- Abbott Labs is a healthcare conglomerate that has managed to grow despite restructuring its business over the past decade.
- The company's strong fundamentals and top-line growth have resulted in strong cash flow and dividend growth.
- The stock is reasonably valued, given an expected surge in EPS this year. Investors can do well by buying and holding this top notch company.
One of the best indicators of a quality organization is one that proactively drives innovation, pushing the envelope rather than resting on existing success. When you have a business that continually adds value in a sector that has a constant thirst for innovation, the results can be lucrative for investors. That is what is happening with healthcare conglomerate Abbott Laboratories (NYSE:ABT).
A few years ago the company reshuffled itself, and focused on prominent healthcare fields such as diabetes and cardiovascular health. This combined with new products impacting Covid is fueling growth that should benefit investors for years to come. We will outline the company's strong fundamentals, what's driving top line growth, and look at whether shares are priced for an investment opportunity today.
Strong Fundamentals, Further Evidence Of Strong Management
If you weren't aware, Abbott Labs has had to drastically change the structure of its business over the course of the past 10 years. At one time, Abbott Labs was this massive healthcare conglomerate with heavy pharmaceutical exposure. But in 2013 the company spun off the majority of its pharmaceutical business as AbbVie (ABBV). We will detail some of Abbott's post-split changes in the next section, but Abbott Labs had to re-establish its fundamental strength.
Despite the dramatic changes to the business that included large acquisitions, Abbott Labs has continued to display strong operating metrics.
After a few years of digesting the major changes to Abbott's business, fundamental operating metrics have all improved and are consistently at high levels. Operating margin has increased, signaling greater profitability. The company is converting more than 16% of its revenues into free cash flow (I generally consider 10% as the benchmark). Abbott's return on invested capital has also improved from low to high single digits. It's not easy for a company to make drastic changes and maintain performance at a high level (lots of execution risk), so I see this as a strong testament to management.
The company had to take on a lot of debt to fund some large acquisitions. This resulted in billions of debt that put leverage at more than 4X EBITDA as recently as three years ago. Since then, the company's financials have drastically improved. Leverage is all the way down to 2.2X EBITDA (below my 2.5X benchmark), and Abbott's cash position is strong at almost $7 billion.
The strong fundamentals and rapid deleveraging have enabled Abbott Labs to continue raising its dividend. While Abbott "technically" lost dividend champion status when it spun off AbbVie, the dividend has been an important aspect of investing in Abbott Labs for decades. Despite the disruptions to the business, Abbott has continued to increase its payout.
The dividend has grown at a CAGR of 8.4% over the past five years, and was just raised 25% at the end of 2020. Despite this, the payout itself consumes a modest amount of Abbott's cash flow at 44.7%. This low payout ratio is how the company has grown its dividend while deleveraging so fast, and wouldn't be possible without the successful growth drivers that Abbott has set in motion.
Strategic Growth Drivers Hitting Stride
The driver behind all of Abbott's recent success has been strong top line growth. We can see how revenues dropped off upon the spin-off of AbbVie, and how revenues have steadily been built back up.
The reason for this growth has been the strategic steps taken by Abbott. In 2017 Abbott Labs acquired St. Jude Medical for $25 billion, a move that bolstered the company's cardiovascular device portfolio. The company bolstered its diagnostics business by acquiring Alere later in the same year for $5.3 billion.
These acquisitions along with strategic product development have shaped the business to what it is today:
- Established pharmaceuticals (12% of sales)
- Nutrition (22% of sales)
- Diagnostics (31% of sales)
- Medical devices (35% of sales)
The company is poised to see extended growth in a few critical areas. The company's rapid test system for Covid has helped drive sales for Abbott's rapid testing segment. In 2020, sales were $4.37 billion (up 113% YoY). With variants of Covid emerging, it's highly likely that a need for testing will remain ongoing even with vaccinations spreading.
The company has also seen continued momentum from its FreeStyle Libre system, a non-invasive system to monitor blood sugar for diabetes patients. Sales in Abbott's diabetes care segment were $3.27 billion in 2020 (29% YoY). This is continued growth from 2018 (the system hit market in late 2017), so I expect sales to continue growing. Diabetes is an enormous market.
The company's other major focal point is cardiovascular care, where the company has a myriad of medical device offerings that fall into multiple categories including rhythm management, electrophysiology, heart failure, vascular health, and structural heart. Sales in most cardio categories were down from 2020 due primarily to the pushback of elective procedures throughout the year to help free up staff and hospital space for Covid patients. Elective procedures are generally rescheduled rather than outright cancelled, so we should see a rebound across the board in the near-medium term future.
All of these factors are contributing to what is expected to be a continuation of growth in 2021. The company is forecasting 2021 EPS at least $5.00 per share, representing YoY growth of 35%. Analysts are projecting strong top line growth to drive this, estimated at $42.25 billion in 2021 (YoY growth of 24%).
Are Shares Attractive Today?
The strong performance has reflected in the share price over the past few years. Abbott's stock chart has been strong, moving "up and to the right" consistently (outside of the March 2020 crash). Shares now trade at $120 per share, near highs.
If we look at Abbott's projected EPS of $5 per share in 2021 (they technically guided for EPS of "at least" $5), the stock's forward earnings multiple is currently 24X. This is a discount to Abbott's historical norms of 27X.
I wouldn't say that Abbott is "cheap" here, because some of this growth will slow down as Covid passes. However, long term investors can certainly accumulate and expect Abbott's strong fundamentals to drive shares higher over the coming years.
Good companies continue to produce value for investors, even as changes and challenges arise over time. Abbott has done a fantastic job restructuring following the spin-off of AbbVie. With acquisitions and new products driving growth, investors are set to reap the rewards over the coming years. Abbott's strong fundamentals and impressive growth make it the "king" of healthcare stocks for the dividend growth investor.
This article was written by
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.