Growth and Yield, at a Healthy Discount
01/19/2011 12:20 pm EST
Abbott doesn’t share its peers’ patent problems, and the unfounded competition worries ailing its stock present an opportunity, write Josh Peters and Damien Conover of Morningstar DividendInvestor.
Unlike many of its industry peers, Abbott Laboratories (NYSE: ABT) faces only a few patent losses over the next five years and is well positioned to ride a strong tailwind of demand for its products.
We continue to expect solid dividend increases in the next five years, and we find Abbott’s current yield of 3.7% highly attractive. The stock has an estimated fair value of $68 and should be bought up to $58. [Shares traded near $47 Tuesday—Editor.]
Taking advantage of many drug firms’ decision to leave primary-care indications like cardiovascular disease, Abbott is becoming a leader with several new drugs to treat heart disease. We believe the less competitive environment should bode well for Abbott.
Most important, we expect continued strong demand for the company’s leading drug, Humira. With drug penetration in rheumatoid arthritis reaching only 20% and even less in psoriasis and Crohn’s disease, Humira could grow at double-digit rates for the next four years. Abbott’s strong competitive position in nutritionals and diagnostics reduces the volatility of its earnings and creates additional avenues of growth.
A Dividend Aristocrat
Its stock may be out of favor, but it’s hard to find fault with Abbott’s performance. The dividend has grown at an annualized pace of 9.9% over the past five years, an improvement on the 7.7% rate from 2000 to 2005. Quarterly dividends have been ongoing since 1924, and annual payments have risen for 38 years straight. The current dividend is well supported by earnings; management estimates $4.16–$4.18 per share for 2010 excluding unusual items, putting this year’s payout ratio [the proportion of earnings paid out in dividends—Editor] at a comfortable 42%.
We expect total revenue to grow at a 6.2% average rate over the next five years, helped in large measure by a lack of expiring drug patents and continued growth across all major product lines (including the 42% of non-pharmaceutical sales).
We also forecast that modest improvement in operating margins and contributions from either acquisitions or share repurchases will result in a 9% average growth rate for earnings and dividends on a per-share basis.
In recent months, the stock market has become deeply concerned about Humira, Abbott’s top product. This treatment for autoimmune disorders (most prominently rheumatoid arthritis) is on track to generate 18.6% of total revenue in 2010. Demonstrating superior efficacy over a broad range of indications, Humira won’t lose patent protection until 2016; even then, biologics like Humira are not nearly as vulnerable to generic competition as other types of drugs.
The Threat from Pfizer
But in 2012, Humira may face competition from a drug Pfizer (NYSE: PFE) is developing. Pfizer’s JAK inhibitor works through different means toward similar ends; it is also a once-daily pill, rather than a twice-monthly injection.
We think the market is overestimating the threat posed by Pfizer, whose drug is still in Phase III trials and is unlikely to receive Food and Drug Administration approval until late 2011 at the earliest. Since trial results so far do not suggest greater efficacy or lower risks relative to Humira, we believe doctors will be reluctant to switch patients away from a therapy that is working even though the JAK inhibitor is a pill.
But even if Humira loses share after Pfizer’s drug hits the market, we think the market for anti-inflammatory treatments is underpenetrated and continues to offer all products significant long-term growth potential.
[Last month, Peters recommended another unpopular drug maker with a storied dividend history—Editor.]