipate another cut soon.

Overview of Baxter International 

Baxter was founded in 1931. It designs, manufactures, and sells a portfolio of healthcare products globally. The firm operates through three segments: Medical Products and Therapies, Healthcare Systems and Technologies, and Pharmaceuticals. It is divesting the Kidney Care business, listed as discontinued operations by late 2024 or early 2025, pending approvals. Baxter sells IV solutions, infusion systems, generic injectable pharmaceuticals, smart bed systems, patient monitoring systems, etc.

Total revenue was $14,813 million in 2023 and $15,062 million in the last twelve months.

Dividend Cut Announcement

A few days after the third quarter 2024 earnings release on Friday, November 8^th, Baxter International (BAX) slashed its dividend distribution. The company’s quarterly dividend rate was $0.29 per share before the announcement. The dividend is now $0.17 per share, a 41.4% reduction. In the press release on November 11^th, Baxter stated,

“This dividend represents the new quarterly dividend rate for Baxter in anticipation of the divestiture of its Kidney Care business segment to Carlyle (NASDAQ:CG), which is expected to close in late 2024 or early 2025, subject to receipt of customary regulatory approvals and satisfaction of other closing conditions. Over its 93-year history, Baxter has consistently paid a dividend to its stockholders and maintained a disciplined approach to capital allocation that balances reinvestment in the business with returning significant value to the company’s investors through dividends and share repurchases.”

“This quarterly dividend targets a payout ratio of approximately 25% of adjusted net income over time and places Baxter in line with its peer set,” said Joel Grade, Baxter’s executive vice president and chief financial officer. “Post the sale of the Kidney Care segment, Baxter will emerge with enhanced strategic clarity, committed to a disciplined capital allocation philosophy that is focused on driving value for all stakeholders, which includes returning value to our stockholders through regular dividends.”

Later, in the earnings call transcript, the company stated,

“So from a dividend perspective, obviously, we are anticipating, as we’ve said, resetting our dividend from the perspective of essentially resizing it, if you will, based on the new size of our organization. We are committed to a dividend and we obviously will be coming out with that shortly here as it relates to what the sizing of it will be.”

Effect of the Change

By implementing a 41.4% dividend cut, Baxter sought to lower its dividend to provide financial flexibility because of the impending sale of the Kidney Care business and the completed divestment of the BioPharma Solutions business. The company also has high leverage after the Hill-Rom acquisition in 2021. In addition, the streak was only seven years long after the Baxalta spinoff in 2015. Baxalta was acquired by Shire, which Takeda acquired. This cut ends that streak and resets it to zero. The result is less free cash flow is required for the dividend distribution and share repurchases that can be directed toward deleveraging.

Challenges

Baxter faces challenges related to its Kidney Care segment and the Hill-Rom acquisition. Additionally, hurricanes are impacting the business.

Kidney Care Business

Baxter’s Kidney Care segment has been performing poorly because of the impact of GLP-1 drugs, intense competition, and supply chain disruptions. The business is being sold to Carlyle for $3.8 billion in cash, which will be used to reduce debt. After taxes and costs, Baxter should lower debt by about $3 billion. However, the segment has about $4.5 billion in sales, meaning Baxter may have struggled to sell the unit. After separation, the business will be known as Vantive.

Hill-Rom Acquisition

Baxter acquired Hill-Rom in 2021 for $10.8 billion in debt, expanding into patient beds, monitoring devices, digital tools, etc. However, inflation has affected input costs, leading to lower margins. Gross margins have declined from 42% in 2019 to 38% in 2023 while operating margins have fallen even more from 16% to 10.2% in the same period. Overall, the acquisition added significant leverage and negatively impacted operating results.

Hurricanes

Hurricane Helene is affecting earnings per share because of its impact on a critical manufacturing facility in North Carolina. It will likely chop $200 million off earlier revenue guidance. The facility is a major source of dialysis and IV fluid. A similar issue occurred in 2017 because of Hurricane Maria in Puerto Rico.

Dividend Safety

Baxter’s dividend safety was declining because of lower earnings per share. Earnings per share peaked in 2021 at $3.61 but are expected to decline severely to $1.83 in 2024. This would mark the third straight annual decline.

As a result, as seen in the chart below from Portfolio Insight*, the dividend yield has risen for the past three years and was recently near 3.5%. Although this percentage is not usually associated with distress, it was much greater than the 5-year average of roughly 2%. After reducing the dividend by approximately 41.4%, the calculated dividend yield is around 2.05%. The quarterly rate is $0.17 per share. The yield is greater than the S&P 500 average.

The annual dividend now requires about $347.5 million ($0.68 yearly dividend x 511 million shares), compared to $586 million in 2023. In addition, based on consensus 2024 estimates of $1.83, the estimated dividend payout ratio will be about 37%. We expect the annual difference in cash flow requirements to be used to reduce debt.

Although the dividend is in a better position and more secure now, the company still has challenges ahead of it. In addition, the healthcare company receives a dividend quality grade of F’ from Portfolio Insight. Hence, Baxter is in the bottom percentile of dividend stocks tracked. However, we do not believe another dividend cut is probable at the moment.

Final Thoughts on the Baxter (BAX) Dividend Cut

Before the pandemic, Baxter was a dividend growth stock with a short streak, making it a Dividend Challenger. However, a poor capital allocation decision, a series of spinoffs, and challenges for a major business segment created difficulties for the firm. The sale of the BioPharma Solutions business and the impending divestiture of the Kidney Care segment will lower debt and leverage. That said, lower EPS and FCF meant that Baxter needed to cut its dividend.

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