Market Ignores AbbVie's Impressive Sales Due To Reliance On Humira

Jul.26.14 | About: AbbVie Inc. (ABBV)

Summary

AbbVie posts solid second quarter results.

After the Shire acquisition, all eyes are on the anticipated HCV launch later this year.

Success is required in HCV and the remaining pipeline to tackle the upcoming expiration of Humira in 2016.

AbbVie (NYSE:ABBV) released a relatively strong set of second quarter results on Friday, yet shares lost some ground during the session.

The results were driven by sales of Humira, but this success only increases the company's reliance on its top-selling drug which is set to lose patent protection in 2016. As such a successful integration of Shire and a successful product launch of HCV are required to drive further appeal.

Second Quarter Highlights

AbbVie posted second quarter sales of $4.93 billion, a 5.0% increase from the year before. Sales benefited by 0.2% thanks to modest favorable fluctuations in foreign exchange rates. Sales came in much higher than the anticipated sales of $4.7 billion by the investment community.

The company could not repeat this growth rate in terms of earnings, with GAAP earnings of $1.10 billion being up by 2.8% compared to the year before. As such GAAP earnings were up by two pennies to $0.68 per share.

Adjusted earnings, which is a non-GAAP earnings metric, came in unchanged at $0.82 per share. The company stressed that previously it guided for non-GAAP earnings of $0.75 to $0.77 per share, which makes the results look good.

Given AbbVie's previously issued own outlook, analysts were looking for adjusted earnings of $0.76 per share.

Looking Into The Performance

Sales growth was of course entirely driven by Humira and even some more. Sales of the drug were up by 26.2% to $3.29 billion, increasing the reliance on the drug to levels over 65% of total revenues. US growth drove the sales growth with domestic sales being up 35.6% while international sales rose by 16.2%. The company notes that Humira sales growth will slow down to levels in the high-teens for the third quarter.

While the company sells ten other drugs, either individually or in combination, AbbVie's second best drug Androgel generated sales of just $218 million. This was down 15.6% compared to the year before. Prescriptions for Androgel were down 20% and this trend is expected to continue going forward. Kaletra sales fell by 21.5% to $216 million, suffering from increased competition in the market for HIV drugs.

Overall gross margins came in at 77.4% of sales which is roughly unchanged compared to last year. Total selling, general and administrative costs came in at 29.4% of sales, down by about 60 basis points compared to the year before.

The company stepped up its R&D investments to 16.9% of sales which represented a 180 basis point increase on the year before. The fact that more of its products are entering late stage development results in the buildup in R&D expenses. This increase in costs limited net earnings growth compared to topline sales growth.

Reiterating The Recently Upgraded Outlook

For the third quarter, AbbVie sees adjusted earnings of $0.77-$0.79 per share while GAAP earnings are seen between $0.68 and $0.70 per share.

Full year earnings are seen between $3.06 and $3.16 per share as the full year outlook has been hiked last month. Full year GAAP earnings are seen between $2.69 and $2.79 per share.

The Shire Deal

After making many attempts to acquire its smaller British competitor Shire, AbbVie has finally succeeded in its attempt. Under the final terms of the deal AbbVie will spend 24.44 Pounds in cash and 0.896 shares of AbbVie per share to acquire Shire's shares. Those terms value the British company at 52.48 Pounds based on the prices being prevalent at the time. The deal values Shire at 32 billion Pounds or $54 billion.

AbbVie on the one hand stresses the steep premium which it is paying in order to convince Shire's shareholders to tender, furthermore stressing the 24 times trailing EBITDA multiple. To its own shareholders, AbbVie stresses the rationale to reduce reliance upon Humira while gaining access to a promising portfolio of various drugs.

Yet the real reason appears to be the expected tax rate of 13% to be realized in 2016, while further accretion should boost non-GAAP earnings by at least a dollar per share by 2020. Given that AbbVie will have about 2.1 billion shares outstanding following the deal, anticipated accretion is sizable. Immediate accretion of about $500 million is anticipated by the effective tax rate of AbbVie which could be reduced by 10% as soon as 2016.

Pro-Forma Valuation

With roughly 2.1 billion shares outstanding for the new AbbVie, equity in the firm is valued at roughly $111 billion following completion of the deal.

The company will use about $25 billion in cash to pay to Shire's investors. At the end of the first quarter, AbbVie held $9.1 billion in cash and equivalents while it operated with $14.4 billion in total debt. This results in a total net debt position of about $30 billion following completion of the deal. As Shire holds about $2 billion in net cash, this debt position will be a bit lower.

Shire reported sales of about $5 billion for 2013 which combined with AbbVie's anticipated sales of $20 billion would result in total sales of $25 billion for the combination. As such equity would be valued at about 4.4 times sales.

Adjusted earnings of $1.4 billion as reported by Shire and $4.4 billion anticipated earnings of AbbVie could result in earnings of $5.8 billion, combined. This values shares at close to 20 times earnings excluding anticipated (tax) synergies, which especially in the short run could be offset by higher financing costs.

Despite the increase in leverage, which is manageable, AbbVie will continue to pay out a generous dividend which is yielding 3.1% at the moment as well as continue to repurchase shares.

Final Takeaway

The deal is finally done and despite the high deal tag and value, investors are comforted by the sizable tax synergies and the improved pipeline. Another key advantage is the diversification away from Humira on which AbbVie is becoming too reliant at the moment.

This means that the company can focus on the next main attention point which of course is the anticipated launch of HCV later this year. The market's expectations for the launch and approval is high given that Gilead Sciences' (NASDAQ:GILD) Sovaldi is firing up all cylinders. Further in the pipeline are other Phase 3 programs in the areas of oncology and immunology which can boost potential for future revenue growth, and reduce reliance on Humira in the coming years.

As such the pipeline is improving of course driven by the much anticipated launch of HCV which will be crucial of course. Its competitor Gilead has been hugely successful, but it has a one year advantage in the market for Hepatitis C with Sovaldi. At least some degree of success is required to offset the expected decline of Humira's sales after facing patent expiry in 2016, while the drug still makes up over 55% of sales at the moment, even after incorporating Shire.

As such I remain very cautious based on the still high valuation and increase in leverage. I continue to favor Gilead in this space.

Disclosure: The author is long GILD. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.