AbbVie: Buy The Humira Fear And Profit

Summary

• AbbVie is a blue-chip pharmaceutical company that is known for its massive dividend.
• The company will lose exclusivity on its top selling drug in a couple of years. AbbVie has begun preparing for this (see Allergan merger).
• Despite AbbVie's strong drug portfolio, the market is pricing in the loss of Humira and keeping valuations down. This is an opportunity for long-term investors.

Photo by vzphotos/iStock Editorial via Getty Images

Pharmaceutical giant AbbVie Inc. (NYSE:ABBV) is a beloved dividend growth stock and massive player in the prescription drug space. The company's product portfolio includes Botox and Humira, the world's top selling drug. However, AbbVie's patent for Humira expires in 2023, which has spooked investors given the company's importance to AbbVie's revenues and bottom line.

While it's certainly an important matter, investors shouldn't avoid the stock simply due to this. AbbVie possesses great fundamentals and a growing portfolio of products that will displace the drop-off from Humira sales as generics enter the market. We will outline our long-term investment thesis for AbbVie and detail the path to success in a post-Humira patent world.

Company Overview

AbbVie is one of the largest pharmaceutical companies in the world. The company has a market cap of roughly $187 billion and generates more than $45 billion in sales every year. AbbVie researches, develops, and sells these drug products all over the world. AbbVie has changed quite a bit over the past decade. The company was once part of Abbott Laboratories (ABT) as a healthcare mega-conglomerate before being spun off from Abbott in 2013 to operate as its own entity.

Then, the company changed again in mid-2020 when it closed on a $62 billion deal to merge with another pharmaceutical company called Allergan. AbbVie’s drug portfolio includes the world’s top-selling drug in Humira, used to treat inflammatory conditions such as arthritis and Crohn’s disease. The company’s product portfolio also includes (among others):

• Imbruvica (treats certain cancers)
• Skyrizi (treats psoriasis)
• Botox (cosmetic)
• Mavyret (treats hepatitis C)

AbbVie today boasts a large pipeline built around treatments in Oncology, Immunology, and Neuroscience. A pharmaceutical company’s pipeline is extremely important, so we will revisit this later.

source: AbbVie Inc.

Understanding The Pharmaceutical Business Model

Before getting too deep into AbbVie as a business, it’s important to understand the business model of a pharmaceutical company at a high level.

Pharmaceutical companies are in the business of discovering, developing, and selling drugs. When a new drug product is developed, the drug’s formulation is protected by patents that last for 20 years from the date that the patent application is filed. When a drug is protected under patent, it’s called “exclusivity". Exclusivity gives the drug company a virtual monopoly on that drug until the patent expires.

With virtually no competition for a drug with exclusivity, these drugs produce tons of revenue and profits for the pharmaceutical company. They are basically a “golden goose” until the patents expire. Once the patents expire, competitors flood the market with cheaper “copy-cat” drugs (referred to as generics) and the sales of the original drug tend to drastically fall off.

Pharmaceutical companies know this, so while they are reaping the rewards of a “blockbuster” drug, the pharmaceutical company is often reinvesting a portion of those profits into research and development to identify and develop the company’s next blockbuster drug.

source: Wealth Insights (author)

In other words, the pharmaceutical business is one of innovation where an inability to bring new products to market will eventually cause the downfall of the business. Organic innovation isn’t always easy, so mergers and acquisitions are very common in the industry as bigger players will “bolt-on” new growth by acquiring smaller companies and their pipelines.

The nature of this industry results in a cycle around innovation where pharmaceutical companies are constantly developing new drugs, acquiring smaller companies, and distributing cash to shareholders all at the same time. AbbVie’s ownership of the world’s top-selling drug Humira has given AbbVie many billions of dollars of cash over the years. This is a large driver behind AbbVie’s strong track record of returning cash to shareholders.

AbbVie Leans On Fundamentals To Fund Growth

To show the strength of AbbVie as a business, we can peel into some key operating metrics. These strong operating metrics illustrate what a tremendously successful product can do for a pharmaceutical company – and its shareholders.

