Abbott Laboratories: A Mixed, Yet Expensive Bag
Contributor since 2011 / 23948 Followers
Summary:
- Abbott Laboratories is suffering from a reversal of pandemic trends and its own issues around pediatric nutrition.
- This creates a tough setup for 2023, as valuations remain demanding.
- While this dividend aristocrat has deleveraged a lot in recent years, overall Abbott Laboratories’ valuations still look a bit too demanding to me in a higher interest rate environment.
Tim Boyle
Back in 2017, I concluded that quality deserves a price in the case of Abbott Laboratories (NYSE:ABT), although I could not justify the prevailing premium price at the time.
Back in 2017, Abbott was showing decent organic growth, delivering on new product approvals, and benefiting from bolt-on dealmaking. The company is great at allocating capital, and runs a diverse set of operations, while it has successfully avoided the conglomerate discount.
Healthcare Giant
Abbott was, and still is, active in a wide range of areas within the healthcare industry. This includes Established Pharmaceuticals, Nutrition, Diagnostics and Medical Devices, creating a diversified long term growth play on the back of aging demographics over time.
The company had been doing some portfolio reshuffling at the time, as it was in the process of acquiring Alere, just after it had acquired cardiovascular device maker St. Jude Medical in a $30 billion deal, partly offset by some smaller divestments as well.
With the St. Jude deal impacting the results during 2017, we saw a business on track to generate $28 billion in sales, led by a $10 billion medical device segment following the St. Jude Medical purchase. This was complemented by a $7 billion nutrition business, a $5 billion diagnostics business, and an almost equally large pharmaceutical business.
In terms of earnings, the company was on track to post GAAP earnings of a dollar and adjusted earnings of around $2.50 per share. Most of the difference comes from amortization charges, as the recurrence of some of the other adjustments can be debated. Nonetheless, it was clear that realistic earnings came in at $2 per share, perhaps a bit more.
In terms of debt, the company reported $12.7 billion in net debt load, but this was ahead of an $8.7 billion underfunded pension liability and comes ahead of the pending closure of a $7 billion deal for Alere, creating a pro forma net debt load of $28 billion, in that case equal to nearly 4 times leverage.
The 1.75 billion shares supported earnings power around $2 per share, and with shares trading around the $50 mark, I found the valuation a bit rich at 25 times earnings, certainly given the steep net debt load as well. That said, there was potential as well following deleveraging efforts and realization of synergies, but as shares ran up 40% in a rather short time frame at the time, I urged a word of caution.
Quality Prevails (And The Pandemic Helps)
Since 2017, Abbott Laboratories shares have generally seen a steady move higher, hitting the $100 mark during the pandemic to peak around $140 late in 2021. Ever since, shares have lost some ground, that is, over the past one and a half year, with shares largely trading around the $100 mark, now trading at $108 and change.
Forwarding to early 2023, we saw Abbott post a mere 1% increase in 2022 sales, albeit that revenues of $43.7 billion were approximately 1.5 times as large as the pro forma revenue base in 2017. This was driven by growth across the board, particularly in diagnostics, the direct result of the pandemic driving demand for such services.
Amidst a stable share count of 1.76 billion shares, the company has grown adjusted earnings to $5.34 per share, having more than doubled since 2017, indicating real margin growth. In the light of these earnings, which of course included a Covid-19 boost to the diagnostics segment, the company guided for 2023 earnings (adjusted) to come in between $4.30-$4.50 per share, a rough dollar per share pullback in anticipated earnings from the 2022 performance.
The anticipated profit decline is due to a reversal of pandemic-related trends and lucrative diagnostics revenue streams, as the company is expected to be hit by self-inflicted issues around U.S. pediatric nutrition activities, with 2022 reported sales in this segment being down 19% to $3.5 billion.
Given this softer outlook, the company announced a bolt-on deal in February. The company has reached a $890 million deal to acquire Cardiovascular Systems, acquiring leadership capabilities of this company in atherectomy, a minimally invasive treatment used in treating peripheral and coronary artery disease. While the contribution is not meaningful to Abbott, it shows that the company is looking to expand the lineup of products in an effort to offset some of the organic weakness.
In April, the company reported an 18% fall in first quarter sales to $9.7 billion due to diagnostics sales essentially being cut in half to $2.7 billion, with a pandemic induced boom on its way back. Outside this impact, the company reported a healthy 10% organic increase in sales, driven by a resilient performance across all the board. Following a $1.03 per share adjusted earnings number for the first quarter, the company maintained the full year earnings guidance.
As of the end of the first quarter, the company has reduced its net debt position to about $14.8 billion, but this number includes a $7.4 billion post-employment obligations, a huge number, of course. With operating earnings (and adding back amortization charges) comfortably running above the $10 billion mark (at least in 2022), leverage is no issue at all anymore, providing sufficient financial firepower for additional M&A.
And Now?
The reality is that the midpoint of a $4.40 per share earnings number for 2023 excludes some cash adjustments, with Abbott Laboratories realistic earnings likely trending close to $4 per share. Even with debt being very much under control (as the company might even be underleveraged), the appeal in Abbott Laboratories shares is still hard to find.
After all, based on such earnings power, Abbott Laboratories trades around 27 times earnings. This is a huge multiple, even as leverage is low as higher interest rates raise the bar for all investments, even for the earnings yield of a reputable business like Abbott Laboratories.
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