Why Abbott Is A Buy After The Lawsuit

| About: Abbott Laboratories (ABT)
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The pharmaceuticals industry is a defense play, just like the food and beverages industry, in terms of sensitivity and market beta. Abbott Laboratories (ABT) is uniquely situated in the industry because of its growth prospects and because it still has a reduced valuation due to lawsuit-related uncertainty.

The month of May brought the end to a lawsuit filed against the company for marketing Depakote, a drug for schizophrenia, for off-label use. The company actually pleaded guilty to a criminal misdemeanor for its actions. The total settlement amount is $1.6 billion. A multi-year cloud that hung over Abbott has been lifted. Although the company will be under government compliance review, management can now refocus on growth initiatives and overall financial performance.

Chief among Abbott's positives is its favorable dividend policy. Abbott's forward annual dividend yield is at 3.40% with a forward annual dividend rate of $2.04 per share. The dividend yield is not the highest in the industry, but the dividend rate is remains impressive. Close investment competitors such as Merck (MRK) and Johnson & Johnson (JNJ) yield 4.40% and 3.60%, respectively. Other competitors, which include Sanofi (NYSE:SNY), had a forward annual dividend yield of 4.90%, the highest reported in this industry.

The various dividend rates are not equal, however. Merck has the highest payout ratio of 77%, while Abbott pays at ratio of 62% of earnings. Johnson & Johnson pays at a ratio of 64% while Sanofi's payout is the lowest at only 48%. This gives you a clear picture of how much room each company has to raise its dividend rate. Overall, the sector has some room for dividend growth.

Many companies, more often than not, struggle to run at the optimal cost of capital. This simply means attaining a balance between the amount of debt used and the amount invested inform of equity. First and foremost, it is of great importance to note that either extreme is considered unhealthy for the company and hence the need to strike a balance. There are several theories that suggest certain levels of debt and equity but in my own understanding, it all depends on the type of industry the company operates. For instance, the level of debt considered safe for financial institutions is lower than that for pharmaceuticals industry. With this in mind, the debt to equity ratio of 62.85 ensures that the company capitalizes on the tax allowable cost of debt in the form of interest expense while at the same time making sure that the stockholders do not lose control to the creditors.

Sanofi, on the other hand, showed some shrewdness in its acquisition of debt by keeping it 27.43, while Merck feels 30.76 is a good level to work with. Johnson & Johnson on the other hand had 34.49 while Roche holdings AG had the highest of levels with 185.42.

Abbott's profit margin is not the best when compared to majority of its competitors. Roche Holdings has a very impressive figure of 21.8% profit margin and 32.92% operating margin as compared to that of Abbott at 12.17% profit margin and 20.90% operating margin. Sanofi and Merck are not really far off from Abbott, as they reported profitability margins of 16.24% profit margin with an operating margin of 21.73% and profit margin of 13.05% and an operating margin of 21.99% respectively. Johnson & Johnson managed to record a profit margin of 14.87%, which is still better than Abbott and an even better operating margin of 24.97%.

All investors are always on the lookout for news impacting on the status of the prospective stock and even the stock they have in their portfolio. While it is not good to focus on the negative aspects only, it is good for precautionary purposes. A lot has been said about Abbott in recent past due to its issues with marketing drugs for off-label use. Nevertheless, it is always good to also look at the positives in order to make the right judgment.

Abbott has plenty of positives. The signing of the deal with Galapagos for development of a next generation JAK (Janus kinase) inhibitor for arthritis and other autoimmune diseases, after which the marketability could be a real catalyst for the stock. Abbott's Humira is already on its way to being an $8 billion per year in sales drug in the autoimmune space. The drug is currently in its second phase II study.

Thus, the pieces Abbott needs to reassert itself as a growth story are already in place. In my view, much of Abbott's marketing-related troubles are behind it with the settlement. A stock that boasts strong fundamentals such as the ones depicted by Abbott can perform well without overhanging uncertainty.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.