First, we see that revenues, free cash flow, and EBITDA have all grown significantly over the past five years. Revenues have grown at a double-digit rate due to both increased drug sales and the added revenues from acquiring Allergan. This has trickled through the business, pushing free cash flow and EBITDA higher as well. This strong growth is nothing new for AbbVie. If we go back 10 years, revenues have grown at a CAGR of 11.3%, and operating income has grown at a CAGR of 9.5%.

source: Ycharts

Next, we turn to efficiency and value creation. As a very asset-light business, AbbVie maintains gross margins, typically at 75% or above. This results in strong free cash flow generation. AbbVie converts approximately 36.6% of every revenue dollar into free cash flow. A company with both revenue growth and strong FCF efficiency creates a wonderful dividend growth stock (which AbbVie has been). AbbVie has also historically generated a strong return on invested capital of between 15%-20%. I use this metric to gauge how a business creates value from its invested resources. We can see that metrics have dipped recently, a result of the Allergan acquisition. As time passes, I expect AbbVie's operating metrics to base, and recover.

source: Ycharts

These strong fundamentals combined with steady growth make AbbVie what I call a "cash cow". This can be great for funding dividends, but it also creates a competitive advantage. The company can invest back into the business to drive innovation or make acquisitions (such as the case with Allergan).

A pharma company with size and strong cash flows has an advantage over smaller or less profitable players in the industry. Pharma companies must constantly invest into developing future drug products. For each blockbuster drug that successfully gets brought to market, there are a handful of products that fail along the way. These failures still incur costs of their own, often many millions of dollars. Similar to how investing works sometimes, the winners often need to make up for the losers. When you are a “mega-player” such as AbbVie, you get more “swings at the plate” to hit those home runs.

Let's Talk About That Dividend

One of the primary reasons you may be interested in investing in AbbVie is the company’s ability to pay out enormous dividends to investors. As of this writing, the company is paying you $5.20 (broken into four quarterly payments), for each share you own. This result is a dividend yield of 4.90%, not bad considering 10-year treasuries are only yielding 1.66%!

So, when we look at a company’s dividend as dividend-focused investors, we really care about two specific questions: is the dividend safe, and how much will it grow?

So, is the dividend safe? To determine this, we will look at how much of AbbVie’s cash flow the dividend takes up. We can see here that AbbVie’s dividend consumes approximately 46% of the company’s cash flow.

source: Ycharts

Since I would consider a payout ratio of up to 75%-80% as “safe”, the dividend is well afforded here. There is enough cash flow left over that AbbVie maintains some financial flexibility to manage its balance sheet, buy back stock, or invest in acquisitions.

As a backstop, we will look at the company’s balance sheet. The balance sheet gives context to a company’s financial situation and enables us to see what the company can fall back on if cash flow streams unexpectedly dry up.

source: Ycharts

AbbVie’s balance sheet has taken on a lot of debt over the past couple of years as a result of the acquisition of Allergan. That deal was worth approximately $62 billion and has leveraged the balance sheet up 6.4X EBITDA (not including cash). This is well beyond what I use as my "safety benchmark" of 2.5X EBITDA, but the payout ratio and cash position create dividend safety. Investors should expect (and look for) management to pay down this debt in the coming years.

One thing that makes AbbVie such a cool dividend stock is that the company’s high dividend yield is accompanied by strong dividend growth. It’s hard to find companies that offer both to the extent that AbbVie does.

AbbVie’s history of raising its dividend goes back well beyond 2013. The once combined entity of Abbott Labs and AbbVie was a dividend aristocrat (25+ consecutive dividend raises), and AbbVie has also raised its dividend each year since the spin-off.

Over the past five years, AbbVie’s dividend has grown at an annual average rate of 14.9%. When you factor in the company’s high yield (averaging 3.4% since the spin-off), this is a tremendous dividend stock – both in growth and in yield.

source: Ycharts

So, what is AbbVie’s dividend growth trajectory looking ahead? I see the dividend growth rate drastically slowing down in the near term given the company’s increased debt load following the Allergan acquisition. AbbVie simply cannot afford to string out all of its cash flow as it works to deleverage the balance sheet. Additionally, AbbVie is about to lose patent exclusivity on its top-selling drug Humira, which we will detail next.

In closing out our discussion on the dividend, investors are looking at shares offering near 5% yield, and the company’s strong level of performance all but ensures that the dividend will be growing at a rate above inflation for the foreseeable future. This means that investors will be getting real increases in their “purchasing power” (outpacing the rate of inflation), year after year. This sort of compounding can lead to huge income streams for investors over time!

Looking At AbbVie Post Humira

Any basic level of due diligence will reveal that AbbVie’s enormous blockbuster drug Humira is about to lose patent protection in 2023. Humira is the world’s top-selling prescription drug and brings in roughly $20B in annual sales for AbbVie (!). Just like as we discussed, when the patent expires, competitors will flood the market with lower-priced generic products. This will cause a sharp drop off in Humira’s sales, and thus in AbbVie’s sales. How important is Humira to AbbVie? The drug accounts for roughly 43% of the company’s total sales!

