Oh Abbott Labs (NYSE: ABT), how I want to love thee. Your P/E of 14.4 looks justifiable considering your double-digit growth, and your 3.6% dividend yield is just icing on the cake. Abbott would be a clear, no-question, sure-thing buy if it weren't for one issue.
The pink elephant
Abbott has a product line that's almost as diverse as Johnson & Johnson's (NYSE: JNJ) and certainly more varied than offerings from Eli Lilly (NYSE: LLY) and Bristol-Myers Squibb (NYSE: BMY). In addition to prescription drugs, the company sells a myriad of health-care products including medical devices like drug-eluting stents, diagnostic tests, and even a line of nutritional products.
But while Abbott may have breadth in its product offerings, the products don't offer enough depth to swamp out Abbott's top seller, the anti-inflammatory Humira. Stellar growth over the past few years has created a $5.5 billion monster that's handily beaten Johnson & Johnson and Merck's (NYSE: MRK) Remicade and Amgen (Nasdaq: AMGN) and Pfizer's (NYSE: PFE) Enbrel in the growth department.
|
Year-Over-Year Increase 2007 |
Year-Over-Year Increase 2008 |
Year-Over-Year Increase 2009 | |
|---|---|---|---|
|
Humira Sales |
49.9% |
47.6% |
21.4% |
Source: Company releases.
On one hand, the growth has been great news for the bottom line. But the company has become so dependent on Humira -- the drug made up nearly 18% of sales last year -- that the overall growth of the company lives and dies by how well the drug is doing.
Abbott's shares have suffered from the vulnerability. Investors know Humira can't keep growing forever and haven't been willing to give the company a premium valuation despite the stellar growth. A price-to-earnings ratio of 14 or so for a company that has grown net income by 12.8% annually over the past two years sounds about right, and I think investors are right to be cautious here.
Milking an elephant
While future growth may not be guaranteed, Humira is currently throwing off cash in every direction. Last year, Abbott produced $6.2 billion in free cash flow, and there's plenty more where that came from.
Abbott isn't hoarding the cash, though. In addition to returning some of it to shareholders in the form of a dividend, Abbott is reinvesting a lot of its cash flow, purchasing bolt-on acquisitions that should help decrease the dependence on Humira. Recent purchases of Facet Biotech, Evalve, and Visiogen are small enough that they shouldn't create any major integration issues.
Abbott did make one major purchase recently, grabbing Solvay's pharmaceuticals business for $6.6 billion, but that looks like a positive, though large, move. The companies were partners on cholesterol drugs Tricor and TriLipix; familiarity is usually a good sign that the acquiring company can accurately value the company it's acquiring.
Solvay will also help Abbott expand into emerging markets, which I'm not all that excited about. Trading growth in high-margin products for lower-margin sales doesn't sound like the best move to me.
Trust management?
Like many investments, Abbott's success will depend on management's running the company well. Peter Lynch's "any idiot" comment certainly doesn't apply here.
For Abbott to grow from here, the company must continue to milk Humira for all it's worth and then wisely use the cash to grow. So far management has done a fairly good job, but it’s a risk that investors need to keep in mind.
