The "hurry up and wait" goes on at Abbott Labs (ABT -0.59%), as it does at many other large med-tech companies, but Abbott is at least showing some growth momentum and the comps for the second half of the year should lead to better reported results. Abbott has also been busying on the M&A front, recently announcing a deal with Mylan (MYL) that shifts the company's Established Pharmaceuticals business firmly toward faster-growing emerging markets. What the company will do about its device business is still an open question and how management addresses it will be something to watch for the remainder of the year.
Above-target for Q2
Abbott's revenue was basically as expected, but the company did better than expected with cost control and delivered a three-cent beat on a per-share basis.
Revenue rose 3% in constant currency terms, coming in just a bit better than analysts expected. The diagnostics business has driven the company's growth over the past year and this quarter was no exception, as revenue rose more than 5% on strong results in Core Lab. Abbott, Danaher, and Roche have been enjoying strong above-market growth (largely at the expense of Siemens, Johnson & Johnson, and bioMerieux) in diagnostics and that seems to be continuing, though the weakness in Abbott's small molecular diagnostics business (down 3%) is something to watch.
Nutrition remains the largest business at Abbott and sales were up 3%. That was slightly below expectations, but Abbott continues to be in position to regain share in China. Established Pharmaceuticals was up 2%, with growth in emerging markets of 10%.
Device revenue was up 1% this quarter, with strong growth in optics (up 12%) partly offsetting ongoing terrible results in diabetes (down 10% and down 27% in the U.S.) and scant growth (up 1%) in the U.S.
Looking at the income statement line items, gross margin improved 1.3 percentage points on an adjusted basis, helping operating income to grow 11% on an adjusted basis. The gross margin line was a sizable beat relative to expectations (almost a point) and Abbott added a little more at both the SG&A and R&D lines.
The drug business is now growth-focused
Abbott certainly sees itself as more like Johnson & Johnson than Medtronic, or at least in terms of choosing to follow a path of diverse exposure to medical and consumer markets through involvement in devices, drugs, and consumer products.
Here of late it is the Established Pharmaceuticals business that has gotten most of the attention. Not only has the company elected to do a "spinversion" of its developed markets business with Mylan, Abbott acquired Russian drug company Veropharm and Chilean company CFR. In total Abbott may spend $3.4 billion (and assume nearly $600 million of debt) to acquire over $900 million in revenue depending upon the finalization of the Veropharm price.
In buying and selling these businesses, Abbott has restructured its drug operations around faster-growing emerging markets like Latin America, Russia/Eastern Europe and Asia. What remains to be seen, though, is how much of the company's prior problems in EPD were due to weak end markets and how much were due to management's own issues and shortfalls. Should these emerging market operations slow down (and/or Mylan do substantially more with the acquired business), it will lead to some pointed questions for management. I mention that mostly on a "devil's advocate" basis, though, as I do believe Abbott's growth-focused restructuring toward emerging markets is a sound strategic move.
Devices the perpetual unknown
Abbott has a strong diagnostics business (particularly in core lab), and a competitive nutrition business (particularly in the U.S.), as well as a newly growth-refocused drug business. The device business may be next for some sprucing up.
On the vascular side, Abbott has acquired a good peripheral stent platform and may be looking to acquire mechanical atherectomy products/technology to complement it. I would expect a smaller-scale deal, but perhaps Medtronic will be looking to sell assets as part of its intended acquisition of Covidien. Speaking of Medtronic, Abbott is likely to find it hard to gain and hold lasting share in the stent business, particularly as Medtronic steps up its efforts to bundle cardiology/vascular products together. That could inspire Abbott to acquire other cardiology products to bulk up its own efforts.
Outside of these areas, I'd be curious to know what, if anything, management is contemplating. The diabetes business is doing quite poorly (even compared to Johnson & Johnson) and Abbott lacks insulin delivery technology to pair with its glucose monitoring products (where reimbursement pressures in the U.S. are hurting sales). The vision care business could be an opportunity for future growth-focused acquisitions, but I'd be particularly interested to know if management is contemplating adding any additional operating/therapeutic platforms.
The bottom line
Trading below 3x forward revenue Abbott isn't expensive by that popular methodology, but neither does the company have what I'd call outstanding near-term sales growth prospects, nor outstanding free cash flow margins. There's room for improvement here and Abbott shares don't seem expensive, but I don't believe that "steady as she goes" will move the stock and it may take further restructuring and acquisition initiatives in the device business to generate more enthusiasm for these shares on the Street.
