In a previous article, I analyzed Becton, Dickinson and Company (BDX) and Medtronic (MDT). I found them to be great companies which are also dividend aristocrats. In the current article, I am going to analyze and try to see whether Abbott Laboratories (ABT) is a more attractive company than Becton, Dickinson and Medtronic. Abbott announced its Q3 results 10 days ago, and it is a good time to take another look at it.
The medical devices sub-sector in the healthcare sector is one of my favorite segments of the market. The companies there are not as attractive as the glamorous pharmaceutical companies, with shining patents and blockbuster drugs. Therefore, many times you can find consistent companies for fair valuation which deliver high returns to investors.
In this article, I will use the following graph to analyze the company. I will look at the fundamentals, valuation, risks and opportunities. I will then try to decide which company is more attractive for dividend growth investors, who invest for the long term. I already know that BDX and MDT are great firms. Time to look at ABT.
Abbott Laboratories engages in the discovery, development, manufacture, and sale of a broad and diversified line of health care products. It operates through the following segments: Established pharmaceutical products, nutritional products, diagnostic products, cardiovascular and neuromodulation products, and other.
The revenue stream has grown significantly in the past several years. The major reason for the growth is the acquisition of St. Jude Medical back in 2016, which was valued at $25 billion. It adds up to the acquisition of Alere at the beginning of 2016 for $5.3 billion. Since then, the company shows continuous revenue growth which is achieved organically. In Q3, the company showed 7.8% organic growth in sales. The organic growth together with the synergies from the acquisitions will support earning growth.
The earning per share is growing at an even faster pace. Abbott did show double digits earning growth in 2017, and it's on its path for similar growth in 2018 despite the currency headwinds. At the same time, analysts predict that the company will offer low double digits earning growth in the medium term. It will be propelled by cost cutting, organic growth and improved margins.
Abbott Laboratories is a dividend aristocrat. It may be confusing, and some websites will tell you that the growth streak is much shorter, but this is the truth. Before the spin-off of AbbVie (ABBV) the company was a dividend aristocrat, and since the spin-off it kept raising the dividend payment. The dividend is extremely safe with the payout ratio at 38% based on 2018 earnings. Investors should expect a dividend raise in the current quarter. The initial yield is a little disappointing, but this is a result of capital appreciation as the fundamentals improved in the past year.
The company is also using its earnings to return money to shareholders using stock repurchases. The company is consistently buying back its own shares, and the only reason why the shareholders were diluted was because the company used shares to pay for the St. Jude Medical Acquisition. I expect the company to use stock buybacks modestly in the coming years, as it used to do before the latest mega acquisition.
The P/E ratio seems too high at the moment, and the company should have some very impressive growth prospects to justify it. It's over than 10% higher than its two peers, while according to the consensus of analysts, the company is not forecasted to show much higher growth. In fact, BDX is forecast to grow faster, but its valuation is more attractive. Medtronic will grow slower than Abbott, but I am not sure it justifies a 28% higher valuation.
The graph from Fastgraph.com tells a very similar story. You can see that the average P/E is lower than 20, and it includes the time when the company was also a pharmaceutical company which usually trades for higher valuation. Not only that, it includes the era of zero interest rate, and as the interest rate is climbing, we should expect lower valuations. In my opinion, the company will have to offer amazing growth opportunities to justify its rich valuation even after the 10% drop in the past month.
When I look at the fundamentals and valuation alone, I still believe that Medtronic is the most attractive company among the three. It's true that its forecasted froth rate is a little slower than its two peers, but its valuation is by far more attractive. Any improvement in Medtronic will unlock a lot of value to shareholders. At the same time, every correction in the share price of BDX and ABT will make them superior options.
Abbott is enjoying global expansion and it enjoys fast growth in emerging markets. Unlike some of its peers, Abbott already enjoys meaningful sales in the emerging markets. It is a leader in major countries like China, India, and Russia, and it plans to keep investing in those markets to achieve rapid growth in the medium term.
Abbott has a diversified pipeline and it shows growth across the board. While some analysts hoped for even higher growth, the slide below shows very impressive growth in all the four segments. The most important segment, medical devices, showed the highest growth, and it also beat the expectation of the analysts. The combination of growth in every segment and in every geographical area is a major advantage for Abbott going forward.
The St. Jude Medical acquisition creates a leading cardiovascular care business. It offers Abbott an entry into promising Neuromodulation area. It is a major acquisition, that once its assimilation will be completed will be very important for Abbott. It will create a whole new business segment, with some major growth prospects.
The company depends on the international markets for almost two thirds of its sales. The interest rate is going up in the United States, and the U.S Dollar is growing stronger. Therefore, the sales of companies like Abbott which sell its products outside of the United States will suffer from currency headwinds. In the beginning of the year the management hoped for currency tailwind, but the opposite has occurred and next year it will suffer from the same issue.
The reliance on foreign markets is a good thing for the company, as it allows it to diversify its revenue stream. However, in the current environment, when free trade is at risk due to possible trade wars, the reliance on foreign markets, and especially emerging markets can be a medium-term risk for the company. If China will use tariffs on products sold by Abbott it will hurt the revenue stream in the medium term.
The company is also facing some fierce competition from its peers. It operates in fast growing segments, with high margins, and therefore other players are competing with it. In addition, it still has to assimilate both St. Jude Medical and Alere and reduce the long-term debt. The assimilation of Alere is more complicated as its business isn't as stable as the rest of Abbott's business segments.
When I look at Becton, Dickinson, Abbott and Medtronic, I find three companies with a very solid future. Now, I prefer Medtronic over Becton, Dickinson and Abbott due to the more attractive valuation. The higher valuation of BDX and ABT is supported by more optimistic forecast. However, I don't think that Medtronic should trade for such a large discount. In the current environment, when we see the interest rate climbing, I prefer companies that offers better valuation and higher margin of safety.
I believe that when you invest for the long term, the current discount is meaningful. I don't care about the next three years. I care about the next decade, and even longer. Therefore, I cannot prefer a company that has similar risks and opportunities profile but trades for a higher valuation due to higher expectation for the coming three years. While I prefer Medtronic, if the market is going to suffer from a pullback and the valuation will be closed, I will prefer adding to Abbott over BDX and MDT. At the moment among the three Abbott is my largest position followed by Medtronic and then Becton Dickinson.
Disclosure: I am/we are long BDX, MDT, ABT, ABBV. 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.