Since its split from Abbott Laboratories in 2013, AbbVie (ABBV 0.01%) has been the third best-performing stock in terms of total returns on capital (assuming the dividend was reinvested) on the esteemed list of Dividend Kings. These special companies have raised their dividends for at least 50 years, and AbbVie inherited this status from its former parent company Abbott.
AbbVie's top-shelf performance has been due to two main factors. First up, the company successfully expanded Humira's label at a breakneck pace over this period, transforming it into the world's first pharma product to exceed $20 billion a year in sales.
Second, AbbVie stock has been highly prized among investors for its all-star dividend program. Since its split from Abbott, the drugmaker has raised its dividend at a compound annual growth rate of 11.94%. That's one of the fastest dividend growth rates within the entire group of Dividend Kings.
However, the company's decade-plus era of ultra-high growth has abruptly come to an end this year as a result of Humira biosimilars entering the U.S. market. Although management appears confident that this down period won't last more than two years, the biopharma should still consider a dividend reduction.
An undeniable trend
When analysts break down why a company may want to consider a dividend reduction, the argument usually centers around metrics such as free cash flow, the payout ratio, the debt-to-equity ratio, etc. And there's a case to be made for AbbVie slashing its dividend based on some of these key financial metrics.
Its payout ratio of 162.8% and long-term debt-to-equity ratio of 459.9% aren't exactly confidence-inspiring, after all. But there's another, lesser-known reason for AbbVie to consider taking such a drastic measure.
With a forward-looking annualized yield of 4.49%, AbbVie's dividend sits in a precarious spot from a risk premium standpoint. Specifically, Dividend Kings with yields greater than 3.8% all lost shareholders money over the prior 12 months. What's more, stocks on this list with yields greater than the S&P 500 average all failed to produce market-beating returns over this period. Peer-reviewed academic studies on the subject have generally attributed this phenomenon to the perceived risk premium associated with above-average dividend yields.
In short, AbbVie's yield, which is almost 3x higher than the S&P 500 average, doesn't bode well for its share-price appreciation prospects in the near term, especially with the company's top and bottom lines moving in the wrong direction. A dividend reduction would improve this situation and also allow the company to redirect capital toward value-creating activities such as deleveraging its balance sheet, business development, and/or accelerating the development of key pipeline candidates.
Final thoughts
Will AbbVie cut the dividend? It's highly unlikely.
The company seems intent on working through this Humira patent cliff in order to maintain its status as a world-class dividend stock. Management has also repeatedly expressed its confidence in the ability of newer immunology offerings, like Skyrizi and Rinvoq, to offset Humira's declining revenue in fairly short order. If that plan works out, a dividend cut won't prove necessary.
Investors, though, should bear in mind that AbbVie is attempting to do something very few pharma companies have been able to successfully achieve. History is replete with pharma companies that thought they had a solid succession plan in place for their flagship medication, only to get thrown off track by unexpected setbacks. Examples include AstraZeneca and Prilosec, Teva Pharmaceutical Industries and Copaxone, GSK and Advair, among many others.
Moreover, several big pharmas are angling to cut into AbbVie's immunology market share with novel compounds, such as TL1A therapeutics. AbbVie, with its deep experience and robust pipeline in the space, may be able to stave off these competitive threats, but it's far from a sure thing.
Until AbbVie definitively proves that its succession plan for Humira will pan out, its shares are probably going to lag behind the broader markets. A dividend cut won't change this fact but would provide additional capital to the company to ramp up its growth initiatives.