I am taking a contrarian stand on Baxter International (BAX), a global diversified healthcare company. Baxter is a major manufacturer and distributor of medical devices, pharmaceuticals and biotech products. Products are used in healthcare facilities of all types including hospitals, nursing homes and specialized medical centers such as rehab centers and kidney dialysis centers.

The company is financially strong; sales growth is exceptional and earnings continue to surprise. Baxter has a solid balance sheet.

Over the past twelve months, sales grew by nearly 10%; significantly better than its five year growth rate of 6.76%. Earning grew by 21.19% as compared to one year ago and this was also stronger than its five year growth rate of 14.03%. Gross profit, operating profit and net profit margins are all above their five year averages. The consensus EPS estimate for FY09 is $3.74 compared with reported FY08 EPS of $3.16.

So what is there not to like? The medical equipment, supplies and distribution business is one bright spot in an otherwise dismal market. I believe the market has driven prices in this industry to unsustainable levels; momentum has displaced the fundamentals.

Herman Saftlas, the Standard & Poor’s analyst that covers Baxter sees continued growth ahead and higher margins. He gives the company a twelve month target price of $65. Alex Kolb at Zacks Investment Research also sees a bright future for Baxter. Barron’s also makes a strong case for Baxter.

Changes are coming to the healthcare industry. Medicare and Medicaid reimbursement rates will be cut under the Obama administration’s healthcare plan. Hospitals and other healthcare facilities will tighten inventories. How material these reductions will be to Baxter are hard to quantify.

Baxter is certainly a strong company and I take no issue with the analyst’s predictions of the future. However, my analysis pays more attention to free cash flow than it does to earnings. Growth needs to be paid for with cash and free cash flow is, in my opinion, the best metric to use in this regard.

I estimate that Baxter will generate $1.97 in free cash flow over the next twelve months as compared to $1.43 in FY08. I note that long term debt and other long term liabilities total $5,541 billion.

My value estimation, based on the fundamental factors I consider important, leads me to conclude that Baxter’s fair market value is approximately $37.56.

Disclosure: I have no position in Baxter International.