Ever since Abbott (ABT) announced that it was splitting into two publicly-traded companies, shareholder value has gone up by 7.2%. While this beat the S&P 500 by almost 400 basis points, it was well behind returns of 11.1%, 14.8%, 15.1%, and 22.4% for Par (PRX), Pfizer (PFE), Merck (MRK), and Mylan (MYL), respectively. I find that the market has yet to appreciate the value behind Abbott's fundamentals, emerging market exposure, and protective diversification. The Street currently rates Johnson & Johnson (JNJ) a "buy" and Abbott a "hold," but I believe that the reverse is the case.
From a multiples perspective, Abbott is more expensive than its peers. It trades at a respective 19.5x and 11.2x past and forward earnings while J&J trades at a respective 16x and 12.5x past and forward earnings. Both offer high dividend yields of around 3.5%, which helps to limit the downside. J&J faces more macro headwinds, in my view, due to the bar being set high for its maturity. Street estimates are particularly bullish on margins and revenue despite FX challenges and dilution from integrating Synthes. Abbott, on the other hand, has possible takeover potential in its higher-risk pharmaceuticals business.
On the third quarter earnings call, Abbott's CEO, Miles White, noted solid results and a favorable backdrop for the split.
"As you can see from our strong third quarter results, Abbott delivered another quarter of strong performance across our mix of businesses. Our ongoing earnings per share growth was more than 12%, as we've now posted double-digit growth in 17 of our last 18 quarters ...
Since 1998, Abbott has nearly quadrupled in revenues to nearly $40 billion in annual sales. During that same 12-year period, we shifted our geographic sales mix from what was more than 60% U.S.-based sales in 1998 to more than 60% international sales today. In 2001, the reshaping of our pharmaceutical business began in earnest when we purchased Knoll Pharmaceuticals, which included an R&D program that's now called by its well-known commercial name Humira. As you know, HUMIRA is on track to soon become the world's leading biologic for autoimmune diseases with annual sales this year of approximately $8 billion. And today, our total research-based pharmaceutical business generates nearly $18 billion in annual sales."
Despite this impressive growth story, shareholder value has gone nowhere over the last decade. The split will better allow investors to focus on the fundamentals and assume preferred risk. With Humira possibly making up more than one-fifth of 2011 revenues, investors are overly concerned about the drug falling short of its potential. While these fears are well-founded, they should be balanced with the understanding that Abbott has solid exposure to high-growth geographies and leading diversification to lower the risk. Humira itself can be used to treat arthritis, psoriasis and Crohn's disease. The drug - in addition to Synagis, Kaletra, Lupron, Creon, and Synthroid - will be part of the unnamed $18B research-based pharmaceutical business. The other unit will continue to be called Abbott, retain ownership of the $22B medical products business, and target double-digit EPS growth.
Consensus estimates for Abbott's EPS are that it will grow by 11.5% to $4.65 in 2011 and then by 8.2% and 7% more in the following two years. Assuming a multiple of 16.5x and 2012 EPS of $4.97, the rough intrinsic value of the stock is $82.01, implying significant upside. Even if the multiple were to drop to 12.5x and 2012 EPS turns out to be 11.5% below the consensus, the stock would hardly budge. Simply put, Abbott is a value play, in my view, and is worth much more than the Street consensus of a "hold."
J&J, on the other hand, is rated a "buy" while I rate it more of a "hold" for now. The acquisition of Synthes for $21.3B would be the largest buyout that J&J ever did in its century-and-a-quarter history. I expect that greater cash financing than originally proposed will be used to fund the deal in order to address 2012 EPS dilution of $0.10. While it will help J&J become the leader in the $5.5B device market, I am concerned about the effect that it will have on margins. Greater volume in McNeil - supported by advertising and rebates - will help offset this issue, but the bar has been set high.
Consensus estimates for J&J's EPS are that it will grow by 4.4% to $4.97 and then by 5.2% and 7.3% more in the following two years. Assuming a multiple of 15.5x and a conservative 2012 EPS of $5.19, the rough intrinsic value of the stock is $80.46, implying meaningful, but not incredible, upside. This position is unchanged from my earlier one, described here.