Drip Portfolio Report
Thursday, September 25, 1997
by Jeff Fischer (TMF [email protected])

ALEXANDRIA, VA (Sept. 25, 1997) -- With $11 billion in 1996 sales, ABBOTT LABORATORIES (NYSE: ABT) is the third largest of our four healthcare considerations, following Pfizer with $11.8 billion in trailing sales, and Johnson & Johnson with over $22 billion in sales. Schering-Plough, with $6 billion in sales, is by far the smallest.

Products that account for more than 10% of sales at Abbott are anti-infectives (13%)(Pfizer is also a leader in anti-infectives), adult nutritionals (11%), and infant formula (10%).

The largest difference between our first two considerations and Abbott is the product mix. While Schering-Plough and Pfizer "rely" on pharmaceuticals for 90% and 72% of revenue, respectively, drugs make up only 57% of Abbott's revenue. Pharmaceuticals are high margin product, so it wouldn't be surprising to see Abbott with lower margins than our other two companies, but -- actually -- Abbott's margins are very impressive.

Abbott has trailing operating margins of 23%; Pfizer's are 27% and Schering-Plough's 29%. Net profit margins are 17% at Abbott, 17% at Pfizer, and nearly 22% at Schering-Plough. There are several factors at play here, though, including that fact that last year Schering-Plough brought in 20% of its revenue from only one drug which did very well, and one can't forget that Pfizer spends more on research and development than any of these companies, which lowers margins at Pfizer some. So, we have a "negative" consideration with Schering-Plough, and a positive to remember with Pfizer.

When looking at Abbott, though, its margins are independently impressive. On products other than pharmaceuticals -- those being hospital and laboratory products -- Abbott achieved 17% operating margins last year, while having 30% operating margins on its pharmaceuticals.

Margins are strong at Abbott -- nearly as strong as our first two considerations. How is the company growing?

In 1996 pharmaceutical sales increased 12% to $6.3 billion, and hospital and lab sales increased 7.3% to $4.7 billion. The year before, these two divisions increased sales 13.6% and 4.2% respectively. As with our other companies, of course pharmaceuticals are most important to the business, both for the margins and for the company's overall growth. Abbott's five year compound growth rate for its pharmaceutical division (which includes nutritional products) is 12.4%, while the five year compound growth rate (CGR) for hospital and lab sales is only 6.9%.

Abbott has grown total sales at a five-year CGR of 9.9%, while earnings over the same period have increased 13.7% annually. Research and development costs have increased 12.6% annually over that period -- faster than sales by nearly 3% per year (though R&D as a percentage of sales has risen from only 9.8% to 10.9% of sales the last five years). Over this period, the stock has returned 16.7% annually.

Of our four considerations, Abbott currently has the weakest balance sheet, with $146 million in cash and $931 million in long-term debt. The stock has a book value of over $6 per share, though, so Abbott is far from hurting, and recent acquisitions can't be ignored when looking at the balance sheet.

We want to look forward, though. We'll next consider Abbott's key products and the products in the pipeline (Pfizer has the most enviable products in the pipeline, so far), and we'll see if Abbott's sales growth, at an average of 9.9% annually the past five years, stands to see increased growth going forward or slow down. With nearly 43% of sales coming from lab and hospital products, the considerations are different, of course, than when considering a Schering-Plough that has 90% of sales in pharmaceuticals. The diversification here -- if sales growth in the diversified segment is slow -- would probably hurt the stock performance more than help over the long term.

It's interesting that we began this study wanting a well-diversified healthcare company. In the end, we may end up wanting a company that is focused almost solely on pharmaceuticals -- where the growth and margins are. I want to write as many of the next Drip columns as possible, in an effort to get through Abbott and Johnson & Johnson, and to the final conclusions and decision. I may wrestle the column away from Randy for Monday and Tuesday, too, following tomorrow's column.

Fool on!

--Jeff Fischer