Abbott Laboratories (ABT) is one of the largest drug manufacturers in the world. The company employs more than 90,000 workers worldwide. Abbott recently announced that it will split into two companies: One of the new companies will specialize in diversified medical products; the other will specialize in research-based pharmaceuticals. Seeking Alpha contributor Analytical Chemist expects both companies to be highly profitable with a strong growth rate of 13%.
As of October 26, Abbott stock was trading at $53, with a 52-week range of $43.84 - $55.61. It has a market cap of $82.5 billion. Trailing twelve month (ttm) P/E ratio is 18.27, and forward P/E ratio is 10.56. P/B, P/S, and P/CF ratios stand at 3.1, 2.2, and 8.7, respectively. The 3-year annualized revenue and EPS growth stand at 10.7% and 8.6%, respectively. Operating margin is 16.3%, and net profit margin is 13.8%. The company has some debt issues. Debt-to-equity ratio is 0.5. Abbott pays nifty dividends. The stock has been able to raise its dividends for 39 consecutive years. Current yield is 3.62%.
Abbott has a 5-star rating from Morningstar. It is categorized as a large-core company. While its trailing P/E ratio is 18.27, it has a 5-year average P/E ratio of 23.2. Thus, Abbott is trading below its historical P/E ratio. Out of 24 analysts covering the company, 7 have buy, 5 have outperform, 11 have hold, and 1 has sell ratings. Wall Street has diverse opinions on Abbott’s future. The bottom line is 0.6% growth, whereas the top-line growth estimate is 13.5% for the next year. Average five-year annualized growth forecast estimate is 10%.
What is the fair value of Abbott, given the forecast estimates? We can estimate Abbott’s fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the Dow Jones industrials has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS of $2.90 along with the mean EPS estimate of $5.02 for the next year (Finviz).
E0 = EPS = ($2.90 + $5.02) / 2 = $3.96
Wall Street holds diversified opinions on the company’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 10% (Morningstar). Book value per share is $16.95.
The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E0 | $3.96 |
V (t=1) | E0 (1+g)/(1+r) | $3.92 |
V (t=2) | E0((1+g)/(1+r))2 | $3.89 |
V (t=3) | E0((1+g)/(1+r))3 | $3.85 |
V (t=4) | E0((1+g)/(1+r))4 | $3.82 |
V (t=5) | E0((1+g)/(1+r))5 | $3.78 |
Disposal Value | E0(1+g)5/[r(1+r)5] | $34.41 |
Book Value | BV | $16.95 |
Fair Value Range | Lower Boundary | $57.64 |
Upper Boundary | $74.59 | |
Minimum Potential | 8.79% | |
Maximum Potential | 40.78% | |
You can download FED+ Fair Value Estimator here.
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Abbott is between $57.64 and $74.59 per share. While Abbott returned 15% since the last month, it still has at least 8% upside potential to reach its fair value range. Moreover, the stock has up to 41% upside potential to reach the upper boundary of its fair-value range.
Summary
Illinois-based Abbott is one of the largest pharmaceuticals in the world. In an industry where takeovers and acquisitions are common, Abbott decided to separate itself into two companies. Chemical Analyst suggests the new Abbott is more likely to concentrate on its core business. It is also expected to have significant international exposure, where two-thirds of its revenue will come from international sales.
In the last 5 years, Abbott was able to increase its earnings per share at annual rate of 6.64%. The company is highly profitable with a gross margin of 59%, and net profit margin of 11.84%. Abbott’s O-Metrix score of 4.72 is in line with the market average.
Similar to what FED+ model suggests, analysts also agree with me. Their mean target price of $58.60 implies almost 11% upside potential. Abbott has a very low Beta of 0.31. The company has more than doubled its dividend in the last decade. In 2001 the quarterly dividend was $0.21 cents; it was raised to $0.48 by 2011. In its most recent earnings report, Abbott confirmed its double-digit growth outlook, and has beaten the analyst estimates. With a payout ratio of 64%, dividends have plenty of room for growth. That is why I think Abbott is a dividend stock pick for the next 5 years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
