Abbott: Back Where We Were 12 Months Ago Is Not A Bad Place To Be

Investment Thesis

I last covered Abbott (NYSE:ABT), a globally recognized developer, marketer and seller of a range of different healthcare products, almost exactly one year ago, giving the company's stock a "Strong Buy" rating.

The headline story 12 months ago was COVID test kits - revenues in Abbott's Diagnostics division - 1 of 4, the others being Established Pharmaceutical Products, Nutritional Products, and Medical Devices - increased by 111% year-over-year in 2020, to $4.35bn, while management sounded extremely bullish about further growth in 2021, with CEO Robert Ford commenting:

I expect testing demand is still going to remain high even as the vaccines roll out. I don’t think we’ve even seen testing demand peak yet, so we’ve built a lot of capacity.

The company's forecasts for FY21 were equally bullish - GAAP EPS of $3.74, a 50% increase on GAAP EPS of $2.49 achieved in FY20 - and in the end Abbott beat this easily, reporting GAAP EPS of $3.94, for a PE ratio of ~30x.

COVID test revenues rose to $7.7bn in FY21 - up another 77% - but in FY22, the forecast is for GAAP EPS of $3.43 - and a forward PE of 35x - with COVID test revenues of just $2.5bn for the year.

That may help to explain why Abbott's share price - which rose as high as $141 in December 2021, has been falling in value, touching a low of $114 on March 11, before a mini-rally which has seen the stock price reach its current value of $120.

That's nearly the exact same price as one year ago when I published my note, and Abbott's market cap valuation is presently $211bn, vs. $213bn one year ago. Abbott was getting close to my price target of $162 in December, but the easing of pandemic pressures, reducing the demand for test kits, and management's more moderate FY22 guidance have dampened enthusiasm.

Furthermore, recent events - such as Abbott's voluntary recall of its powdered baby food brands Similac, Alimentum and EleCare manufactured at its Sturgis, Michigan facility, owing to cases of bacterial infection Cronobacter sakazakii, which have been linked to two infant mortalities, have not painted the company in a positive light.

Abbott is a massive company, however, generating revenues of $43.1bn in FY21, and driving growth across nearly all of its business lines last year, not just COVID test kits, as shown below:

Yes, by far the biggest jump - 95% - was within the Rapid Diagnostics segment, and in 2022 that division's revenues will likely be lower than they were in 2020 - but Abbott is a well organized, well-run company, whose share price has risen by 165% in the past five years, and investors should not abandon ship if the company fails to grow in 2022.

In all honesty, the price target I set last year of $162 may be out of reach in 2022, since revenues will almost certainly shrink year-on-year, and EPS is forecast to shrink, and after adjusting my discounted cash flow model accordingly, I believe a target in the mid $130's is probably more realistic.

With that said, however, nobody can foresee with genuine accuracy if the pandemic is truly at an end, or whether a new strain will emerge that will require ongoing mass testing.

Abbott management is monitoring the situation on a quarter by quarter basis, so we could see the $2.5 of forecast test kit revenue rapidly adjusted upward, and there is little prospect of it being adjusted downward, since most of it will be realised in Q122.

Abbott's business model has never been just about diagnostics, however - there is plenty more dynamism to be found at the heart of the company, to complement the steady, recurring revenue generation in lesser growth markets.

As such, investors can view the current stock price of $120 as a satisfactory entry point and be optimistic of making perhaps a 12%-15% gain in FY22, whilst the real value lies in holding onto the stock for four to five years, benefiting from a reasonably generous (and growing) dividend currently paying $0.47 per quarter, and yielding 1.6%, and also benefiting from some of Abbott's innovative and high growth business segments.

In the remainder of this article I will review performance across the four divisions in 2021, and highlight some bright spots of Abbott's business to keep an eye out for, besides diagnostics, which could still spring a major surprise in 2022 itself.

Surprisingly Strong Growth Under Pandemic Conditions

Abbott's annual top line revenue growth since 2017 is reasonably impressive, being +31%, +12%, +4%, +8.5%, and +24.5% last year in 2021.

Last year, the Established Pharmaceuticals Division earned $4.72bn, up 9.6%, and representing 11% of total revenues. Nutritionals revenues grew by 8.5%, to $8.3bn, representing ~19% of all revenues, Diagnostics grew by 45%, to $10.8bn, representing 36% of all revenues, and Medical Devices by 22%, to $11.8bn - ~33% of all revenues.

Established Pharmaceuticals At A Glance

Taking Established Pharmaceuticals first, as I discussed in my last note on Abbott, this division:

is primarily focused on sales in emerging markets, notably India, Russia, China and Brazil. Abbott's product lines are generic pharmaceuticals targeting gastroenterology, women's health, cardiovascular and metabolic conditions, pain and central nervous system ("CNS") disorders, and respiratory drugs and vaccines.

