- AbbVie's respective adjusted diluted EPS and FCF payout ratios of 44.7% and 46.0% strike a great balance between deleveraging and rewarding shareholders with generous dividend increases.
- Even with COVID headwinds, AbbVie generated 3.3% YoY operational revenue growth and 18.1% YoY adjusted diluted EPS growth in 2020.
- Despite a 12% runup in AbbVie compared to the 8% increase in the S&P 500 since I last covered the stock, AbbVie is still firmly undervalued.
- Between its 4.8% yield, 5.0-6.0% annual earnings growth, and 1.1% annual valuation multiple expansion, AbbVie remains positioned to meet my 10% annual total return requirement over the next decade.
While 2020 was fraught with revenue declines and earnings plunges for many businesses around the world, there were still a selective few that managed to deliver revenue and earnings growth in 2020.
One business that produced strong operating and financial results in a challenging operating environment was AbbVie (NYSE:ABBV).
As I'll discuss below since I covered AbbVie last November, AbbVie's dividend payout ratios in 2020 were highly sustainable, AbbVie generated impressive revenue and earnings growth in 2020, and the stock is trading at a solid discount, which is why I still believe that shares of AbbVie are a buy at this time.
AbbVie's Dividend Remained Safe In 2020
When comparing AbbVie's current 4.83% yield to the S&P 500's 1.53% yield, it appears as though the market doesn't view AbbVie's dividend as sustainable over the long-term. I will dispel the belief that AbbVie's dividend is unsustainable in the long-term by examining AbbVie's adjusted diluted EPS and FCF payout ratios during 2020.
After all, if a dividend proves itself to be safe in even a challenging operating year such as 2020, it can be argued that the dividend will remain safe in just about any operating environment short of a zombie apocalypse.
While this is a respectable payout ratio, it's even better than AbbVie's 47.9% adjusted diluted EPS payout ratio in 2019 (page 9 of AbbVie's Q4 2020 earnings press release), which suggests contrary to the market's belief, the dividend is growing safer with each passing year.
Moving to FCF, AbbVie generated $17.588 billion in operating cash flow against $798 million in capital expenditures (according to data sourced from page 53 of AbbVie's recent 10-K), for FCF of $16.790 billion.
When compared to the $7.716 billion in dividends paid out during this time, AbbVie's FCF payout ratio during 2020 equates to a respectable 46.0%.
This is once again a moderate improvement from 2019's FCF payout ratio of 49.8% (as per data sourced from page 53 of AbbVie's recent 10-K).
Since I have established that AbbVie's dividend payout ratios are gradually improving, the next step is to determine the growth potential of AbbVie's dividend.
When I consider that there is the potential for a slight expansion in AbbVie's payout ratios over the long-term (as it deleverages long-term debt taken on in its acquisition of Allergan), I believe AbbVie is positioned to grow its dividend slightly ahead of its earnings growth over the long-term.
Given that Yahoo Finance is forecasting 4.8% annual earnings growth over the next 5 years (which I believe is too pessimistic given the 21.9% annual earnings growth over the past 5 years), I believe that AbbVie is positioned to deliver annual dividend growth of 6.0% over the long-term.
COVID Headwinds Could Not Stop AbbVie From Delivering Impressive Growth In 2020
Image Source: AbbVie Q4 2020 Earnings Press Release
In what was a challenging year from an operating perspective for many businesses, AbbVie demonstrated the resiliency of its business model in 2020.
AbbVie generated 3.3% operational revenue growth in 2020, reporting $45.804 billion in net revenues during the year (as per data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
It's worth noting that despite the fact that AbbVie faced lower new patient starts across its segments, AbbVie generated strong growth in its Immunology, Hematologic Oncology, and Neuroscience franchises, which helped to offset the declines in other segments, of which the most prominent were in Aesthetics and Women's Health (according to data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
AbbVie's Immunology segment benefited from across the board growth, with mid-single digit growth in Humira's total sales during 2020, as well as more than 100% growth in the sales of Rinvoq and Skyrizi (both of which were on the market for their first full year in 2020 as noted by Chairman and CEO Richard Gonzalez's opening remarks during AbbVie's Q4 2020 earnings call).
