With stocks like St. Jude Medical, Boston Scientific, Medtronic (NYSE: MDT ) , and Johnson & Johnson (NYSE: JNJ ) so strong in 2013, Abbott Labs (NYSE: ABT ) has been tapped by many sell-side analysts as a catch-up pick for 2014. For the second straight quarter, though, Abbott has come in a little shy of growth expectations. Although the excuse was reasonable (the ongoing impact of Fonterra recalls on nutrition), there's not a lot of tolerance in Abbott's valuation model for ongoing shortfalls.
Another "just OK" result
Even if most of Abbott's miss relative to consensus was from currency, a miss is still a miss. Revenue increased less than 1% this quarter as reported, or up a little more than 3% on a constant currency basis.
Abbott's diagnostics business was the growth star this quarter, with sales up almost 9% in constant currency. It probably isn't fair to compare Abbott's performance here to the no longer competitive diagnostics business of Johnson & Johnson, so investors will need to wait for Siemens, Roche, and Danaher to report to really compare the results. Even so, barely 1% growth in molecular diagnostics strikes me as weak, while the 14% growth in point of care testing and 9% growth in core lab should compare quite favorably.
Devices were also surprisingly strong, with sales up better than 4%. Medical optics led the way with nearly 15% growth driven by the cataracts business, while vascular was up a more-than-respectable 4%. Diabetes was down less than 4% (versus down 13% at JNJ), as Abbott's smaller diabetes business continues to get hurt relatively less by competitive bidding than either JNJ or Roche so far.
Established pharmaceuticals was up a mediocre 1% even as "key emerging markets" saw 10% operational growth. As mentioned before, nutritionals was also a disappointment as weakness in the U.S. (down 2.5%) weighed on international results already hampered by recalls in the pediatric business.
Abbott basically matched expectations with its margins. Adjusted gross margin improved about a half-point from last year, while operating income increased about 9%.
Nutrition still the crown jewel
It remains to be seen how quickly Abbott's pediatric nutrition sales will recover in the wake of well-publicized contamination recalls. It wasn't actually anything that Abbott did wrong, they recalled products that were packaged on potentially contaminated lines run by Fonterra (a New Zealand-based multinational dairy cooperative). Even so, the Fonterra-related recalls by Abbott, Danone, and Coca-Cola got a lot of press in China and it remains to be seen whether Mead Johnson or Nestle can capitalize with sustainable share capture.
This is no small matter, as nutrition is not only the largest individually reported segment for Abbott (30% of Q4 revenue), but also the one expected to deliver the most growth, with average sell-side three-year growth rates in the neighborhood of 10%.
Good news from devices, but work still to be done
Abbott has actually had some relatively good news on balance from its device businesses. The company got FDA approval of MitraClip despite an iffy panel meeting, and an Italian study presented at TCT suggested a potentially meaningful angina benefit to Abbott's Absorb stent (16% at one year versus 28% for Xience). Given that the primary benefit to stenting is angina reduction, that could be a significant competitive edge for Abbott against Medtronic and Boston Scientific, even though the Absorb stent can be tricky to maneuver.
I do still wonder if Abbott needs to add scale in its structural heart business. Assuming that Abbott can work out better reimbursement for MitraClip (current reimbursement only covers about half of the expected ASP), this could be a $250 million device in the U.S. based on Abbott's comments to the FDA panel or a $750 million device (or more) if you believe the company can capture all of its addressable market.
The thing is, though, Abbott has nothing else to offer in this area – no transcatheter valves, no atrial fibrillation treatments, no AAA therapies and so on. That's an impediment to achieving better sales force utilization and margins. There are several acquirable companies in these spaces, though, so I would not be surprised if Abbott made one or more deals to augment its MitraClip sales effort.
The bottom line
Pretty much nothing has changed in regard to my view of Abbott, other than the models shift forward by a year. With that, I'm still looking for mid-single digit revenue growth, low double-digit free cash flow growth, and a fair value around $40. I'm a little concerned that the Street is too invested in Abbott as a company with both growth and margin leverage prospects, but in a large cap med-tech world short of cheap ideas, Abbott will do for now.
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