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In the recent past, I have written a few articles about companies and stocks with a high dividend yield. This includes stocks like AT&T (T) as well as Altria (MO) or Magellan Midstream Partners (MMP), which all have a dividend yield in the high single digits. AbbVie (NYSE:ABBV) has "only" a dividend yield of 4.2%, which is not so impressive as the dividend yield of the other three stocks, but still high enough to be interesting for dividend investors.
My last article was published in April 2021, when AbbVie was trading for $110. The stock is now trading about 25% higher and we must determine if AbbVie is still a good investment.
Quarterly Results
And when trying to answer this question, we can start by looking at the last quarterly results. In the third quarter of fiscal 2021, AbbVie generated $14,342 million in revenue and compared to $12,902 million in the same quarter last year which is an increase of 11.2% year-over-year. Operating income also increased from $3,255 million in Q3/20 to $4,306 million in Q3/21 - an increase of 32.3% YoY. Diluted earnings per share increased from $1.29 to $1.78, reflecting an increase of 38.0% year-over-year. And adjusted diluted earnings per share, which get more attention, increased from $2.83 in the same quarter last year to $3.33 this quarter - a 17.7% YoY increase.
And similar to the previous quarters, AbbVie reported strong growth rates for revenue (in the last few quarters, AbbVie reported revenue growth above 50% several times - but that was due to the acquisition of Allergan). Additionally, AbbVie also reported strong growth rates for operating income in most quarters.
Growth Assumptions
And while AbbVie could report strong growth in the past, analysts are not so optimistic for the years to come. For fiscal 2022, analysts are expecting earnings per share to grow again, but in the following years (until 2030) earnings are estimated to fluctuate at the same level. Basically, analysts are seeing no growth potential in the years to come.
(Source: Seeking Alpha Earnings Estimates)
We can look at the growth rate in the last decade with revenue growing at a CAGR of 11.35% and operating income growing at a CAGR of 9.58% and when looking at these results, we can assume that AbbVie might be able to grow with a similar high pace in the years to come. But it is quite difficult to estimate if AbbVie can grow in the years to come - like it is with most pharmaceutical companies as we don't know how much revenue will decline for products without patents and it is even more difficult to estimate what revenue could be expected from the pipeline. AbbVie has new products like Skyrizi or Rinvoq, which are growing with a high pace and in the last nine months, Skyrizi already generated $2,044 million in sales and Rinvoq generated $1,134 million in sales. Management is expecting Rinvoq and Skyrizi to generate $15 billion in combined sales in 2025, but sales for both products are not expected to peak before early 2030s and therefore both products might contribute even more than $15 billion in the years to come.
(Source: AbbVie J.P. Morgan Healthcare Conference)
But management must replace about $20 billion in annual sales from Humira in the next few years (which will lose patents and see declining revenue). In the first nine months of this fiscal year, Humira generated $15,360 million in sales and was responsible for 37% of total sales. And losing revenue from one major product could be a huge problem for pharmaceutical companies and leads to stagnating revenue for several years - Gilead Sciences (GILD) might be a good example.
Huge Discrepancies
Another problem is the huge discrepancy between the net income AbbVie is reporting according to GAAP and the adjusted net income. In fiscal 2020 for example, AbbVie reported $2.72 in earnings per share according to GAAP, but adjusted earnings per share were $10.56. The huge difference stems from several aspects. When looking at fiscal 2020 results the biggest contributors to the higher adjusted earnings per share were "intangible asset amortization", "acquisition and integration costs" as well as "change in fair value of contingent consideration".
Additionally, we are also seeing huge discrepancies between "net income" and "free cash flow" and there are several companies which generate a higher free cash flow than net income. But in case of AbbVie, the cash conversion ratio was 233% on average in the last three years. And this should make us question if we can take the free cash flow as basis for our intrinsic value calculation (as we usually do).
To be honest, these huge discrepancies make me a bit uneasy - especially as the difference is so extreme and we are seeing these discrepancies for several years now - we will return to this aspect, when calculating an intrinsic value.
Balance Sheet
Another problem for AbbVie is the balance sheet. In 2020 AbbVie finalized the acquisition of Allergan and aside from Allergan shareholders receiving AbbVie shares (which increased number of outstanding shares), AbbVie also paid $123.30 in cash for each Allergan share resulting in huge debt levels on the balance sheet. On September 30, 2021, AbbVie had $16 million of short-term borrowings and $74,049 million in long-term debt and finance lease obligations. When comparing that amount to the total equity of $13,577 million we get a rather high D/E ratio of 5.45. However, when comparing the total debt to the operating income AbbVie generated in the last four quarters ($17,460 million), it would take about 4.25 years to repay the outstanding debt, which is rather high, but still seems acceptable. Additionally, we must mention $12,182 million in cash and cash equivalents that could be used to repay outstanding debt.
