An Abbott Update (Drip Port) July 1, 1999

<THE DRIP PORTFOLIO>
An Abbott Update
Changes Afoot at Drugmaker

by Brian Graney (TMFPanic)

ALEXANDRIA, VA (July 1, 1999) -- After Jeff's recent three-part look at Pfizer (click here for the first column), I poked around in the Drip Port's 1997 archives to review what other healthcare companies Jeff and Randy looked at en route to selecting Johnson & Johnson as a holding. Besides Claritin-maker Schering-Plough (NYSE: SGP), Abbott Laboratories (NYSE: ABT) was also considered but didn't make the final cut. However, things have been changing recently out in Abbott Park, Illinois, so an update seems to be in order.

From a financial point of view, Abbott's business looks much like it did two years ago when we first looked at the company. (Click here to time-warp to Part 1 of Jeff's 1997 review and here for Part 2.) Revenues have grown an average 6.5% over the past two years to $12.5 billion, while earnings have climbed at a faster 11.3% average rate and now stand at $2.3 billion. Operating margins are a healthy 25%, up from 23% two years ago, while net profit margins work out to 19%, up from 17%. The firm's R&D spending, a moving part we like to consider when looking at drug firms, has been holding steady at about 10% of annual revenues over the past few years.

Turning to the balance sheet, cash and equivalents have more than doubled to $352 million (as of March 31) from $146 million when we last looked. However, Abbott's long-term debt position is also 44% higher than it was before and now stands at $1.3 billion. Depending upon which side of the glass-is-half-empty, glass-is-half-full equation you prefer, the added leverage has either boosted the firm's long-term debt-to-equity ratio to 23% from 19% or juiced return on average equity to 44% from 41%.

The company is still based on four main U.S. business lines -- pharmaceuticals, diagnostics, nutritionals, and hospital products -- each of which account for about 20% of total revenues. When lumped together, international sales of all four segments represent the remaining one-fifth of the revenue pie. Abbott's major products include the antibiotic Biaxin, the anti-HIV protease inhibitor Norvir, the nutritional drink Ensure, and Similac infant formula -- all in all a fairly decent lineup of brandnames. The diversity makes the company similar to our current healthcare holding J&J and sets Abbott apart from the drug-dependent Pfizer (we mean that in a good way, of course), which garnered 87% of its 1998 revenues from prescription pharmaceuticals.

While we tend to be more attracted to the high-margin drug business over any other area in the healthcare universe, the profitability that Abbott is able to wring out of its various businesses is still impressive. Yet, the company is still not satisfied, and that's what we like to hear. Focusing on the most profitable aspects of the business and notching up the performance-o-meter even more is a major goal of the company's new management team, which is trying to put a more aggressive face on this staid yet steady grower. (Annual earnings have grown at a double-digit rate consistently since 1972, back in the day when Jeff was listening to the latest Liberace hit on his parents' 8-track.)

Since our initial look in 1997, many senior level managers at the firm have been replaced with new blood. Heading the list of fresh faces is Miles White, a 15-year veteran of Abbott who became CEO in January and added the chairman's title in April. Along with another Abbott vet, new President/COO Robert Parkinson, White has set his sights on boosting the company's growth prospects through savvy acquisitions and joint ventures. Since the start of the year, the company has entered into joint drug agreements with Cephalon, Triangle Pharmaceuticals, and Germany's Boehringer Ingleheim, just to name a few. But those deals were small potatoes compared to Abbott's $7.3 billion deal to acquire the drug developer and drug delivery company Alza Corp. (NYSE: AZA), which was unveiled last week.

Alza, best known for developing the hypertension drug Procardia and the NicoDerm patch that helps smokers kick the habit, has been building a name for itself over the past five years as a fully-integrated pharmaceutical company specializing in cancer and urology drugs. The company's net pharmaceutical sales rolled in at $119 million last year, more than doubling 1997's sales and five times greater than 1996's totals. Overall, total revenues have more than doubled in five years' time to $584 million last year, while earnings per share have risen an average of 16% per year over the same span. Abbott scooped up Alza for about $53.03 per share, slightly below the company's 52-week high of $55 3/4 per share and 36 times its estimated forward EPS of $1.48 per share -- expensive to our price-conscious eyes but considered a steal by several industry observers.

The companies themselves and the majority of Wall Street analysts excitedly called the deal "a perfect fit" that will end up benefiting both parties in the long-run. First off, acquiring Alza's pipeline of promising drugs should help quiet rumblings about Abbott's own drug pipeline. Secondly, Alza's products will get a major marketing boost from Abbott's better-known brand name, its much larger sales force, and its international presence. As Ren and Stimpy might put it, "Happy happy, joy joy."

All exuberance aside, what interests us most about this deal is whether the addition of Alza will act as the sparkplug Abbott needs to drive home supra-industry returns in the coming years. We'll examine that question and take a peek at the growth expectations currently built into Abbott's share price tomorrow.

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