Why One of My Favorite Healthcare Companies Is Too Expensive

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Abbott Labs (NYSE: ABT) has been one of the biggest players in the healthcare sector for many years, but a lot of changes have been taking place within the company. Most significantly, Abbott spun off its research-based pharmaceuticals business on the first of the year, creating the new entity AbbVie (NYSE: ABBV). In its current form, Abbott produces nutritionals, diagnostic products, generic medications, and medical devices. With a great balance sheet, solid revenue growth, and a pullback from its recent post spin-off highs, is Abbott a good buy now, or are we better off looking elsewhere?

What does Abbott do?

Abbott is truly a global company, with just 30% of its sales coming from the United States. Emerging markets account for an impressive 40% of Abbott’s sales, and developed nations outside of the U.S. make up the rest. 

Abbott’s nutritionals segment is the company’s largest source of revenue, and should account for approximately 39% of the company’s sales this year. Products include the Similac, Ensure, Prosure, and other lines of adult nutritionals. Abbott’s other major revenue streams include their pharmaceutical business, which now consists of the company’s branded generic drugs. These are generic drugs that are marketed under Abbott’s brand name, which allows the company to sell them at a higher price than comparative “no-name” generics, but still significantly cheaper than name-brand drugs. For this reason, Abbott’s pharmaceuticals have become very popular in emerging markets.

The company also makes a variety of diagnostic equipment including screening tests for several diseases, diagnostic instrumentation, hematology systems, and pregnancy tests. Abbott’s vascular division makes stents, catheters, and products used in the course of surgery. Other products by Abbott include blood glucose monitoring equipment, Glucerna shakes, and other products for diabetics.

Growth ahead?

Despite Abbott already having a very large global reach, there is still room for growth. The trend in the U.S. and other developed nations toward healthier diets should create tremendous growth opportunity for Abbott’s nutritional business. New products like the Xience Expedition stent should mean higher sales for the vascular division. Finally, the diagnostic equipment’s sales will be greatly helped by such factors as an aging population which will lead to a greater need for medical testing.

Cheap or expensive?

A look at Abbott’s earnings over the past year is somewhat misleading, as it takes into account the earnings from the part of the company that was spun off just about 6 months ago. The consensus calls for earnings of $2.01 this year, meaning that shares trade for 17.3 times this year’s earnings, which actually strikes me as a bit high. While it is indeed worth noting that Abbott has one of the best balance sheets in the sector with almost as much cash as debt, there is only about 8% annual earnings growth expected over the next few years. While I love Abbott as a company, this kind of valuation leads me to examine some other options…

Should we look at the “other half”?

AbbVie represents the prescription pharmaceuticals business that was, until recently, a part of Abbott. AbbVie produces a wide range of drugs for many different uses including HIV medications, cholesterol treatments, and anesthesia products, to name a few. AbbVie actually seems to be a little cheaper than Abbott and with earnings expectations of $3.12 per share for this year, the stock trades at 14.1 times this year’s earnings with a similar growth rate as Abbott’s expected.

Another alternative: Hologix

Another favorite of mine in the medical equipment business is Hologix (NASDAQ: HOLX), which is a leading manufacturer of medical products for women. Products include diagnostics, medical imaging systems, and gynecological surgical products. Hologix is expected to earn $1.54 per share this year, for a current-year P/E of 12.3 with double-digit earnings growth expected. In fairness to the other companies mentioned, Hologix’s balance sheet does not look nearly as good, and features over $4.3 billion in net long-term debt (cash minus debt), and their entire market cap is just $5.1 billion.

Conclusion

While this comparison is by no means exhaustive, nor is it an endorsement for Hologix as a long-term investment, it does show that Abbott is relatively expensive compared to some of its alternatives in the segment. It is certainly true that quality commands a premium, and Abbott is indeed a high-quality company, but I would need to see a significant pullback before considering Abbott for my portfolio.


Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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