In addition, AbbVie's Hematologic Oncology segment generated strong growth in both of its blockbuster drugs, Imbruvica and Venclexta (as per data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
Imbruvica generated mid-teens YoY operational sales growth, while Venclexta reported an astonishing 69.3% YoY operational sales growth (as indicated by data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
AbbVie's 11.1% YoY operational growth in its Neuroscience segment was largely driven by 57.5% YoY operational growth in its antipsychotic drug, Vraylar (as per data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
As a result of the decreased traffic to physician offices in 2020 due to COVID-19, AbbVie's Aesthetics segment endured a 16.9% YoY operational sales decline in 2020 because its Juvederm and Botox products must be administered by a physician (according to data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
AbbVie's Women's Health segment also declined 13.3% YoY on an operational basis, which was due to declines in Lo Loestrin and Other Women's Health (as per data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
Moving to adjusted diluted EPS, AbbVie generated 18.1% YoY growth from $8.94 in 2019 to $10.56 in 2020.
Image Source: AbbVie Q4 2020 Earnings Press Release
While AbbVie delivered a strong 2020, all indications point to what will be an even stronger 2021.
As noted by Chairman and CEO Richard Gonzalez's opening remarks in AbbVie's Q4 2020 earnings call, AbbVie is forecasting that it will generate 9.4% YoY operational sales growth in 2020 based on the recent outperformance of its business, which was $1.7 billion in excess of the analyst consensus at the time of AbbVie's Q4 2020 earnings call.
As a result of AbbVie's forecasted operational sales growth in 2021 and expectations of $1.7 billion in Allergan acquisition synergies in 2021 (as outlined in CFO Rob Michael's opening remarks during AbbVie's Q4 2020 earnings call), AbbVie is forecasting a 200 basis point expansion in its adjusted operating margin to roughly 50% of sales.
The combination of increased sales and operating efficiency is expected to lead to a midpoint adjusted diluted EPS figure of $12.42, which represents 17.6% YoY growth or essentially as much growth that was delivered in 2020.
When I take into consideration AbbVie's strong operating results in 2020, as well as the company's promising outlook for 2021, I believe that AbbVie is capable of being a great long-term investment if shares are acquired at or below fair value.
Risks To Consider
Although AbbVie is an excellent business operating in an industry that is set to benefit from an aging demographic, it is critical for investors to occasionally monitor AbbVie's risk profile to ensure that the investment thesis remains intact.
Therefore, I will be discussing several risks that are outlined in AbbVie's recent 10-K.
The first risk to AbbVie is that although AbbVie has held up well despite COVID-19 headwinds (i.e. lower new patient starts across the therapeutic portfolio), the ultimate long-term impact of COVID-19 remains to be seen at this time (pages 15-16 of AbbVie's recent 10-K).
Even though AbbVie has experienced no material disruptions in its supply chain to date as a result of COVID, there is no guarantee that will continue to be the case. If AbbVie does experience material disruptions to its supply chain and doesn't have adequate backup plans in place to address such an issue, its operating and financial results could be adversely impacted.
As those that are even vaguely familiar with the biopharma industry recognize, AbbVie faces the risk of loss of exclusivity of Humira in the United States in 2023 (where the drug generated over 80% of its 2020 revenues per data sourced from page 8 of AbbVie's Q4 2020 earnings press release).
While I believe the LOE of Humira in 2023 will be a medium-term headwind to AbbVie as biosimilars pressure revenue, AbbVie's non-Humira Immunology franchise (i.e. Skyrizi and Rinvoq), Hematologic Oncology franchise (i.e. Imbruvica and Venclexta), and Neuroscience franchise (i.e. Vraylar) will be in a position by 2023 to largely offset the decline of Humira's revenue as a result of rapid growth and continued indication expansion (this is supported by Chairman and CEO Richard Gonzalez's opening remarks in AbbVie's Q4 2020 earnings call that non-Humira Immunology franchise revenue will double to $4.6 billion in 2021, Hematologic Oncology franchise revenue will surge double-digits to $7.5 billion in 2021, and a massive uptick in Neuroscience franchise revenue to $5.7 billion).
The final risk to AbbVie is that although AbbVie spent 14% of its net revenues or ~$6.6 billion on research and development in 2020 (per data sourced from page 39 of AbbVie's recent 10-K), the nature of the biopharma industry leads to a high rate of failure in bringing drugs to market for reasons such as inability to demonstrate a drug's effectiveness, safety concerns, or excessive costs to manufacture, among other reasons.
As such, there is no guarantee that AbbVie's billions of dollars of spending will continue to lead to commercial success in the future. If AbbVie isn't able to bring drugs to the market at a large enough volume to offset the loss of revenue in drugs as a result of loss of exclusivity, its long-term operating and financial results could be unfavorably impacted, potentially breaking the investment thesis.
While I have discussed a few key risks facing AbbVie, the above discussion shouldn't be interpreted as exhaustive. For a more complete discussion of AbbVie's risk profile, I would refer interested readers to pages 15-25 of AbbVie's recent 10-K, as well as my previous articles on the stock.
