Drug, device, and nutrition conglomerate Abbott Labs (ABT) continues to oscillate just above and below the point where it looks like an interesting buy in the healthcare space. Valuation may not be too demanding, investors nevertheless have reason to pause before jumping into this name. On both sides of the soon-to-be-split business, there is real work that needs doing.
A Solid, But Somewhat Unbalanced, Quarter
Long-term holders may be content that Abbott basically made numbers, but I have some issues with how the company got there. Revenue rose 2% as reported (up almost 7% operationally from last year and about 8% from Q1), but pretty much every item except Humira was a disappointment to one degree or another.
Drug sales were up 2% as reported, with 9% operational growth in the Proprietary Pharmaceuticals segment, with Humira sales up 23%. Abbott continues to be exceptionally aggressive on pricing -- certainly helping to maximize the potential of the drug, but making it an even more compelling target for biosimilars. AndroGel was the only other drug to show meaningful growth (up 25%), but it's a relatively small contributor.
Although somewhat short of Street estimates, 8% operational growth in nutrition was solid. Likewise, while diagnostics revenue missed estimates on larger forex headwinds, underlying performance was in the solid mid-to-high single digits. Diabetes was soft overseas, but grew more than 8% in the U.S. and initial reviews on InsuLinx have been positive. Vascular remains a mixed bag; operational growth of more than 4% after backing out royalties isn't terrible, but the company is still waiting for the U.S. business to go positive again.
Below the top line, Abbott did pretty well operationally. There are some charges and expenses that create separate GAAP/non-GAAP results, but the performance was directionally similar. Gross margin improved almost three points, while operating income rose by 10% (adjusted) on controlled SG&A spending.
Post-Split, Both Ends Need Work
While Abbott has given investors more information about the upcoming spin-off of the AbbVie business, there are still issues left to work out. Key among them is how the company's debt and cash will be sorted out -- it arguably makes sense to put more debt with the drug business, but investors were not pleased to see in the filings that this business is actually less profitable than believed.
Leaving aside the capital structure, managements of both companies have work to do. Humira will be a dominant part of AbbVie's revenue, profits, and cash flow, and that's an inherently unstable situation. Even if Pfizer's (PFE) tofacitinib is relegated to second or third-line status, the day will come when biosimilars, price competition from other a-TNF drugs at Amgen (AMGN) or Johnson & Johnson (JNJ), and/or payor pushback take their toll.
Now, I'm optimistic that drugs like atrasentan and Elagolix and the company's Hep-C pipeline can contribute more than the Street presently expects, but it still leaves Abbott as a risky play -- arguably a bit too much like Forest Labs (FRX) or AstraZeneca (AZN) in terms of such high reliance on a very small number of drugs.
On the device side, Abbott has a lot of work to do with its U.S. diagnostics business and needs to augment its drug-coated stent business with other lines. Not only are Medtronic (MDT) and Boston Scientific (BSX) legitimate threats to the stent business, but it would help greatly for Abbott to be in some additional growth markets (even if stents and diabetes are very solid plays on aging populations).
Fortunately, this is a fixable problem - unlike JNJ (whose size makes value-additive deals in devices harder to find), Abbott can likely find more bang for its buck, and the combination of ongoing stagnation in the U.S. market plus the upcoming medical device tax should create a pool of motivated (or at least willing) sellers. I could certainly see Abbott considering companies like Vascular Solutions (VASC), AtriCure (ATRC), or Volcano (VOLC) as targets, and even St. Jude Medical (STJ) could be plausible, to say nothing of going beyond cardiology/vascular care.
The Bottom Line
Nitpicking aside, I think Abbott is a high-quality company floating between slightly undervalued and slightly overvalued. Right now, I see it as more on the "overvalued" side, though not to an extent that I'd be in a hurry to sell. Investors looking to commit new capital to healthcare are probably better off with names like St. Jude, Covidien, or Sanofi right now, but Abbott remains a stock well worth watching as it progresses towards its split.