Biotech Values

[DewDiligence]

Abbott Is Unloved and Undervalued

[This makes a good companion read with #msg-61383188 and #msg-59590951. I fully concur with the premise.]

http://online.barrons.com/article/SB50001424052970204536004576232754191857330.html

›APRIL 2, 2011
By MICHAEL SANTOLI

Abbott Laboratories is a decidedly above-average company trading at a below-average price, a health-care leader that consistently has rewarded shareholders' patience and taken good care of investors' capital over many decades.

At a recent price near 49, down from a 2010 peak above 53, Abbott (ticker: ABT) is among the more compelling values in a stock market being carried toward three-year highs by riskier, more cyclical names.

Abbott, with superior historical growth, a well-balanced revenue mix and powerful core health-care franchises, merits a substantial premium over pure pharmaceutical companies, which face regulatory pressures and patent expirations that will hurt key products.

Yet at 10.7 times forecast 2011 profits of $4.59 a share, up from $4.17 in 2010, Abbott's price/earnings ratio is only about 1½ multiple points above both Merck's (MRK) and Pfizer's (PFE), and about 1½ points lower than similarly balanced Johnson & Johnson's (JNJ). [Moreover, ABT has much better management than JNJ, IMO.]

The market is treating Abbott, whose revenue rose 14% last year, as if it is far more dependent on patented pharmaceuticals and a new-drug pipeline than it is.

Abbott has three main business groups.

What it calls its Proprietary Pharmaceuticals division, the typical patent-dependent drug business, made up a bit more than 40% of 2010's $35 billion in revenue, notes Chief Financial Officer Thomas Freyman.

That's the same proportion contributed by the Durable Growth Businesses. These include steady products, such as "established pharmaceuticals" (mainly branded generic drugs), core diagnostic and diabetes-screening items and a powerful nutritionals portfolio, featuring infant formulas, such as Similac, and adult nutritional drinks like Ensure. The nutritional products are valuable, substantially global and underappreciated. Mead Johnson Nutritionals (MJN), a pure-play competitor spun off from Bristol-Myers Squibb (BMY) in 2009, is a growth-stock favorite that commands a P/E of 22 times 2011 profits. Abbott's brass has resisted splitting off the nutritionals unit, believing that more transparency about its business mix and a push to get nutritionals' profit margins near Mead Johnson's should boost the stock's valuation.

Freyman says that the Durable Growth segment offers "sustainable annuities" that "can grow in the upper-single-digit [percentage] range."

Innovation-Driven Device Businesses contributed the final $5 billion of 2010 sales. It includes cardiac stents, in which Abbott is a leader [#msg-61503095], and other vascular instruments.

One factor that has hurt the stock: Investors' nervousness about the outlook for Abbott's most important proprietary drug, Humira. This $6.5 billion injectable pharmaceutical—good for nearly 20% of company revenue—treats rheumatoid arthritis and other inflammatory autoimmune conditions, such as Crohn's disease.

The immediate concern is the potential threat to Humira from tofacitinib, an oral drug for rheumatoid arthritis that Pfizer is developing and which probably will be cheaper and more convenient to take. Yet tofacitinib won't hit the market before late 2013, assuming further trials go well. Annual sales are forecast at about $1 billion by 2015.

Phil Nalbone, a Wedbush Securities analyst, notes that, even if the new drug hits the $1 billion target by 2015, it presumably would draw sales not just from Humira, but from rival drugs from J&J and Amgen (AMGN), too. Humira sales probably will have risen to $9 billion by then, he says, and the hit to Abbott's revenue probably would be about $300 million—out of a total likely to be above $50 billion in 2015. [This is not novel arithmetic—see #msg-59338771.] He sees the focus on Humira as overblown, and suggests "sentiment on Abbott's stock will improve throughout the year, as more is learned about the outlook for tofacitinib." His one-year target for the shares: $62.

A related concern is that Humira begins losing patent protection in 2016 [#msg-60342122]. By then, Abbott's new-product pipeline—including expected new approved uses for Humira and some two dozen new drugs slated to be in Phase II or Phase III clinical trials—will have to bear fruit. But the outlook is promising. Abbott's pipeline has mostly been in early stages in recent years, but several oncology, kidney treatments and others are rounding into shape.

Prospects abroad look good, too. Abbott's purchase last year of Solvay made it the leading branded-generics drug outfit in India [#msg-59590951]. Freyman likes to remind the Street that 25% of the drug maker's revenue now comes from emerging markets. Growing at a 15% annual pace, they could account for a third of the business in four or five years. The nutritionals business also has lots of room to grow in emerging markets, where Abbott sells formula for babies and nutritional beverages, such as Gain and Grow, that have become increasingly popular with older kids.

This year, the company will focus more on building cash than making acquisitions. Abbott boosted its dividend in February for the 39th straight year, to an annual $1.92 a share, taking its yield near 4%. Given that yield, plus Abbott's demonstrated ability to raise earnings at a low-double-digit clip, the stock should deliver upside of 25% or better over the next two years–even if it doesn't win the enhanced valuation it deserves.‹