From high dividend yields to low betas, biotech provides some of the strongest risk/reward opportunities. While the Street is currently bullish about Merck & Co. (NYSE:MRK), it continues to be reserved on Abbott Laboratories (NYSE:ABT). Based on my multiples analysis and DCF model, I find these reservations to be unfounded.
From a multiples perspective, Abbott is the cheapest of the three. It trades at a respective 19.2x and 11.1x past and forward earnings while have the least volatility. Mylan (NASDAQ:MYL) and Merck, meanwhile, trade at a respective 23.1x and 26.6x past earnings. The former offers the highest dividend yield at 4.3%, which is fooled by Abbott at 3.5%.
At the third quarter earnings call, Abbott's CEO, Miles White, noted solid performance:
"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. We'll generate similar performance for the full year, which will again place us among the top performers in our peer group.
So we're pleased with our consistent financial performance. But as evidenced by today's other important news, we are taking a significant next step in aligning our long-term strategic goals with our shareholders' best interest".
The company also recently announced that it will be spinning off its pharmaceutical business. In light of complications at Humira, valuations for the whole business have been depressed and thus this action will be accretive to long-term value. Pfizer (NYSE:PFE) reportedly received several bids for its infant nutritional business. Abbott appears not to be interested, as it is the leader in this field. Should Nestle take this asset over, however, Abbott could find itself struggling to penetrate China in this segment. In any event, Abbott has solid free cash flow generation and strong buyback activity. ABSORB BVS is fully dissolvable and remains a major catalyst going forward.
Consensus estimates for Abbott's EPS forecast that it will grow by 11.5% to $4.65 in 2011 and then by 8% and 6.6% in the following two years. Assuming a multiple of 16.5x and a conservative 2012 EPS of $4.97, the rough intrinsic value of the stock is $82.01, implying significant upside. Modeling a CAGR of 8.7% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $68.34 - more than enough upside to justify upending a long investment.
I am similarly bullish on Merck. The company posted solid third quarter performance with stellar top-line momentum and management of the cost structure. I believe that the 17 potential launches under development have been overshadowed by Merck's reputation for having a weak pipeline. Furthermore, the company faces around 50% less exposure to generic competition than its peers do. And while the $50B worth of patent expiry gives reason for pause, innovation is stronger than the market recognizes with MK-6096, for example,showing strong efficacy in sleep tests.
Consensus estimates for Merck's EPS forecast that it will grow by 9.9% to $3.76 in 2011, grow by 1.9% in 2012, and then decline by 1% in 2013. Modeling a CAGR of 3.5% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $48.86, implying 26% upside.