These 2 Pharmaceuticals Will Outperform Abbott

Includes: ABT, MRK, PFE
by: Ry Frank

Abbott Laboratories (NYSE:ABT) announced last fall that it would be spinning off its proprietary pharmaceutical business from its diversified medical products business. "Abbott expects the post-spin-off diversified medical products company, which will retain the Abbott name, to return to double-digit annual adjusted earnings growth," reports MarketWatch. The new Abbott will be made up of the company's current "branded generic pharmaceutical, devices, diagnostics and nutritional businesses," as explained in the press release announcing the spin-off's name. It is this high growth that prompted the spinoff in the first place., which is expected to be finalized by the end of this year.

The pharmaceutical portion of Abbott will become AbbVie - a name adopted in tribute of its heritage ("Abbott") and its new direction ("Vie" is Latin for "life") - and include a portfolio of market-leading brands, like Humira, Lupron, Synagis, Kaletra, Creon and Synthroid. The company is receiving mixed reactions for the name of its planned spin-off (some people say the word "vie" conjures up thoughts of competition) but, to me, a rose by any other name would smell as sweet. Abbott, whatever you call it, is a great stock.

In looking at fourth-quarter 2011 compared with the same quarter the previous year, Abbott increased its profit by 12%, going from $1.4 billion, or 92 cents a share, at the end of 2010 to finish 2011 with profit of $1.6 billion, or $1.02 a share. That's a fair increase, but it gets better. The latest quarter had a variety of acquisition and restructuring costs. If you count those out, Abbott would have had an earnings per share of $1.45. The company also had a 4.1% revenue increase, which was only marginally less than its industry's average of 4.3%. According to Yahoo Finance, the company's earnings will grow by 8.28% a year on average over the next five years. In comparison, its industry is expected to grow 6.88% on average.

Driving this growth was a 16% increase in sales of Humira, a drug that treats rheumatoid arthritis and a few other conditions. It will become part of the AbbVie portfolio after the spin-off. The company's pediatric nutritional products, like the brand name formula Similac, also saw a strong increase in sales, moving up roughly 14% from last year. Emerging markets also figured prominently.

Almost 25% of Abbott's sales last year came from emerging markets; nutritional, vascular and diagnostic products were especially important in this arena. While this is encouraging, a recent event left some doubt over Abbott's quality in these markets after the company's Similac formula failed to meet China's quality standards as verified by an independent lab in Germany. Abbott's Similac, which had been included as a benchmark of quality was actually the worst sample in the set. The news came just after reports broke that a father in China had found half a condom in the formula he purchased for his daughter - decidedly not Abbott's best moment.

While those claims have yet to be substantiated, it's hard to say what effect this will have on the company's foothold in the Asian markets or how widespread the problems are. Otherwise, Abbott looks like a winner.

In spite of its solid performance and (generally) positive outlook, Abbott is still priced less relative to its future earnings than its peers. It has a forward price-to-earnings ratio of 11.06 compared with its industry's average of 16.90. Abbott is also priced less than its peer with regard to its price-to-book ratio (3.80 vs. 4.94), its price-to-sales ratio (2.39 vs. 3.18) and its price to cash flow (10.35 vs. 11.23). Abbott also intends to continue buying back shares in 2012, which is another plus in its book. The company is currently trading at roughly $60 a share and pays a $2.04 dividend (3.40% yield).

The question is - is Abbott worth the risk?

I think this is a situation in which it is better to wait and see, especially since Abbott has so many strong competitors. Look at Pfizer (NYSE:PFE). It is currently trading at just under $22 a share and it pays an 88 cents dividend (4.00% yield). At this level, the company is priced at just 9.25 times its future earnings, and considerably less than Abbott. Pfizer's revenue leaves something to be desired - it dropped by over 3%, which in turn lowered the company's earnings per share - but the company is priced low enough to take a chance. In addition to having a low forward price-to-earnings ratio, Pfizer boasts a price-to-book value that is less than its peers (2.02 vs. 4.94). Its price-to-sales ratio is also lower (2.46 vs. 3.18) as is its price-to-cash flow (8.20 vs. 11.23).

The company has relatively low earnings growth estimates (which accounts for its low pricing), but I think that Pfizer is in a position to turn things around. It recently rebuffed an offer from Novartis AG (NYSE:NVS) to buy its animal health business. While that deal fell through, Bayer AG is reportedly interested and there has been some talk of Pfizer spinning off that portion of its business. Either way, that section of its business is valued at $15-$20 billion - however, it plays out selling or spinning off that portion is going to make a huge difference across the board.

Rival Merck (NYSE:MRK) is also in a good position. The company has enjoyed incredible net income growth of 384.4% compared with the same quarter last year and has enjoyed a positive trend in its earnings per share as a result. Merck is also priced low at just over 10 times its forward earnings - which is less than Abbott but more than Pfizer. The company also boasts a low price-to-book ratio, coming in at 2.12 versus its peers' average 4.94, as well as a low price-to-sales ratio (2.41 vs. its peers' 3.18) and low price-to-cash-flow ratio (9.35 vs. its peers' 11.23).

I like Merck because it is priced low, but I am also a fan of the new products. There is Bridion, a neuromuscular reversal agent. There's also V503, a vaccine for cancers associated with HPV; odanacatib, a drug for osteoporosis patients to take just once a week; tredaptive, a niacin-based cholesterol reducing drug; and, suvorexant, an insomnia therapy drug. Merck plans to file Bridion and suvorexant with the FDA in 2012.

My recommendation is to leave Abbott on the back burner for now and put your money in well-known, well-performing stocks like Pfizer and Merck - both of which have big things in the works and are priced exceptionally low.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.