Established in 1888, Abbott Labs (NYSE:ABT) is a diversified healthcare conglomerate with a global presence. The company spun off its proprietary pharmaceutical business as Abbvie (NYSE:ABBV) earlier this year and now operates in four main segments: Nutritionals, Diagnostic, Vascular and Generic Pharmaceuticals. In addition to the above mentioned segments, the company also has a portfolio of Diabetes and Medical Optics products.
The company looks very different since the split, without the massive proprietary pharmaceutical business. Accordingly, we have launched a new model for the firm in order to fully capture its new structure and business environment. The remainder of this article discusses the key drivers that we believe will drive the company’s stock going forward. We have a $38 price estimate for Abbott, which is around 10% ahead of the current market price.
Growth In Emerging Markets
We expect the most significant tailwind assisting Abbott’s top line for the next few years to be the growing demand for its products in emerging markets. Countries like China, India, Russia and Brazil continue to grow at a faster rate than most developed economies, and have a rapidly growing middle class. For example, McKinsey & Company predicts that the urban-household income in China will double by 2022 and that the majority of its urban consumers will earn between $9,000 and $34,000 annually by that time.  As the middle class continues to grow in these markets, people are likely to increase their focus on healthy living and increase their discretionary spending on nutritional products (food supplements) and point-of-care diagnostics.
Further, as emerging markets grow, governments (and people) in these countries are also likely to focus more on the use of sophisticated testing platforms in order to stave off infectious diseases, cancers and cardiovascular problems. This is likely to drive the demand for new diagnostic products for many years to come.
Given the huge opportunity, Abbott has been heavily investing in emerging markets. Under its current plan, the company intends to increase emerging markets revenue as a percentage of total revenue from 40% today to around 50% in 2015. 
Continuous Investments In R&D
Abbott has been continuously investing in its R&D centers in order to develop new and more innovative products. It has opened six manufacturing and R&D facilities in its nutritional and pharmaceuticals businesses in the Asia Pacific region during the past three years, including three in China. The new R&D centers situated in emerging markets are especially beneficial for the company’s nutritional business because these centers can help develop products that better meet the local needs and preferences of consumers in these countries. The company’s investments in R&D have already resulted in a 5x increase in the number of new nutritional products launched annually since 2008 and a 10x increase in both clinical trials and patent applications. If even some of these new products gain the favor of their target audience, we expect the company to grow at a faster rate than the market itself.
Within the diagnostics division, the company is developing six next generation systems from the ground up based on customer needs and market analysis.  As more of these products are launched, we expect the company to continue increasing its market share in the diagnostics market also.
Currently we forecast Abbott’s R&D expenditures to remain at 6-7% of revenue for the next few years as it continues to develop new products. However, we expect the figure to start declining over the long term as more and more of the company’s R&D work is happening in low-cost centers like India and China. The company currently projects that by 2016 more than 35% of its R&D staff will be located in high growth emerging markets like China and India.
Drive For Efficiency And Scale
While Abbott’s top-line is expected to continue growing, the company is constantly looking to reduce its costs in order to maximize margins. The new manufacturing units that are being built by the company around the world are deliberately located nearer to the markets they are intended to serve. This is likely to reduce Abbott’s distribution and logistics expenses significantly when these plants become operational. Further, these plants are designed to be more efficient and use the latest technology that improves yields and, as a result, margins. The company is also looking into its raw material and packaging material costs in order to improve its gross margins.
On the distribution side, Abbott started selling its products directly to its customers in several of its markets. It recently acquired its distributor in Vietnam, which is its largest nutrition business outside of the U.S. and China, and will from now on reach out to customers directly in this market. We believe that with a focus on reducing logistics costs and by removing middlemen, the company will able to make gradual improvements in its margins going forward.
- Mapping China’s middle class, McKinsey & Company, June 2013
- Abbott Laboratories’ Management Presents at UBS Global Healthcare Conference, SeekingAlpha, May 22, 2013
Disclosure: No positions