Why Abbott Labs Has Upside Potential

Aug. 5.14 | About: Abbott Laboratories (ABT)

Summary

We discuss the strengths and weaknesses of Abbott Labs in this article.

Financial gearing, yield, valuation and growth potential are in focus.

We also compare Abbott Labs to a sub industry peer to get a picture of its relative valuation.

In this article, we are focusing on the strengths and weaknesses of Abbott Labs (NYSE:ABT) and comparing it to Becton Dickinson (NYSE:BDX). We're comparing it to Becton Dickinson because the two companies not only sit within the same GICS sector of health care, but also within the same GICS sub industry of health care equipment and services.

Sure, the two companies are of totally different sizes, with Abbott Labs having a market cap of $63 billion and Becton Dickinson's market cap being a comparably small $22 billion. However, we realize that many investors apportion capital based on sectors and sub industries, so we feel a comparison of the two could be useful and interesting, as we aim to find out whether Abbott Labs offers good value based on its recent performance and future potential.

Financing

A key starting point for us is how a company is financed. Indeed, we think this is more important than ever in the health care space right now due to the vast number of acquisitions that are taking place. We feel that there are a relatively large number of opportunities for M&A activity on offer within the sector, so we're pleased to see that Abbott Labs runs a very disciplined capital structure. It has low levels of debt, as evidenced by its debt to equity ratio of just 26.1%, which means that it has considerable scope with which to make future acquisitions.

Becton Dickinson, although having the capacity to do likewise, has a debt to equity ratio of 78.7%. This means that it perhaps does not have the financial flexibility to make acquisitions to the same extent as Abbott Labs does. However, the flip side is that it makes Becton Dickinson more profitable based on the return on equity measure. Indeed, while Abbott Labs' low financial gearing works against it, with it having a return on equity figure of 10.2%, Becton Dickinson's use of debt means it delivers more bang for equity holders' bucks due to its return on equity being much higher at 25.6%. Although far lower than Becton Dickinson's figure, we feel that Abbott Labs is highly profitable given its relatively conservative stance on financing.

Yields and growth prospects

It's tough to find high yielding stocks right now, so while Abbott Labs' yield of 2.2% may not sound much, it's higher than the S&P 500's yield of 1.9%. Becton Dickinson's yield of 1.8% is slightly disappointing, although both it and Abbott Labs have considerable potential to increase dividends per share, since their payout ratios are only 42% (Abbott Labs) and 43% (Becton Dickinson). Moving forward, we feel that both companies could be solid income plays, but Abbott Labs is clearly the preferred choice for income seeking investors, given its higher current yield.

Meanwhile, the same is true of growth prospects for the two stocks. Abbott Labs pips Becton Dickinson, with its EPS forecast to grow by a highly impressive 10.8% next year, while Becton Dickinson is slightly behind at 9.3%. Both numbers, though, are strong and show there is considerable potential within the health care equipment and services sub industry.

Valuation

Although the two companies trade on forward P/Es that are identical (17.1), Abbott Labs' higher EPS growth rate over the medium term means that it appears to be more attractive based on the PEG ratio. Indeed, it has a PEG of 1.8, versus a PEG of 2.1 for Becton Dickinson, which is a 14.3% discount to its sub industry peer. We also feel that evidence of Abbott Labs' better value can be seen in its yield, with both companies having near-identical payout ratios, Abbott Labs has the higher yield. This indicates better value and, as such, we believe that Abbott Labs could outperform Becton Dickinson going forward.

Conclusion

We're impressed with the low-risk balance sheet of Abbott Labs and, although its profitability numbers aren't as impressive as those of Becton Dickinson, we think it has more potential to pursue M&A activity and that this could be an important future play when it comes to future profitability. In addition, the deal to offload the generics drug business to Mylan for $5.3 billion provides even more scope for acquisitions in future.

Furthermore, Abbott Labs has a higher yield and higher growth rate than Becton Dickinson. It also has a lower PEG ratio, which we feel indicates that it offers better value for money than its sub industry peer. As a result, we think that Abbott Labs could outperform Becton Dickinson going forward, as the market reacts to what appears to be a potential mispricing through bidding up the price of Abbott Labs' shares.

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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.