So, as an investor, our concern revolves around how AbbVie will be able to backfill that upcoming drop in sales. Fortunately, AbbVie is already taking steps to do this. The loss of Humira was the primary motivator in the company’s decision to acquire Allergan.

source: AbbVie Inc.

With the acquisition of Allergan, AbbVie is diversifying its pipeline. This is headlined by the Botox brand. The pipeline also touches on a number of other areas including Neuroscience, Gastrointestinal, Women’s Health, and Eye Care. Allergan’s pipeline totals approximately $15.7 billion in revenues that are being bolted onto AbbVie’s existing business.

In addition to the newly acquired Allergan assets, AbbVie is developing some exciting growth prospects within its own pipeline. AbbVie has two products in early life stages in Skyrizi and Rinvoq. These are two new immunology drugs with 2020 sales that came in at just over $2B. Management has projected that the two products could combine for $10B in annual sales by 2025, which could almost replace the lost revenues of Humira alone (remember, Humira’s sales won’t completely disappear).

The company expects the two drugs to cover all ten conditions that Humira is currently approved for, so AbbVie should remain competitive in this space. The hope is that between these new drugs and the remaining Humira sales, that AbbVie will come out near “even” on a net loss basis. AbbVie has continued this process with recent submittals/updates with regulators (both for Skyrizi, and Rinvoq).

In addition, the company's oncology drugs Imbruvica and Venclexta drive about $5 billion worth of revenues and should continue to grow in the years ahead. The company's pipeline is intact with patents lasting mostly into the early 2030s (Imbruvica expires next after Humira in 2026). Execution is always a question to be answered, but when you look at what AbbVie has going on before factoring in the Allergan Acquisition - I like AbbVie's chances to sustain reasonable topline growth beyond the Humira loss in 2023.

source: Seeking Alpha

Analysts are projecting AbbVie to grow revenue to nearly $60 billion while Humira is exclusive. AbbVie’s loss of Humira exclusivity is very unfortunate, but to discard the stock because of it, is a lazy reaction in my opinion.

Risks To Investment Thesis

Pharmaceutical companies consistently have to innovate, and juggle a number of risk factors, so investors need to be aware of these risks before putting their money into a company like AbbVie. I want to remind investors that AbbVie must continue to stock its pipeline so that revenue growth (and therefore dividend payments) can continue years into the future.

Now what I think the largest risk is to AbbVie, is the political landscape. Whether you are for or against government-run healthcare, drug prices are constantly a headline grabber. If the everlasting lobbying efforts of big pharma fail in DC, regulations that force lower drug prices could be catastrophic for the profits of pharmaceutical companies.

AbbVie would certainly be a target of this type of legislation because AbbVie is one of the boldest players in big pharma when it comes to raising prices. If AbbVie can continue to innovate and avoid the ire of Congress, I think AbbVie is set up for a long runway of solid growth and flowing dividend payments.

Humira Worries Has Priced The Stock Attractively

While the stock currently trades near 52-week highs at $107 per share, the stock is just now recovering to where it was in the summer of 2018. Shares have seen pricing pressure from a number of factors since then including the looming Humira expiration, the Covid crash, and uncertainty over the huge Allergan merger.

source: Ycharts

While shares have bounced high off of lows, the stock remains attractively valued. If we look at guided EPS for this year at approximately $12.50 per share, the stock is valued at just 8.6X forward earnings.

The stock has historically averaged a 20X multiple, so we are still significantly below that - even at highs. The primary reason for this is continued fear/anticipation of the loss of Humira sales.

While we have already discussed the company's path to replacing those lost revenues, the stock is continuing to price in the loss. Even if AbbVie does see a reduction in revenue/earnings due to the eventual loss of Humira, the business is so significantly undervalued, that I see a margin of safety at these levels to protect against that. It's hard to find deals in a frothy market, but I'm not sure there are many better "deals" out there for true "blue chip" dividend growth names than AbbVie.

Wrapping Up

AbbVie is a great company that offers investors a combination of steady growth, strong fundamentals, and a growing (and high yielding) dividend. While the balance sheet needs to be cleaned up, AbbVie has the cash flow to get it done. The loss of Humira shouldn't be glossed over, but with AbbVie's robust pipeline and growth prospects, it shouldn't derail an investment thesis either.

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.