market folly

East Coast Asset Management is out with an in-depth presentation on Becton Dickinson (BDX). They lay out the bullish case for the company and assume that if you hold it for three years that an internal rate of return (IRR) on BDX if purchased now would be 17.6% annualized. This is not the first time we've covered commentary from this firm as we previously highlighted their deflation-reflation continuum debate. We're excited to bring you their latest market commentary as well as their presentation on Becton Dickinson. So, how do they come to this conclusion on BDX?

Let's first start with the thesis behind this play. Anant Ahuja, Christopher Begg, and Jack McManus have laid out the model for East Coast Asset Management and point out that Becton Dickinson is a niche business with a diverse set of products aimed at capitalizing on the increasing amount of aging baby boomers. Shares have been under pressure due to concerns over exposure to Europe, weak 2009 sales, and unfavorable foreign exchange trends.

The stock currently trades at 8x EV/EBITDA, well below the historical 5 year average of 10.1x EV/EBITDA. They argue that the business has an intrinsic value of $90-95 per share, representing 35-40% upside in the stock. East Coast highlights that Becton Dickinson has an impressive past of shareholder value creation. Over the past five years, BDX has seen 23.5% ROIC, 22.2% ROE, EPS CAGR of 15.8%, and 37 consecutive years of dividend increases. Not to mention, the company has repurchased a consistent amount of shares, with $450 million allocated this year. Given that these are attributes Warren Buffett often likes to see in a business, it should come as no surprise that his Berkshire Hathaway added to its BDX position in the first quarter.

East Coast says that, "the market, in its predictable myopia, has oversold BD out of concerns and speculation over matters that are not implicit in the underlying metrics of the core business." East Coast Asset Management argues that at current share prices, the company is being valued at a future free cash flow of only ~ $4.50 per share. Ahuja, Begg, and McManus wager that this is a floor in valuation as this assumption infers no capital expenditure being allocated toward growth. Their estimates fancy that the business is worth closer to $92 per share (compared to the $67 per share it's trading at currently).

As with any investment, there are also risks involved. They try to highlight these potential headwinds by outlining a possible rise in input costs, a medical device excise tax, as well as low cost manufacturers in other emerging markets thwarting business. Despite these reasons and others listed in their presentation, East Coast Asset Management is confident that the current share price is mainly a "result of macro fears and lack of granular clarity in the short term."

Embedded below is East Coast's twelve page presentation on Becton Dickinson (BDX):



You can download a .pdf copy here.

For more from East Coast, be sure to check out their previous market commentary on the deflation-reflation continuum. Stay tuned as later today we'll also be posting up their most recent market commentary. In the mean time, you can head to some of the recent hedge fund letters we've posted as well for investment insight.