AbbVie Is A Fairly Priced Blue-Chip
Even though AbbVie is a high-quality business, it is crucial to an investor's long-term success to avoid overpaying for shares of the stock to minimize the likelihood of a lower starting yield, valuation multiple contraction, and lower annual total return potential.
It's for this reason that I will be utilizing two valuation metrics and a valuation model to arrive at a fair value for AbbVie's shares.
The first valuation metric that I'll use to estimate the fair value of shares of AbbVie is the TTM price to sales ratio to 8 year median TTM price to sales ratio.
As per Gurufocus, AbbVie's TTM price to sales ratio of 3.96 is slightly below its 8 year median TTM price to sales ratio of 4.10.
Factoring in a reversion to a TTM price to sales ratio of 4.00 (which I believe appropriately takes AbbVie's risk profile into account) and a fair value of $108.76 a share, AbbVie's shares are trading at a 0.9% discount to fair value and offer 0.9% upside from the current price of $107.75 a share (as of February 27, 2021).
The second valuation metric that I will utilize to approximate the fair value of shares of AbbVie is the TTM price to FCF ratio to 8 year median TTM price to FCF ratio.
According to Gurufocus, AbbVie's TTM price to FCF ratio of 10.79 is well below its 8 year median TTM price to FCF ratio of 13.86.
Assuming a reversion to a roughly middling TTM price to FCF ratio of 12.25 and a fair value of $122.38, AbbVie's shares are priced at a 12.0% discount to fair value and offer 13.6% capital appreciation from the current share price.
Image Source: Investopedia
The valuation model that I'll use to assign a fair value to shares of AbbVie is the dividend discount model or DDM, which consists of 3 inputs.
The first input into the DDM is the expected dividend/share, which is the annualized dividend/share. AbbVie's current annualized dividend/share is $5.20 following its 10.2% dividend increase last October.
The second input into the DDM is the cost of capital equity, which is simply the annual total return rate an investor requires on their investments. While this often differs from one investor to another investor, I require 10% annual total returns on my investments because I believe that offers adequate reward for the time and effort that I spend researching investment opportunities and monitoring my investments.
The third input into the DDM is the annual dividend growth rate over the long-term or DGR.
Unlike the first two inputs into the DDM that merely require data retrieval to find a stock's annualized dividend/share and subjectivity to set an acceptable annual total return rate, accurately forecasting a stock's long-term DGR requires an investor to consider numerous factors, including a stock's payout ratios (and whether those payout ratios are positioned to remain the same, expand, or contract over the long-term), annual earnings growth potential, the strength of a stock's balance sheet, and industry fundamentals.
Considering that I believe AbbVie's payout ratios are in a position to slightly expand over the long-term and that I estimate AbbVie will generate 5.0-6.0% annual earnings growth over the next decade, I am raising my long-term estimate from 5.5% annually to 6.0% annually.
When I plug the above inputs into the DDM, I arrive at a fair value of $130.00 a share, which implies that AbbVie's shares are trading at a 17.1% discount to fair value and offer 20.6% upside from the current share price.
Averaging the three fair values together, I compute a fair value of $120.38 a share, which indicates that AbbVie's shares are priced at a 10.5% discount to fair value and offer 11.7% capital appreciation from the current share price.
Summary: AbbVie Offers A Market-Shattering Yield With Moderate Growth Potential
While AbbVie's S&P 500 tripling yield may cause some to question the safety of its dividend, investors can rest assured that AbbVie isn't a yield trap. I am confident of this based on AbbVie's steadily improving adjusted diluted EPS and FCF payout ratios that were in the mid-40% range in 2020.
Despite a 2020 that resulted in lower new patient starts across AbbVie's therapeutic portfolio (as a result of less doctor visits overall from 2019 to 2020), AbbVie generated impressive 3.3% operational revenue growth and 18.1% adjusted diluted EPS growth during that time.
Given that AbbVie is anticipating a recovery in new patient starts across its portfolio after the second quarter of this year, the company is forecasting nearly double-digit operational revenue growth, as well as 17.6% adjusted diluted EPS growth in 2021 at the midpoint of its guidance.
Even though AbbVie is positioned for yet another strong year, the market hasn't quite come around to AbbVie, which means that investors can still purchase the stock at a 10% discount to what I estimate is its fair value.
Between its 4.8% yield, 5.0-6.0% annual earnings growth, and 1.1% annual valuation multiple expansion, AbbVie remains positioned to meet my 10% annual total return requirement over the next decade.
The foregoing points serve as the basis for my decision to reiterate shares of AbbVie as a buy at this time.
This article was written by
Analyst’s Disclosure: I am/we are long 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.
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