Tuesday, August 4, 2015

What should I do with Baxter and Baxalta after the split?

Note: I originally planned to post this article tomorrow, but in light of recent developments about Baxalta being in the process of being taken over by Shire, I am posting it today. I sold two-thirds of my Baxter and Baxalta shares yesterday. 

In early July, Baxter International split into two companies – Baxter and Baxalta. For every share of legacy Baxter, shareholders received a share of new Baxter (BAX) and a share of new Baxalta (BXLT).

A few readers had asked me about the new dividend payments after a press release from late June indicating that there might be a decrease in dividends. I decided to hang on, until both companies formally announced what their dividend policy will be.

Both companies recently announced dividend cuts effective in September. The new payment for Baxter will be 11.50 cents/quarter, while the payment for Baxalta will be 7 cents/quarter. This totals 18.50 cents/quarter, which is much less than the 52 cents/quarter that legacy Baxter paid to shareholders.

My goal as an investor is to generate a rising stream of income from my dividend growth portfolio. As such, I purchase shares in companies that can afford to and do grow dividends per share over time. I have found that it is easier to forecast and rely upon dividend income, rather than capital gains in the retirement years. Therefore, companies that have cut dividends have no place in my portfolio since they are no longer fitting with my overall goals and objectives that made them a purchase in the first place.
This is the 6th dividend cut I have experienced since starting my journey as a dividend growth investor in 2007 – 2008. The others include American Capital Strategies (ACAS), General Electric (GE), State Street (STT), British Petroleum (BP),and Vereit (VRE). Vereit is the new name of American Realty Capital (ARCP), the friendly REIT which was involved in an accounting scandal that lead to the suspension of the dividend in 2014.

I analyzed all sales I have done after a dividend cut. I found that in the case of selling after a dividend cut, I was better off only in the case of American Capital Strategies (ACAS) and American Realty Capital Properties ( now called Vereit). In the case of General Electric (GE) and State Street (STT) in 2009, as well as British Petroleum (BP) in 2010, I would have been better off simply holding on to my existing positions. On the other hand, the mistake was softened by the ability to write off losses, and reinvest that capital in another dividend growth stock.

It looks like selling has been a mistake in retrospect. Each situation was different however – it looks like purchasing shares after companies have started growing a dividend again could have been a good thing to do. Of course, the bigger mistake was probably buying the companies with the low streak of dividend increases the first place. Of all the companies that I owned which cut dividends, only two had raised them for over ten years. There is room for improvement for me, where I should focus on companies that grow dividends for at least a decade. Companies that have raised dividends for less than a decade are unproven and speculative, since they do not have a track record of consistent earnings and dividend growth.

Moving on to the companies I wanted to talk about today. I reviewed Baxter and Baxalta businesses – they seem to have decent businesses, which would likely deliver decent returns over time.

Baxter is expected to earn $1.29/share in 2015, and to grow earnings to $1.91/share by 2018. This means that the stock is selling for 31 times estimated earnings and yields 1.15%.

Baxalta on the other hand is expected to earn $1.94/share in 2015, and to grow earnings to $2.35/share by 2018. This means that the stock is selling for 16.90 times expected earnings and yields 0.85%.

The valuation on Baxter seems high, while the valuation on Baxalta seems adequate. The important thing is that both companies seem poised to grow earnings per share over time, which is what will drive future dividend growth and intrinsic value growth. It also looks like the companies in total could have afforded to at least maintain dividends to shareholders.

Historical Baxter spin-offs have done really well for shareholders. Plus, Baxter has had a weird dividend history in 2001, when they effectively announced payment of dividends for the next year I 2000, but only ended up paying one quarter’s worth of dividends in 2000. However, the new companies could end up being acquisition targets, which could make holding on to them potentially lucrative.

I am going to be selling both Baxter and Baxalta from my taxable accounts – this is over 2/3rds of my stake. The rest is sprinkled between several retirement accounts, so selling would be expensive. Unfortunately, I am unsure why the dividend was cut. It seems as if both companies do not want to take responsibility for the dividend from the legacy company. It is unfortunate that both new companies are unwilling to continue the dividend growth legacy of old Baxter. In contrast, during the Abbott Laboratories spin-off in 2012 - 2013, there was a clear visibility about the dividend policy, and the legacy shareholders saw their dividend income increase. While earnings per share are posed to grow for Baxter and Baxalta and they were adequate to support the dividend payment from legacy Baxter, the new companies have decided that the dividend is not a priority. The dividend cut in both is a disappointment that will result in a 1% decline in overall income for the dividend growth investor portfolio. The nice thing is that I am selling at prices which are very close to my cost, which means that by reinvesting my funds elsewhere, I will not only maintain overall level of dividend income on the portfolio level, but might also end up a little better off.

I am also considering disposing of the Halyard Heatlh (HYH) shares I received last year from Kimberly Clark's (KMB) spin-off. While overall dividend income was unchanged from that legacy Kimberly Clark (KMB) position, I do not believe Halyard Health will be paying a dividend. Since my goal is to live off dividends, it doesn't make a lot of sense to hold on to a stock which will not help me achieve my goals.

That being said, I might consider initiating a position in either company once/if they approve their first dividend increase.

Full Disclosure: Long BAX and BXLT, ABBV, ABT, GE, BP, VRE, KMB

Relevant Articles:

Replacing dividend stocks sold
Dividend Portfolios – concentrate or diversify?
When to buy back dividend shares that you have previously sold?
How I manage my dividend portfolio
Stock Spin-Offs – What Should Dividend Investors do?

Popular Posts