AbbVie: What Will Happen After Humira?

| About: AbbVie Inc. (ABBV)
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Summary

Humira is ABBV’s blockbuster representing over 50% of their sales and an even bigger portion of their earnings.

The company shows strong cash flow projections insuring a strong dividend yield and growth for the upcoming years.

Will ABBV be able to use the cash flow generated by Humira to grow even bigger?

DSR Quick Stats

Sector: Healthcare

5 Year Revenue Growth: 7.89%

5 Year EPS Growth: 3.47%

5 Year Dividend Growth: N/A

Current Dividend Yield: 3.55%

What Makes AbbVie (NYSE:ABBV) a Good Business?

AbbVie is a spinoff from Abbott Laboratories (NYSE:ABT). Since 2013, ABT is concentrating on diversified products including medical devices, diagnostic equipment and nutrition products, while AbbVie would operate as a research-based pharmaceutical manufacturer. ABBV is a research-based specialty biopharmaceuticals company with a broad portfolio of medicine-including leadership in immunology and virology and a pipeline of breakthrough therapies.

A very important part of their sales come from Humira. Humira's biological composition patent expires this year in the U.S and in 2018 in Europe. This will open the door for competitors and will eventually lead to sales declines and margins reduction.

ABBV is investing massively in its new drug pipeline. For example, Imbruvica, a cancer drug, currently shows great potential in clinical experiments. ABBV's main challenge will definitely be to compensate for Humira's declining sales.

Ratios

Price to Earnings: 19.33

Price to Free Cash Flow: 13.71

Price to Book: 22.35

Return on Equity: 134.70%

Revenue

Revenue Graph from Ycharts

When you look at the short revenue history, you can't complain against such strong revenue growth. This is mainly due to ABBV blockbuster drug Humira. This drug represents 50% of sales and will continue to post double digit growth due to recent approvals of usage for rheumatoid arthritis, psoriasis and Crohn's disease. Don't expect the revenue trends to keep hiking over the next 2-3 years as Humira patents start to expire.

How ABBV fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I've been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let's take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn't Equal High Returns

My first investment principle goes against many income seeking investors' rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it's because the market thinks it's a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

The company shows an interesting dividend yield between 2.50% and 3.50% since its introduction on the stock market. Considering the company has sufficient cash flow to sustain its dividend payment for the upcoming years, ABBV yield should remain over 3%. ABBV meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management's trust in the company's future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can't be derived from anything else but increasing revenue. Who doesn't want to own a company that shows rising revenues and earnings?

The company has been paying an increasing dividend payment for 43 consecutive years. You will not see this data if you look for ABBV dividend history, but its parent company, Abbott Laboratories has been paying these dividends. So far, ABBV is off to a great start to keep the company's tradition of dividend growth. ABBV meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

As you can see, both the dividend payout ratio and cash payout ratio show very good standards. The company will enjoy good cash flow entries for the next couple of years while we expect revenues to decline. We may not see such strong dividend growth in the future, but more reasonable increases are secured for the upcoming years. The long haul will be harder to define. So far, ABBV meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

As is the case with any healthcare company, ABBV's strength relies on the weight of its pipeline and current drug sales. Management intends to enter into several legal battles due to various patents linked to Humira that expire only in 2022 to 2034. However, the most important patent expires over the next two years will definitely open the door for generic products. Other strong players in the healthcare business such as Amgen (NASDAQ:AMGN) are not afraid of legal issues and will definitely eye Humira's market share sooner than later.

ABBV's future seems to be linked with cancer drugs, particularly in the blood cancer segment. Besides Imbruvica, ABBV also shows promising results with Rova-T, a small cell lung cancer drug. However, the current pipeline doesn't seem strong enough to compensate completely for Humira future sales declines. ABBV's business model seems too risky at the moment and doesn't meet my 4th investing principle.

Principle #5: Buy When You Have Money in Hand - At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn't mean that you should buy everything you see because you have some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

The company doesn't show a very long history of valuation but it seems to be reasonably valued considering the current market. At a 19 PE ratio, ABBV seems interesting.

In order to have a better idea, I will also use a double stage discount dividend model. Making assumptions at this stage is difficult but I will try to remain conservative in order to find a strong intrinsic value. Since the company will not be able to compensate future sales decline in the upcoming years, I've used a 5% dividend growth rate for the first 10 years and 6% for the years after. I've used a 10% discount rate to reflect the risk that ABBV's drug pipeline may not be strong enough to ensure strong growth as previously:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$2.28

Enter Expected Dividend Growth Rate Years 1-10:

5.00%

Enter Expected Terminal Dividend Growth Rate:

6.00%

Enter Discount Rate:

10.00%

Here are the results of my calculations:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$88.92

$66.91

$53.69

10% Premium

$81.51

$61.33

$49.21

Intrinsic Value

$74.10

$55.76

$44.74

10% Discount

$66.69

$50.18

$40.27

20% Discount

$59.28

$44.60

$35.79

Source:Dividend Monk Toolkit Excel Calculation Spreadsheet

It is without surprise that ABBV trades at a 20% premium according to the dividend discount model. Investors hope that ABBV will be able to legally protect a part of Humira sales decline over the next decades. They also hope that their new drugs will generate additional growth. However, from a dividend growth investor perspective, ABBV doesn't meet my 5th investing principle.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I've found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

AbbVie benefits from the strong success from its immunology drug Humira driving lots of cash flow. There is a lot of room for Humira to grow as penetration rate for rheumatoid arthritis; psoriasis and Crohn's disease are below 25%. A great portion of this cash flow is now used to support their drug pipeline and assure the company's future. The short term future growth seems secured, but the company may show stagnating sales and revenues for a few years afterwards.

Risks

Besides the obvious risk that more than 50% of ABBV's sales is tied to Humira, the company also developed several drugs in partnership with other companies. This limits their ability to generate strong profits from these products. In my opinion, ABBV's drug pipeline doesn't seems to be able to support revenue growth over the long haul. For this reason, ABBV doesn't show an investment thesis strong enough to support my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segment: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the "dividend growth stock addition" where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segment helps me to categorize my investments into a "conservative" or "core" section or into a "growth" section. I then know exactly what to expect from it; a steady dividend payment or higher fluctuation with a great growth potential.

At this stage, investors in ABBV should consider it as a growth investment. Since it's a riskier bet, ABBV pays an interesting yield and shows growth potential in the event new drugs are as effective as expected. ABBV is definitely not a core portfolio holdings mainly due to the fact that the upcoming years will show volatile revenue and earnings trends. ABBV is a growth holding.

Final Thoughts on ABBV - Buy, Hold or Sell?

I'm happy to have gone through ABBV stock analysis as it is a good example of how a company showing current strong numbers may not be able to repeat its success in the future. ABBV was successful and was a great investment since its introduction on the stock market in 2013. However, looking forward to 10 years from now, it remains difficult to determine whether or not this stock will continue its dividend growth streak. At this time, I'm not an ABBV buyer.

Disclaimer: I do not hold ABBV in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.