(Source: AbbVie Annual Report 2020)
When looking what debt is due in the next few years, we see a rather high amount in fiscal 2022 and the free cash flow generated will probably not enough to pay the dividend (AbbVie will need about $10 billion for dividend payments) and repay $12.4 billion in debt. But in the following years until 2025, free cash flow should be enough to pay dividends as well as debt, and for fiscal 2022, AbbVie could use the cash it has on its balance sheet. AbbVie will probably not run into major troubles in the years to come, but the company must grow organically in the next few years as it does not have enough cash to make another huge acquisition.
Dividend
I mentioned above that AbbVie is interesting for its dividend. Like other pharmaceutical companies, AbbVie has a rather high dividend yield and a dividend yield of 4.2% is making the stock certainly interesting for dividend investors. Recently, AbbVie increased the quarterly dividend from $1.30 to $1.41 resulting in an 8.5% dividend growth.
When trying to calculate a payout ratio, it gets interesting again. In most cases, we use the earnings per share according to GAAP. When taking the expected GAAP earnings per share for fiscal 2021 ($6.31), we get a payout ratio of 89.4%, which does not seem to be very sustainable. However, when taking the expected adjusted earnings per share ($12.65) we get a payout ratio of 44.6%, which seems acceptable. Additionally, we can also look at the amounts paid in dividends and compare them to the free cash flow. In the last four quarters, AbbVie had to pay $9,048 million in dividends and generated a free cash flow of $21,677 million - this resulted in a payout ratio of 41.7%.
At this point I often mention about the share buyback programs companies have additionally to boost the dividend. And in the past, AbbVie also spent billions on share buybacks, but in the last two years AbbVie only spent very small amounts on share buybacks. And the number of outstanding shares increased in the last few years due to the Allergan acquisition.
Intrinsic Value Calculation
Calculating an intrinsic value for AbbVie seems to be a rather difficult task. When looking at two simple valuation metrics - price/earnings ratio as well as price/free-cash-flow ratio - we once again see a huge discrepancy (not surprising when knowing about the huge discrepancy between net income and free cash flow mentioned above). Right now, AbbVie is trading for 31.44 times earnings while the stock is trading only for 10.83 times free cash flow. And we can also see that this discrepancy is not just an issue becoming apparent in the last few quarters, but in the last ten years, AbbVie has been trading for an average P/E ratio of 25.10 while it has been trading for an average P/FCF ratio of 14.59.
And when calculating an intrinsic value, we must make several assumptions what growth rates might be realistic and what amounts of free cash flow a company can generate. Usually, we take the free cash flow of the last four quarters - in case of AbbVie $21,677 million. And when taking that free cash flow as basis in our calculation and assuming no growth for the years to come - which is basically in line with analysts' assumptions - the intrinsic value would be $121.99 for AbbVie and the stock would be slightly overvalued.
But I already mentioned above that the free cash flow in the last few years was exceptionally high and that the huge discrepancy between net income (GAAP numbers) and free cash flow is making me a bit uneasy. If we would take the net income of the last four quarters as basis for our calculation instead ($7,534 million) - and assume 0% growth like before - we get an intrinsic value of $42.40, and AbbVie would be extremely overvalued.
Now we must determine what numbers are realistic assumptions for the cash AbbVie can generate in the years to come. In the last ten years, AbbVie had a cash conversion rate of 175% (pretty high number) and if we use that cash conversion rate and the net income of the last four quarters, we get a free cash flow of $13,185 million we could take as a basis in our calculation. To be fairly valued right now (stock price $135), AbbVie must grow 4.5% in the years to come. In my opinion, these assumptions might seem realistic as 4.5% growth in the years to come could be an achievable goal, and AbbVie could be fairly valued right now.
Conclusion
AbbVie seems to be an investor's darling with both Seeking Alpha contributors and Wall Street Analysts being rather bullish about the stock.
(Source: Seeking Alpha)
And in my last article published in April 2021, I was also rather bullish about AbbVie. But now, I probably would move more towards a neutral position with the stock trading almost 25% higher and my question marks about the discrepancy between free cash flow on the one hand and the GAAP earnings per share. I still think AbbVie is a solid investment and a good long-term investment, and with its 4.2% dividend yield, it is certainly interesting for dividend investors. But it is probably not an extreme bargain right now and there seem to be some issues with AbbVie.
