Abbott: A great company, but the stock price makes it unattractive
As a dividend growth investor, I am constantly on the lookout for additional opportunities to increase my current and future income stream. I analyze both businesses I own that may have become attractive, and new businesses it may be a good fit for my wallet. As the market volatility is higher now, I hope to find several long-term investment opportunities.
One of the biggest industries in my portfolio is the medical device industry. These companies tend to enjoy solid long-term growth and lower volatility than pharmaceutical companies. I own Becton Dickinson (BDX), Abbott Laboratories (NYSE:ABT) and Medtronic (MDT). Lately, Abbott has been in the headlines due to formula shortages due to its recall and plant closure.
I will analyze the company using my dividend growth stock analysis methodology. I use the same method to make it easier to compare analyzed stocks. I will examine the fundamentals, valuation, growth opportunities and risks of the business. I will then try to determine if it is a good investment.
According to Seeking Alpha’s business overview, Abbott Laboratories “discovers, develops, manufactures and sells healthcare products worldwide. It operates in four segments: established pharmaceuticals, diagnostics, nutritionals and medical devices”.
Over the past decade, revenues have increased dramatically. The company has tripled its sales in just ten years and the growth is both organic and inorganic. The company, for example, grew by acquiring St. Jude for $25 billion, and it also grew organically by moving quickly and offering Covid testing. Going forward, analyst consensus, as seen on Seeking Alpha, expects Abbott to continue to grow sales at an annual rate of around 1% over the medium term.
The company’s EPS (earnings per share) may seem a bit misleading. It appears that EPS has only increased by 40% over the past decade, which is significantly lower than sales growth. However, this is due to two main reasons: GAAP earnings differ significantly from non-GAAP results after the AbbVie spin-off, and the spin-off itself reduced the company’s EPS. Since the completion of the spin-off 9 years ago, non-GAAP EPS has increased by 280%. Going forward, analyst consensus, as seen on Seeking Alpha, expects Abbott to continue to grow EPS at an annual rate of around 2% over the medium term.
Abbott Laboratories is part of a very unique group of companies called the Dividend Kings. These companies have paid an increasing dividend for more than 50 consecutive years. Abbott pays a very safe dividend with a payout ratio of less than 42% using GAAP earnings and 33% using non-GAAP earnings. Investors should expect lower dividend increases over the next 2-3 years as the company is expected to grow EPS more slowly than average. The current entry yield is 1.64% and is in line with historical yield.
The number of shares outstanding over the past decade has increased by 11.5%. A decreasing number of shares outstanding is always an advantage as it supports EPS growth. Until 2017, the company systematically repurchased shares. It issued more shares in 2017 to fund the St. Jude acquisition, and since then buybacks have been limited and haven’t eaten up employee compensation. If the stock price becomes more attractive, additional buybacks would help.
The company’s P/E (price to earnings) ratio is in the same place as it was twelve months ago. In 2021, the company’s valuation has increased significantly. The highest P/E ratio in 2021 was close to 30, significantly higher than the current P/E ratio of 23. However, as the company is expected to show very little growth in the medium term, this valuation seems too high in my opinion. . .
The chart below from Fastgraphs highlights just how expensive Abbott still is. The company’s average P/E is 30, and the current one is 23. As the company is expected to suffer from declining EPS in 2022, the current valuation looks too high. I expect the company to trade even further below the average valuation, as this valuation historically corresponded to a much higher growth rate of 12%. At the current expected growth rate, I think a forward price/earnings ratio of 15-17 will be attractive.
In conclusion, Abbott benefits from extremely strong fundamentals which have led the company to become a dividend king. Consistent top line and earnings growth and dividend growth above inflation are essential. However, the company is not attractively valued at the moment despite the shares trading at a below average valuation.
Diversification and global presence are key opportunities. Abbott is a giant medical device company operating globally, with a broad product portfolio. This diversification allows the company to become a better allocator of capital. The company is not required to invest in a narrow market of a specific product line. Instead, he can constantly analyze the market and the portfolio and invest in the markets and products where the return will be the highest.
Another advantage of Abbott is the stable demand for its products. As a medical device company in the healthcare sector, it benefits from constant demands from its private and government customers. Even in a recession, people will continue to monitor their diabetes and hospitals will continue to use medical devices. Therefore, when the probability of a recession is higher, Abbott is a good solid company. During the 2008-2009 recession, Abbott saw its sales increase by nearly 4%, for example.
Diabetes Care is another significant opportunity for Abbott. Diabetes is a pandemic in the western world due to poor eating and exercise habits. Abbott offers extensive medical device solutions. This segment is growing rapidly and in the first quarter of 2022 grew by 26% with Abbott’s FreeStyle Libre device that monitors blood sugar surpassing the $1 billion mark in sales.
The first risk is the use of Covid tests. As more countries normalize their public health policy, the demand for testing will decline. The company saw a 35% increase in sales of its diagnostics business in the first quarter of 2022. It sold more than $3.3 billion worth of Covid tests in the last quarter alone. As these sales are likely to gradually disappear, this is one of the main reasons for the lack of medium-term growth.
The recall of infant formula is another risk because it increases uncertainty. Abbott sells the formula under the Similac brand and produces it in the United States for the US market. The recall, which took place in February when there were signs of contamination, will harm consumer confidence in the brand. Formula is a trustworthy product and it may take time for Abbott to regain market share.
The third risk is competition. The large reach of the business means that it has different competitors in different segments. Some of the biggest names are Medtronic, Becton Dickinson and Johnson & Johnson (JNJ). It is a competitive business and inflationary pressures can make it difficult to raise prices. In addition, in the infant formula sector, the company will have to face increasingly intense competition while rebuilding consumer confidence.
Abbott Laboratories is a great company. The company is not a dividend king by mistake. It has performed extremely well for decades, providing investors with ever-increasing sales and income. The company also increased its dividend by continuing to innovate and adapt its portfolio to the most current needs of the medical world.
However, there are risks to investing in Abbott. There is high uncertainty regarding the demand for Covid tests, and consumers may prefer other baby formulas once the market rebalances. With such high uncertainty, the company’s current valuation, given limited medium-term growth, is not attractive. I believe the company is on hold, and it will be in the buy zone if its P/E hits 15-17.