Building a Stronger Core With Abbott Laboratories
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It has been more than a 100 days since Abbott Laboratories (NYSE: ABT) separated its research-based pharmaceutical business into a newly formed entity named AbbVie (NYSE: ABBV). As is often the case, the spin-off has been the initial winner. AbbVie has produced a total return of more than 32% in pretty quick order. Abbott has done well, but the 17% return has clearly not kept pace. AbbVie is now a concentrated pure pharmaceutical company with heavy reliance on Humira. The stock will likely do well given the difficulties in a competing firm will have in producing a generic biologic compound to compete with Humira once the patent does expire. However, investors seeking out wide-moat firms should instead turn their attention to Abbott Labs.
Abbott Labs is the company that retains wide-moat status and offers a compelling story. The debate is whether this story also comes with an attractive valuation. Should investors buy Abbott Labs today?
Abbott Labs is now a diversified health care company that is the market leader in each of its segments. This is quite a feat and clearly establishes the company’s wide-moat status. Their four main segments are Nutritionals, Medical Devices, Established Pharmaceuticals, and Diagnostics. The company is well positioned in the growth segments of the health care industry and this is further aided by the fact that emerging markets account for 40% of sales. Emerging market health care penetration is woefully inferior to that of the developed world. This, along with a general aging of the population in the developed world, sets the stage for consistent earnings-per-share growth of 10% of more over the next several years.
Given the diversity of the company, valuing the company on a sum-of-the-parts analysis makes the most sense.
Nutritionals is the largest business segment at roughly 30% of sales. This division is mainly comprised of infant and adult nutrition. Abbott is the market leader in infant nutrition with their Similac branded infant formula. They have a market share close to 40%. This slightly outpaces Enfamil which is owned by Mead Johnson Nutrition (NYSE: MJN). Ensure is the leader in the adult nutrition space. The entire Nutrition division is growing north of 8% on a constant currency basis. There are substantial growth opportunities coming from both the aging population as well as with increasing hospital usage rates for these scientifically proven nutritional formulas.
Mead Johnson Nutrition is the clear comparable here. The pure play nutritional company produces annual sales close to $4 billion compared to more than $20 billion for Abbott. Sales growth is actually slightly lower than Abbott’s Nutrition division, but very consistent and offers a similarly compelling story. From a risk standpoint, Abbott has credit ratings of A+ from Standard & Poor’s whereas Mead Johnson is several notches lower at BBB minus. Mead Johnson has a forward price-to-earnings ratio of 24x.
Medical devices comprise about one-quarter of total sales. The majority of sales come from stents and again the company is the clear global leader. Also supporting this division are solid growth opportunities in blood glucose meters along with cataract and LASIK medical equipment. The comparable in this division is Medtronic (NYSE: MDT) who is the number two player in stents and a well-established medical device maker. Growth rates for stents and pace makers have stalled in recent years amid several industry recalls and a notable slowdown in Europe. This has pushed valuations to historic lows in recent years with Medtronic stock currently trading at 13x forward EPS. Medtronic forecast 2013 sales growth of 3-4% and EPS growth of 5-6%.
Abbott’s division should be rated the same at this point in time, but I want to highlight the future potential. Abbott is the first company to develop a stent that over time gradually absorbs into the heart vessel. Metal stents remain behind and have been the cause of many recalls and debate. Trials have been exceedingly positive, but guidance for actual sales and earnings numbers remains difficult. Needless to say, there is plenty of upside in this new technology that could ultimately result in this division should be treated with a premium valuation to Medtronic at some point in the future.
Established Pharmaceuticals account for one-quarter of total sales and is comprised of more than 500 branded generic drugs sold exclusively outside the United States. Once again, the reliance and growth opportunities of emerging markets become evident with 60% of this division selling into these markets. This number is only going higher given that emerging markets are growing 15% annually for the company in this division while developed market sales are shrinking.
There are substantial growth opportunities for health care penetration in the emerging markets. According to Credit Suisse, pharmaceutical spending per capita is over $600 in developed markets compared to just $81 in the BRIC countries. Developed market headwinds persist, but are more than offset by the enormous emerging market potential.
Diagnostics account for roughly 20% of sales and the bulk of the sales come from the immunoassay and chemistry business that detect diseases and other medical conditions. Abbott holds a number two position in in-vitro diagnostics behind Roche Holding (NASDAQOTH: RHHBY). Worldwide sales increased 6% in the first quarter of 2013, but this division’s earnings are growing faster than sales. The company said they remain on track to improve operating margins to 20% by 2015 compared to less than 10% in 2007.
Roche is a diversified health care company as well with a sizeable presence in branded pharmaceuticals. Their key drugs of Avastin, Herceptin, and Rituxan are anticipated to show similar growth to that of Abbott’s established pharmaceuticals division in the next several years. All told, the established pharmaceutical and diagnostic divisions should be combined and matched against Roche. Roche trades with limited liquidity on U.S. exchanges, but has a forward price-to-earnings ratio of 16x in its home market of Switzerland.
Putting it all Together
Abbott Lab’s fair value forward price-to-earnings ratio is 19.8x based on sum-of-the-parts valuation. The company is forecast to earn $2 per share in 2013. The simple math puts a fair value stock price at roughly $39.60. This is 8% higher than the current stock quotation. There doesn’t appear to be a lot of home run potential at this juncture. However, the company has strong competitive advantages, trades at a modest discount to fair value, offers great earnings visibility, and has a bit of upside potential from their new stent technology. Even at current prices, the stock makes for a good addition as a core holding in modest to conservative accounts.
Justin Carley has no position in any stocks mentioned. The Motley Fool owns shares of Medtronic. 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!