On January 2nd, Abbott Laboratories (ABT) completed its previously announced spin-off of its pharmaceutical business, establishing AbbVie (ABBV) as a separate company focused on biopharmaceuticals and new drug development. Since completing the transaction, there has been a fair amount of investor enthusiasm in AbbVie, which includes among its assets its best-selling, anti-inflammatory drug Humira, as evidenced by the stock's rapid 10% gain during the first month of trading. In contrast, the "new" Abbott has been relatively flat, and many investors are unsure whether or not they should hold onto the shares.
Earnings & Dividend Potential
One challenge that investors face in evaluating Abbott is the lack of clarity around the company's recent performance. While Abbott did release its fourth-quarter and fiscal-year results for 2012, they continued to report these metrics as a single company, including the now separated proprietary pharmaceutical business. So investors do not have a clear, separated baseline of financial performance for the new Abbott. The management team has stated that they will release a post-separation baseline of the quarterly income statement on both the GAAP and non-GAAP basis with appropriate reconciliations prior to Abbott's first quarter earnings release in April.
However, Abbott did provide guidance and their business outlook for 2013 that reflected only the new Abbott businesses. For FY 2013, Abbott is guiding EPS for $1.98-$2.04, and Q1 EPS of $0.40-$0.42, before specified items of ~$0.17. Taking the full year EPS guidance and the current market price of ~$33/share gives us an P/E ratio of around 16.5. While this doesn't necessarily scream "cheap", it is interesting to note that the companies earnings' yield would be ~6.1%, or just about 2x the 30-year U.S. Treasury bond rate. Furthermore, the management team is very focused on growing sales at a mid- to high-single digit rate, while continuing to return capital to shareholders in the form of share buy backs and dividends.
Management's past actions appear to support this guidance, as Abbott has increased its dividend for 40 consecutive years. Abbott previously declared a $0.14/share dividend ($0.56/share annualized) following the spin off, giving the company a meager 1.7% dividend yield. However, using management's full year EPS guidance of $2, the current dividend is supported by a very low 28% payout ratio. Given the low payout ratio, the strong free cash flow (guidance of $4B for FY 2013), the stability and diversification of the business units, as well as Abbott's history of returning capital, it is a good bet that this dividend will be increasing this year, and steadily going forward.
Company Balance Sheet
Investors also face a challenge in evaluating Abbott's balance sheet, though it will likely be another positive aspect for the company. Back in November 2012, prior to the separation, Abbott completed one of the largest U.S. corporate bond offerings on record, selling almost $15B of bonds through the new AbbVie unit. The proceeds were used to pay a $8.5B cash distribution to Abbott from AbbVie. Abbott's management has been consistent in its plans to use the proceeds to execute a tender offer for their debt outstanding, as well as to pay down a portion of commercial paper outstanding. In other words, to reduce its debt.
While the tender process while likely expensive given the current interest rate environment, it is also very likely that it strengthened the company's balance sheet in the long run. AbbVie was able to issue 10-year bonds at ~2.8% and 30-year bonds at ~4.5%, so it is probably safe to assume that at least Abbott's short-term borrowings are on excellent terms. Back in Oct, management provided guidance on what the balance sheet for the separated Abbott Labs would look like: $7.5B in debt (combination of long-term debt, commercial paper and other short-term borrowings) and $5B in cash. Investors will have to wait for either the carve-out updated financial statements or the Q1 earnings release to get a more granular update. However, the company's strong free cash flow and history of allocating capital intelligently suggests that the estimated level of debt will not be a problem for Abbott going forward.
There are still several concerns that investors should be aware off, especially given Abbott's global footprint and expected growth internationally. First, the fiscal problems present throughout Europe have resulted in an environment of austerity, and the healthcare industry has not been spared from this headwind. The Established Pharmaceutical Division [EPD] generates roughly 1/4 of Abbott's overall revenue, and a large portion of the business commodity generic business comes from Europe. However, the European segment of the business has been experiencing a high degree of pricing pressure and utilization decline due to the austerity pressure, so sales have been declining. This weakness is Europe is counteracting the growth that EPD is experiencing in developing markets, and stunting overall growth for division.
Abbott has been attempting to adjust costs so that they appropriately match the market opportunities in the region, as well as capturing market share from competitors, in order to offset the decline. However, this will likely continue to be a problem for EPD throughout 2013, and certainly one issue investors will want follow closely.
In addition to Europe, EPD also faces potential challenges in India. Although emerging markets segments, including India, have been experiencing strong growth in revenue, India's new drug pricing policy may pose a significant threat to this geographical segment of EPD's business. Abbott's EPD has roughly $800M - $1B in exposure to the Indian market, so significant changes in the pricing environment would obviously have an impact on the company. Industry estimates show that implementation of the new policy would bring ~30% of the market under price control, and significant increase from the 18% under price control from the previous drug-pricing policy established in the mid-1990s.
On a positive note, the policy does take a market-based approach to setting prices, in comparison to the previous cost-based mechanism. Still, foreign pharmaceutical companies, Abbott included, will likely have a harder time adjusting their cost structure to match an price controls implemented. So it is hard to see how this does not potentially slow revenue growth and/or significantly impact margins for EPD, which have been very healthy until this point. Abbott's management team believes they have appropriately captured these factors in their planning assumptions for 2013, so it should not significantly impact their provided guidance. However, investors would be smart to pay close attention to how these issues develop, and whether other developing countries follow suit.
Since completion of the spin off, investors have been drawn to the more sexy, "fraternal twin", AbbVie, however, Abbott Labs appears to be an attractive investment opportunity as well. It is one of the largest and fastest growing diversified healthcare investments available, with a balance across its four business units and a diverse customer base and payer mix. Additionally, the company is well positioned to take advantage of the growth opportunities present in the faster growing, emerging economies. At its current price, Abbott seem fairly, but not overvalued, and should provide long-term investors with both solid capital appreciation as well as dividend growth.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the dividend growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.