Abbott Laboratories: A Solid Business For An Attractive Valuation

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About: Abbott Laboratories (ABT)
by: Andres Cardenal, CFA
Summary

Abbott is a diversified company benefiting from a leadership position in its main markets.

Management is leading the company in the right direction, and financial performance has been quite strong over the years.

Looking at valuation levels through comparative ratios, discounted cash flows, and multi-factor analysis, Abbott is fairly attractively valued.

Buying a solid business for a reasonable valuation can be an effective strategy for superior returns over the long term.

Successful investing doesn't need to be too complex or sophisticated. It all comes down to buying a solid business for an attractive valuation, and Abbott Laboratories (ABT) stock fits this description pretty well.

A Solid Business

Abbott is a leading manufacturer of medical devices, blood glucose monitoring devices, diagnostic equipment, nutritional healthcare products, and drugs. The company is one of the largest players across all of the main markets in which it operates.

The business model is well diversified: pharmaceuticals generate 14% of revenue, medical devices 37%, diagnostics 25%, and nutrition 24%. Diversification reduces risks for investors, and it makes financial performance more stable and predictable. Importantly, Abbott's different segments are producing consistent growth, so the business is firing on all engines.

Source: Abbott Investors Relations

Over the past several years, the company has made a series of acquisitions and divestments to better focus on businesses with superior potential for growth and profitability.

Some notable moves include:

  • In 2014, Abbott acquired CFR Pharmaceuticals.
  • In 2015, it purchased Tendyne Holdings.
  • In 2017, Abbott acquired St. Jude Medical, and later that year, it purchased Alere Inc.
  • Abbott sold its developed markets branded generics pharmaceuticals business to Mylan (MYL) in 2015.
  • The company also sold its animal health business to Zoetis (NYSE:ZTS) in 2015.
  • In 2016, Abbott sold its vision care business, Medical Optics, to Johnson & Johnson (JNJ).

These transformations have created some volatility in financial performance over time, but the key variables are clearly moving in the right direction. Metrics such as revenue and free cash flows have performed remarkably well in the past five years.

Chart Data by YCharts

Attractive Valuation

Companies in the medical devices industry typically trade at a premium versus the broad market because the segment is particularly attractive in terms of the growth opportunities and the potential for profitability. That said, valuation levels for Abbott look quite reasonable by industry standards.

The table compares price to earnings growth, price to sales, price to cash flow, and price to book value ratios for Abbott versus the average player in the industry. The stock is priced at a discount versus the industry average across the four valuation indicators considered.

Abbott Industry
PEG 2.23 2.27
Price/Sales 4.57 5.03
Price/Cash Flow 24.99 33.94
Price/Book 4.60 5.2

Data from S&P Global via Portfolio123

The table below shows a simple discounted cash flow analysts of Abbott stock. The exercise is assuming $4.9 billion in sustainable free cash flow, an initial growth rate of 12% over six years, a subsequent growth rate of 8% over five more years and a terminal growth rate of 3%. The required rate of return is 9%.

Based on these calculations, a reasonable estimate of fair value for Abbott would be around $88 per share, indicating that the stock is undervalued by 14% at current prices.

Sum of Present Value of Cash Flows: $60,416
Perpetuity Value of Final Cash Flow $94,540
Equity Value $154,957
Implied Share Price $88
Discount/Premium to Current Price 14.20%

Discounted cash flows valuations rely on a multiplicity of assumptions about the future, and they can provide a false sense of precision by offering a single value estimate for a stock. For this reason, these kinds of calculations should always be taken with a big grain of salt. That said, it's good to know that Abbott stock is fairly priced based on reasonable cash flow projections for the business.

It's important to acknowledge that valuation is a dynamic as opposed to a static concept, and fundamental momentum can be a powerful return driver for stock prices.

The current market price is reflecting a particular set of expectations about the future of the business. If the company delivers better than expected earnings and, expectations about future performance are increasing, then the stock price will probably increase to reflect those improving expectations

Abbott is being driven by strong fundamental momentum, and earnings expectations for the company in both the current year and next fiscal year are significantly increasing in recent years.

Chart Data by YCharts

Valuation should always be analyzed in its due context. A company with superior financial performance and strong fundamental momentum obviously deserve higher valuation levels, there is not much discussion about this. However, it can sometimes be difficult to incorporate the different quantitative metrics in a single tool.

The PowerFactors system is a quantitative algorithm available to members in The Data Driven Investor. This system basically ranks companies in a particular universe according to four quantitative return drivers: financial quality, valuation, fundamental momentum, and relative strength.

Abbott is the top quintile, with a PowerFactors ranking of 97.46. The stock also has elevated rankings across the four dimensions considered: quality (84.4), value (91.18), fundamental momentum (87.8), and relative strength (83.8).

Data from S&P Global via Portfolio123

According to the backtested performance data, companies with the strongest quantitative rankings tend to generate superior performance in the long term.

Backtested performance does not guarantee future returns, and quantitative algorithms should always be interpreted with caution. The algorithm shows that a group of companies with strong quantitative metrics tend to outperform the market over the years. However, this does not really tell us much about what kind of performance a particular company such as Abbott will deliver in a specific year such as 2019.

Nevertheless, the quantitative data shows that Abbott is well positioned for attractive returns when looking at the company from a multi-factor perspective.

The Bottom Line

Abbott operates in a competitive industry, and potential disruption from new drugs and technologies is always a relevant risk factor to keep in mind. Besides, there is a lot of public pressure to reduce healthcare costs across the board, and this could have negative implications on pricing power and profitability in different segments.

In spite of these risks, Abbott is a solid business trading at a very reasonable valuation, so the stock looks well positioned for attractive returns going forward.

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.