Strong But Vulnerable
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Today I’m going to analyze one of the biggest names in the pharmaceutical industry, Abbott Laboratories (NYSE: ABT). Patents on major revenue generating drugs are expiring. These expiring patents threaten both revenues and earnings at many of the major pharmaceutical companies. American consumers saved $193 billion in 2011 by purchasing generic drugs. A good chunk of that came right out of the pockets of big pharma. Abbott Laboratories is in better shape than most, losing only one patent, Tricor, last month. However, Abbott faces other unrelated challenges. I will discuss those in the course of our analysis here in the hopes of giving the reader some direction in this dynamic industry. First, let’s look at the company’s fundamentals from a value investor’s perspective.
Abbott currently trades around $66 per share and has a market cap of $104 billion. The price to earnings is 21.57, its price to earnings growth ratio is 1.54 and its price to book is 4.10. Its quarterly year-over-year revenue growth is at 2% and quarterly year-over-year earnings growth at -11.2%. It reports a debt to equity ratio of 65.17. Abbott pays a handsome dividend, yielding 3.1% against a payout ratio of 63%. Abbott has slightly above average financial strength and sales increased 6.1% in the second quarter.
My concerns with Abbott are twofold. First, a continued rise in the share price pushes the stock beyond its fair value. As a result, teh share price is not likely to continue to rise as it has in the past several months. The stock has seen growth in its share price of almost 33% over the past 52 weeks, but restructuring costs continue to depress earnings. At this point, the discounted cash flow value and share price are in equilibrium. The stock is trading at “fair value.” Second, aside from the fiscal impact, there are other uncertainties surrounding the pending spin-off of its prescription drug business. This new entity will be called AbbVie and it has been suggested that AbbVie will be overly dependent on sales of Humira, its #1 selling drug, for the bulk of its revenues. If this is true, AbbVie may be in a world of hurt. Roche Holding AG (RHHBY), in a recently released study of its rheumatoid arthritis drug, Actemra, demonstrated results superior to those of Humira in Phase IV trials. With Abbvie in a position of reliance on Humira for the bulk of its revenue, post spin-off, a threat from Roche is a real concern. Those buying Abbott stock in anticipation of suitors for a merger or acquisition, should at least consider the impact of this potential threat to Humira’s marketability. The first is of concern to the trader, and the second is of concern to the long term investor. Clearly, Abbott is vulnerable to competition moving into the final two quarters of 2012 and beyond.
Other household names in big pharma aren’t faring much better. GlaxoSmithKline (NYSE: GSK) trades at around $47 and has a market cap of $115 billion. GlaxoSmithKline has a price to earnings growth ratio of 2.19 and an ugly price to book of 10.37. Return on equity sparkles though, coming in at 54.09%. Quarterly year-over-year revenue growth is at least positive, reported at 0.8%. Quarterly year-over-year earnings, however, come up beyond short at -13.11%. GlaxoSmithKline’s debt to equity position won’t blow your skirt up either, reported at 153.67. The current ratio is textbook at 1.12. GlaxoSmithKline is the dividend king here, offering shareholders a dividend with a monster yield around 4.5%, but tempered by the highest payout ratio in the group at 75%. GlaxoSmithKline’s patent on Combivir expired in November, 2011. It invested $6.6 billion in research and development last year. GlaxoSmithKline's pipeline is improving and it has some 15 therapies in phase III testing.
Competitor Pfizer (NYSE: PFE) currently trades around $23 and has a market cap of around $182 billion. Its price to earnings ratio around 18.00 with a price to earnings growth ratio of 3.41. Pfizer’s price to book is an agreeable 2.21 but return on equity is unimpressive at 9.55. Equally unimpressive are quarterly year-over-year revenue and earnings growth which are reported at -6.6 and -19.3 respectively. You will like Pfizer’s debt to equity and current ratio which are 46.72 and 2.03 respectively. It also provides a nice dividend, yielding 3.6% with Pfizer paying out 62% of its profits to shareholders. Pfizer’s revenues took a big hit with patents expiring on Lipitor and Caduet in November, 2011 and it lost exclusivity on the antipsychotic Geodon in March of 2012. Pfizer’s research and development budget was $9.1 billion in 2011. Seems the money was well spent. Pfizer has about 38 therapies in phase III.
Competitor Merck (NYSE: MRK) has a market cap of just under $135 billion and trades at about $44. It has a trailing twelve month price to earnings of 20.39 and a price to earnings growth ratio of 2.68. Merck’s price to book is 2.43 and it also has a weak return on equity of 12.42%. Refreshingly, quarterly year-over-year revenue and earnings growth are both in positive territory, reporting at 1.3% and 66.6% respectively. It offers the best debt to equity ratio here today at 31.68 and also the strongest current ratio at 2.07. Merck gives back 76% of earnings to shareholders, providing a yield of 3.7%. Merck faces patent expiry on the wildly popular Singulair in August, 2012. Merck poured $8.4 billion into research and development in 2011. In spite of this level of spending, it has but two major drugs in phase 3.
I believe Pfizer is the best long-term play of the bunch. The stock is undervalued by 27% on a discounted cash flow basis. The recent failure of its highly touted Alzheimer's treatment bapineuzumab is almost certain to create some pullback in share price. I view this as an opportunity to add this stock to your portfolio. Its robust pipeline, sound financial footing and attractive, yet sustainable, dividend makes it a winning opportunity in my book. I believe Abbott has peaked and we will see its share price drop through year-end. GlaxoSmithKline has all the earmarks of a value trap. Merck’s bottom line continues to suffer as a result of costs associated with its integration with Shering-Plough and litigation over weak warning labels on its baldness therapy, Propecia.
jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of Abbott Laboratories and GlaxoSmithKline. Motley Fool newsletter services recommend GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.