Interestingly, Abbott has one of the largest exposures to revenues from Russia, although it amounts to

As a healthcare company, we have an important purpose, which is why at this time we continue to serve people in all countries in which we operate who depend on us for essential products, some life sustaining.

Established Pharmaceuticals isn't a fast growth area of Abbott's business, but it's an essential one that makes a valuable contribution each year. Abbott doesn't specify the percentage of R&D and SG&A that's allocated to each division, or their net profit margins, but my suspicion would be this division offers a decent return on the smallest financial outlay across the divisions, with most products sold direct to wholesalers overseas.

Products include the likes of Creon, indicated for cystic fibrosis and chronic pancreatitis, Duspatal for irritable bowel syndrome, women's health products, focused on gynecological disorders and hormone replacement therapy for postmenopausal women, cardiovascular and metabolic products, pain and central nervous system directed products, and some vaccines, including influvac for influenza.

Established Pharmaceuticals may be Abbott's smallest division but is in fact an interesting area - witness the decisions of the big pharma's Pfizer (PFE) and Merck (MRK), to spin off their legacy asset businesses (and in Merck's case, its Women's Health division) into new companies.

Viatris (VTRS) now controls Pfizer's Upjohn legacy brands business, and has merged with generics giant Mylan, whilst Organon (OGN) is the Merck spinout. Both of these companies are arguably substantially undervalued (my bullish note comparing both is here) and may shake up the legacy brands business globally, looking to extract the maximum revenue from older drugs.

Although Viatris has already sold off the biosimilars element of the business, to Biocon, it has retained a sizeable stake, and I wonder if this field, with a total addressable market in the hundreds of billions, will be one in which Abbott could play a meaningful role in the future. I would keep an eye on this opportunity, which could make Established Pharmaceuticals more central to Abbott's overall business.

Nutrition At A Glance

Like Established Brands, Abbott's Nutrition division does much of the heavy lifting revenues-wise, without being an especially dynamic element of the company. Nevertheless, double digit percentage growth in US Pediatric and high teen percentage growth in International adult sales is impressive.

Missteps such as the product recall issues mentioned above are not going to help it maintain a positive reputation, but Abbott considers itself to be the global leader in nutrition, led by Ensure, its balanced nutrition brand for adults, Glucerna, its diabetes nutrition brand, and infant formula brand Similac, and that position is doubtless hard won.

Abbott shares little information about market dynamics in general and especially so when it comes to nutrition, but we do know that operating margins decreased from 23% in 2019, to 21.3% in 2021, and that management cites a slowing in China as its biggest concern in relation to this division.

Alongside the likes of Danone, Pfizer, Nestle, Baxter and a handful of others, Abbott is one of the industry's incumbents, and while there may not much to investors to take from recent performance, the uptrend in US Pediatric and International more than offsets losses in US adult and international pediatric, which can be taken as encouraging news - as pandemic headwinds ease, this division could drive stronger growth.

Diagnostics At A Glance

Clearly, diagnostics revenues look likely to fall in 2022, owing to falling demand for COVID testing, as discussed, and given growth in point of care and Molecular is somewhat stagnant, this division will likely be the biggest under-performer over the next 12 months.

With that said, demand for test kits could spike overnight depending on whether new variants are discovered, infections rise, new lockdowns are reintroduced, etc., and additionally, Abbott's Core Laboratory segment - substantially larger than point of care or molecular, driving $5.1bn of revenues vs.

Diagnostics is a very fluid industry in which notable breakthroughs are being made in areas such as genetic profiling (to detect susceptibility to disease), and oncological testing - such as the release of Galleri by Illumina (ILMN) / GRAIL, a blood test which detects 50 different cancers before they are symptomatic.

Illumina spent $8bn acquiring GRAIL - a company which it had developed in house, before spinning out (leading to some heavy criticism from regulators and investors alike), and when prompted by analysts on Abbott's Q421 earnings call about potential M&A in the diagnostics space, CEO Ford had the following to say:

If there's anything out there that looks strategic for us and that makes financial sense, then yes, we'll be -- we've got plenty of capacity, as you said. We've generated a lot of strong cash flow, and quite frankly, it's been a meaningful step-up in that cash flow over the last kind of 1.5 years or so. So yes, strategically, financial fits, as I've always said. We're in a great position now to be able to look at that.

This would be a good time to mention that Abbott reported a cash position of $11.1bn as of FY21, and its debt is rated as A+ by Standard & Poor's, and A2 by Moody's. According to its 10K statement:

payments required on long-term debt outstanding at Dec. 31, 2021, are $754 million in 2022, $2.3 billion in 2023, $1.2 billion in 2024, $1.5 billion in 2025, $3.0 billion in 2026 and $9.3 billion in 2027 and thereafter.

