With the planned split into two companies nearing, Abbott Laboratories (ABT) is looking like an attractive healthcare play. The strategic action will result in one diversified medical products company and a research-based pharmaceutical company. Perhaps most importantly, this will divorce struggling Humira from profitable lines and allow investors to better allocate risk.
In this article, I will run you through my DCF model on Abbott and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Merck (MRK) and Pfizer (PFE). As an investor relations consultant, I also recommend considering companies that can explode in value from greater news flow. GeoVax Labs (OTCQB:GOVX) and Pharma-Bio Serv (OTCQB:PBSV), in particular, are looking attractive.
First, let's begin with an assumption about revenues. Abbott finished FY2011 with $38.9B in revenue, which represented a 10.5% gain off the preceding year. Analysts model a 8.3% per annum growth rate over the next five years, and I view this as conservative, given that it is about 300 bps below that expected for the S&P 500. However, for the sake of staying safe, I accept the projections.
Moving onto the cost-side, there are several items to address: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat 40% of revenue versus 28% and 10% for SG&A and R&D, respectively. These figures are roughly in-line with historical 3-year average levels. Capex is estimated the same way, so I assume 3% of revenue. Taxes are factored in at 20%.
We then need to subtract out net increases in working capital. I model accounts receivable as 20% of revenue; inventories as 22% of COGS; prepaid expenses as 15% of SG&A; accounts payable as 5.3% of OPEX; and accrued expenses as 70% of SG&A.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 8%, yields a fair value figure of $80.36, implying 38.7% upside. Even if the perpetual growth rate is just 1% and the WACC is 9%, the company is still fairly valued. Abbott merits a higher-than-average perpetual growth rate and a lower WACC because of its 0.31 beta and business model.
All of this falls under the context of strong recent results:
"Abbott reported another year of strong performance in 2011 despite what's been another challenging year for the healthcare industry and for the global economy. We managed through these challenges as we've always done and delivered full year ongoing EPS growth of nearly 12%. And as we announced this morning, we expect to deliver another year of strong performance as we issued guidance of $4.95 per share to $5.05 per share for 2012. I'll talk more about the year ahead in a moment.
In 2011, Abbott sales grew more than 10%, driven by double-digit growth in Established Pharmaceuticals, International and Nutritionals, Molecular and Point of Care Diagnostics, International Vascular and Global Proprietary Pharmaceuticals. HUMIRA had another outstanding year, and with nearly $8 billion in sales, solidifying its global position as the anti-TNF market leader. In addition to full year double-digit sales growth as forecasted, we improved the profitability of many of our operating businesses".
From a multiples perspective, Abbott is also attractive. It trades at 19.3x past earnings, but only 10.8x forward earnings. Pfizer, also attractive, trades at corresponding figures of 19.5x and 9.1x. Merck, another attractive pick, trades at corresponding figures of 18.5x and 10.1x. Assuming a multiple of 15x and a conservative 2013 EPS of $5.31, the rough intrinsic value of Abbott's stock is $79.65 - basically in-line with my DCF result.
Despite being known for having weak pipeline, Merck has more than a dozen potential launches under development. The company is also well positioned, due to its much lower exposure to generic competition relative to peers. Much of the reason why investors are staying on the sidelines is due to the $50B worth of patent expirations; however, value drivers have been overly discounted as a result.
Pfizer, despite facing $1.3B worth of exclusivity losses, had meaningful momentum in the fourth quarter. Top-line growth was actually strong across the board and, in my view, Eliquis, tofacitinib, and Xalkori will keep the momentum going.
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