For a company in the midst of a transition away from the medicine that made it a star performer over the last decade, AbbVie's (ABBV -4.58%) valuation looks surprisingly high. Why is the market pricing a business, which is barely expecting much growth over the next couple of years, so expensively? The market's expectations, it seems, are a bit out of whack with the company's fundamentals.
But that doesn't necessarily mean that you need to avoid adding to your position right now. Here's what you need to know about this stock and its pricing in light of its upcoming opportunities and current struggles.
What's driving its valuation?
At the moment, AbbVie's price-to-earnings (P/E) ratio is 31. The average P/E for the pharmaceutical industry is 19. There are a few possibilities as to why a stock's valuation could be higher than its peers, and it's important to understand them to assess whether AbbVie is too overpriced to buy.
For one, investors could be anticipating that its rate of growth will be faster than average. In this case, that seems unlikely. Management isn't anticipating significant top-line growth until 2025, and for the rest of the decade after that, it's estimating a compound annual growth rate (CAGR) of 9% at most. Analysts on Wall Street concur, finding on average that 2022's total revenue of $58 billion will decline this year and next year, rebounding to $56 billion by the end of 2025. The culprit for falling sales isn't anything new.
Since the start of this year, AbbVie's smash-hit arthritis drug Humira has no longer been protected by its manufacturing exclusivity protections, so its market share is getting devoured by generic copies. Those sales won't ever be coming back. Furthermore, analysts expect oncology sales to follow a similar trajectory for the same set of reasons, with sales expected to pick up again in the latter part of the decade. So, expectations for near-term growth are low and guarded for the medium term.
There could also be key upcoming catalysts that are expected to increase the value of the company by proving or demonstrating important factors, like the efficacy of a drug or the utility of a technology platform. In 2024, the business could obtain regulatory approval for as many as seven of its programs. It'll also report data from five of its late-stage programs.
The catch is that nearly all the potential approvals and data readouts are for expanding the indications of medicines it already has on the market. In other words, there won't be many headlines about groundbreaking new drug launches, and the revenue it earns from the new indications is likely to be lower than the revenue from the original indications the medicines were approved to treat. After all, pharma companies formulate their pipeline strategies by advancing the programs they think will be the largest and most profitable markets first. Thus, approvals for follow-on indications are not major catalyst events, even if they can drive some sales growth.
While we all know that past performance doesn't predict future returns, strong historical performance does tend to give people more confidence when it comes to making an investment, so a good track record can also keep share prices up somewhat. Here, it's easy to see why someone might think that AbbVie might be worth paying a bit more for. Over the last 10 years, its total return of 322% trounced the market's return of 179%, and its trailing-12-month (TTM) diluted earnings per share (EPS) rose by 90% to reach $4.86. Humira was a key driver for that expansion, but moving forward, investors can't count on it.
Finally, it could also be the case that the market is incorrectly valuing the stock as a result of investors believing improbable narratives about growth. The higher the valuation, the more likely it is that hype is a major driver. But in AbbVie's case, its P/E multiple isn't unreasonably high. Plus, there's not exactly anything abnormally promising in the pipeline, nor is the popular narrative showing signs of frothiness.
Take a long-term perspective if you're interested in buying
So, AbbVie's valuation does indeed look to be a bit high on the basis of what it will probably accomplish over the next two or three years. Bargain-hunting investors should look elsewhere for a deal, as this stock isn't one right now. But there's a factor we haven't covered yet that's actually the piece that ties everything together: the dividend.
The company's dividend yields 4%. It has TTM free cash flow (FCF) of approximately $25 billion. Over the past five years, its payout climbed by 54%. It will have absolutely no problem with continuing to pay and increase its dividend for the foreseeable future, even as its top line shrinks a bit in the near term. It takes rock-solid financial stability for a business to do that, and such stability is exactly what's keeping AbbVie's valuation propped up as it enters a transitional period where old revenue sources are drying up, and new ones are coming online.
With so many programs in the pipeline approaching maturity -- whether they're expansions of a commercialized drug's indications or something new altogether -- there's little chance of AbbVie's fortunes falling into hard times. Therefore, if you're inclined to hold this stock for the long term to capture its dividend as well as its return to growth past the midpoint of the decade, it's not too pricey to touch whatsoever. The main challenge will be to ride out any turbulence from the likely downbeat earnings over the next couple of years.