There's money available for acquisitions, then, although Ford suggested that "tuck in" and "medium sized" deals would be more likely.

Unlike its spinout AbbVie (ABBV), Abbott is a financially conservative company, and therefore it would be sensible for investors to consider the COVID test revenues explosion as a one-off - but that does not make the 13% growth ex-COVID test kit impact achieved last year any less impressive. To all intents and purposes diagnostics remains a strong division for Abbott.

Medical Devices At A Glance

Medical Devices - the second fastest growing of Abbott's four divisions in 2021, and COVID test revenues aside, the fastest, at 22% overall - is also where you will find arguably Abbott's most exciting product.

All of the medical device segments under Abbott's umbrella had praiseworthy years, and medical devices is clearly a key area of focus for the company - stroke prevention, cardiac monitoring, electrophysiology, etc., are all high growth markets that are beginning to be embraced by physicians as the marriage of technology and health is cemented by safer and better performing products.

The key growth driver is Libre Freestyle, however, Abbott's integrated continuous glucose monitoring ("iCGM") device, which drove a 33% year-on-year increase in revenues within the diabetes segment for the company.

Libre Freestyle helps diabetics monitor their glucose levels using an implanted device that communicates with an app, and if needed, an automated insulin pump, meaning diabetics are no longer required to use painful fingersticking procedures, or self-inject insulin.

It's breakthrough technology, and Abbott only has two serious rivals in the space in Medtronic (MDT), and Dexcom (DXCM). Crucially, Abbott's cheaper price point is helping to win the market share race, and sales of Freestyle Libre - now in its third iteration - grew by $1bn in FY21, to $3.7bn.

When quizzed about prospects for 2022 by analysts on the Q421 earnings call, CEO Ford suggested he expected similar growth this year - $1bn in sales, or ~25% sales uplift. For context, Dexcom (DXCM) reported revenues of $2.5bn in FY21, and has guided for ~$2.9bn in FY22, which, given Libre's lower price point of ~$2,300 per annum all in, versus Dexcom's $3,800, appears to suggest Libre is the market leader, whilst Dexcom has arguably the greater accuracy.

The reality is that iCGMs, or the so-called "artificial pancreas," remains an underserved market, with massive growth potential, and is perhaps the clearest example yet of how technology and healthcare can combine to deliver genuinely groundbreaking products.

Libre is a key asset to keep an eye on for any investor or prospective investor in Abbott - while much of the company's portfolio relies on recurring revenues and steady accumulation, and Abbott's position as an established market incumbent, Libre is an example of where Abbott is creating a genuinely new and innovative market.

Conclusion - Abbott Thrived In A Pandemic And Its Share Price Doubled, Then Sank - Expect Steady Accumulation in 2022 But Keep An Eye On Libre

As a company in the healthcare / technology / biotechnology space Abbott does not traditionally provide the stand out highlights that investors are on the lookout for, but is as well run as any consumer facing company, whilst maintaining solid relationships with physicians and health insurers, and occasionally introducing new and innovative products.

That has helped the company grow at twice the pace of the S&P 500, and flagship biotech and healthcare ETFs over the past five years, and the reason why the company found itself in the position of being able to become a major - perhaps the largest - supplier of COVID test kits over the past 18 months.

That unexpected source of revenue is likely to disappear gradually over the next 12 months if, as expected, the pandemic comes to an end, but what it arguably does from a valuation perspective is give Abbott a lower beta when it comes to determining a target share price for the company based on discounted cash flow analysis.

I set a price target of >$160 one year ago, and although Abbott came with $20 of meeting it, ultimately the company begins the second quarter of 2022 at more or less the same valuation as last year.

There will likely be a ~$5bn decline in COVID test revenues in 2022, and that will not be entirely offset by growth across other divisions, which are more focused on steady accumulation than explosive growth - especially Nutrition and Established Pharmaceuticals.

But within each growing division, there are notable opportunities, such as biosimilars, diagnostics M&A, and growth of Freestyle Libre. It's this nice balance of reliability and opportunism that has made Abbott recession proof and pandemic proof, and importantly, as good for its earning potential and profitability as the demand of the pandemic were for Abbott, the return of a BAU market may see revenues surge in other areas, thanks to the return of e.g. elective surgeries, reliable international infrastructure, and other factors.

There are unique challenges to face also in the form of e.g. dealings with Russia, manufacturing issues, intense competition, the need for innovation, but investors shouldn't be afraid of backing Abbott to succeed in this type of environment.

The company performed well for investors pre-pandemic, in the midst of the pandemic, and it will likely continue to be a solid stock in any investors' portfolio, although as explained, the share price gains are not going to be explosive in the short-to-medium term.