In this article, I take a look at Abbott Laboratories (ABT), a diversified healthcare company. We are going to evaluate it as an equity investment. We're going to examine the industry, the company's financial statements and the valuations.
Typically, healthcare companies are non-cyclical. The companies typically have stable cash flows and high dividend yields. Drug firms and medical device firms have historically created value for investors. Their return on invested capital has been higher than their weighted average cost of capital. The industry has high barriers to entry. For drug manufacturers there is the threat of substitute products when their proprietary drugs are off patent. Initially their customers don't have much, if any, bargaining power. And the industry typically isn't supplied with unionized labor. The suppliers of labor don't have much, if any, bargaining power.
Pharmaceuticals and medical devices are mature industries with little or no growth, industry consolidation and high barriers to entry. Industry growth is limited to replacement demand and population expansion. The companies should have brand loyalty and efficient cost structures. The industry usually avoids price wars. Companies in the industry with superior products or services are likely to gain market share and experience above-industry-average growth and profitability. However, the industry does face a potential threat from biotech.
Between 2010 and 2011 Abbott's sales grew 10.5 percent. During the same period Johnson & Johnson's (JNJ) sales grew 5.6 percent. J&J is trading at 2.88 times twelve trailing months sales and Abbott is trading at 2.66 times sales. Abbott's sales are forecasted to grow 2.2 percent this year while J&J's sales are forecasted to grow 3.5 percent. J&J is 8.3 percent more expensive on a price-sales basis.
- Buy - Be long
- Neutral - No position
- Sell - Be short
(The ratings, research and analysis in this article should be considered as a starting point for further research.)
Abbott Laboratories -- Neutral or Sell
Abbott's revenue is increasing. However, operating income and net income have been flat. The financial performance of the firm isn't confirming the increasing valuation. However, Abbott isn't quite overvalued. Although, it is nearing overvalued levels.
Investors would be wise to consider hedging positions using options or decreasing long exposure. New investors should either be neutral or consider short selling shares of Abbott. Also, U.S. equities are nearing the high of the year and may be headed for a correction in the coming months. However, the trend remains towards higher prices.
Company vs. Industry [TTM]
- Return on Assets: 7.89 vs. --
- Return on Investment: 10.78 vs. --
- Return on Equity: 19.22 vs. --
(The company vs. industry data is courtesy of Reuters.)
Net sales increased 2 percent to $9.8 billion in 2012's second quarter compared to 2011's second quarter. Net sales increased 4.5 percent in the first quarter of 2012 compared to the year-ago quarter. Total operating expenses declined 1.8 percent in the second quarter. The operating margin was 21.5 percent. The year-ago operating margin was 18.4 percent. Net earnings declined 11.2 percent to $1.72 billion as the tax expense increased. The net profit margin was 17.6 percent. The cash dividend increased 6.3 percent. The dividend was almost half of earnings. Comprehensive income declined 94.8 percent to $122 million: the firm lost $1.65 billion on foreign currency translation. On a price-comprehensive EPS basis, Abbott is overvalued.
More important than earnings is the quality of earnings, and Abbott's earnings are high quality. However, the company didn't generate enough cash from operations to cover its investing activities. Further, the firm issued $2.7B of short-term debt in the first six months of 2012. Abbott is paying dividends and repurchasing shares by issuing short-term debt. Paying dividends and repurchasing shares by issuing debt is unsustainable. Cash increased $239 million to $7.05 billion.
Total current assets increased 10.5 percent in the second quarter of 2012 compared to the fourth quarter of 2011. The increase is mostly because of an increase in short-term investments. Total assets increased 2.6 percent to $61.9 billion. The current ratio is 1.53. The cash liquidity ratio is 0.64. The financial leverage ratio is 2.52. Abbott is liquid and solvent.
Overall, the segment performance was strong. Almost all segments increased revenue and operating income. Performance in the proprietary pharmaceutical products segment, the largest segment, was strong as revenue increased 5 percent, and operating income increased 13.1 percent.
The changes to the Medicaid rebate rate will continue to have a negative impact on the gross profit margin of the proprietary pharmaceutical products segment.
While legal proceedings may have a material impact on 2012 cash flow, long-term the company isn't currently facing material risk from legal proceedings. There is about $800 million of liability being paid in the second half of 2012.
Revenue-share is increasing and book value-share is decreasing. The indicators are conflicting. Conflicting indicators suggests investors remain neutral on Abbott Labs.
Price-sales and price-book value are increasing. Both valuation metrics suggests the firm is overvalued or nearing overvalued levels.