Abbott Laboratories: Tailwind From Healthcare Spending And Emerging Markets

 

Abbott Laboratories logo

I have been a shareholder in Abbott Laboratories (ABT) since the acquisition of St. Jude in 2016. I believe this is a very good stock to own for the long run, not because of the dividend, but because of the potential long-term returns. Furthermore, Abbott’s products are needed both in good and bad times. Below you find some very brief notes on why I’m long Abbott:

The business:

Abbott’s principal business is the discovery, development, manufacture and sale of a broad line of healthcare products. Abbott’s products are generally sold directly to retailers, wholesalers, hospitals, health care facilities, laboratories, physicians’ offices and government agencies throughout the world. The reportable segments are as follows:

  • Established Pharmaceutical Products: branded generic pharmaceutical products.
  • Nutritional Products: Adult and pediatric nutritional products.
  • Diagnostic Products: Diagnostic systems and tests for blood banks, hospitals, commercial laboratories and alternate-care testing sites.
  • Medical Devices: Electrophysiology, heart failure, vascular, structural heart, neuro-modulation and diabetes care products.

Revenue and operational earnings are divided like this between the segments:

Revenue % Operating earnings %
Established pharmaceutical products 14.09 10.90
Nutritional products 23.26 20.57
Diagnostic products 24.22 23.06
Medical devices 38.43 45.46

Abbott is an American company, but most of the sales are international (36%):

Sales 2019 %
USA 11 398 35.73
China 2 346 7.35
Germany 1 751 5.49
Japan 1 435 4.50
India 1 397 4.38
Switzerland 1 068 3.35
The Netherlands 975 3.06
All other countries 11 534 36.15

A strong dollar reduces income and revenue, while a weak dollar inflates the results. In the long run this is a factor I don’t consider at all, on the contrary, Mr. Market throws some nice opportunities because of currency swings. For example, back in 2016 Abbott fell due to the acquisition of St. Jude but also because of a weakening currency in Venezuela. This was the best entry in Abbott for a long time.

The market and its runway:

Healthcare is a sector that most likely will have a decent tailwind in the decades ahead:

Abbott Freestyle, tool for measuring blood sugar levels.
  • Obesity and diabetes are rising: Wrong diet and lack of exercise mean more and more people get a diabetes diagnosis. Even worse, many even have diabetes without knowing it. Up to 30% of the population in the US is estimated to have pre-diabetes, a “mild” form of diabetes that can be reversed by changing diet and/or starting to exercise (diabetes 2 is due to lifestyle – diabetes 1 is due to genetics). According to Abbott, 463 million people have diabetes globally, while it’s estimated to reach 700 million by 2045.
  • The average age increases, and Abbott estimates that “old” people over 65 years will double by 2030 on a global basis from today.
  • Emerging markets currently allocates about half to healthcare compared to developed nations. World Economic Forum estimates that one third of the future total global health expenditures will occur in emerging markets.

Moat:

Abbott has a huge brand, build since its founding back in 1888. Unlike many other healthcare companies, a huge part of sales are directly to the end-user/consumer, build up through brand recognition (a bit like “normal” consumer companies – like P&G for example).

  • Dominant market position.
  • Most brands are number one or two in most of their markets.
  • Few players in most of their markets, thus resembling an oligopoly. The biggest are Abbott, Stryker, Medtronic and Johnson & Johnson.
  • Many markets are highly regulated. For example, both the pharma and medical devices segments need government approvals for their products, thus leading to very high R&D in developing products. About 8% of sales go to R&D. Small companies have problems funding such investments, hence creating barriers of entry.
  • Distribution channels take years to develop and maintain.
  • Protection provided by patents and trademarks.

The dividend:

Many investors are long Abbott because of it’s reliable dividend. The dividend has been paid continuously for 96 years and increased 48 years in a row, but personally I believe the dividend is a distraction from the real focus which should be total return. You can always sell share to generate “income”, as I have explained in detail in this article.

The last dividend hike was 12.5%, the yearly dividend is 1.44 USD, the yield is 2.1% and a the payout ratio is about 40%.

Based on the business model, its diversified revenue streams, moat and low payout ratio, I believe the dividend is pretty “safe”. I write “safe” because a dividend is not a coupon and every investor should be cautious to depend on dividends to pay for expenses.

Management and inside ownership:

To align the interests between the management and the outside investors I normally prefer that the management is owner-operated. Abbott is no such company. All directors and executives own about 13 million shares, of which the retiring CEO, Miles White, owns and controls 5.3 million. This equals to 0.73% and 0.3% respectively. Miles White was the CEO from 1999 until end of 2019, and he is now being replaced from 1st of April 2020 by Robert Ford, an internal recruitment, which I prefer, who has worked in the company since 1996.

Risks:

A big part of the growth has been through acquisitions, both small and big. For example, over the last five years St. Jude (25 bn) and Alere (5 bn) were acquired, both pretty big acquisitions. M&A always involve risk because of potential misalignment between shareholders and management, clash of cultures or lack of expected synergies.

Because 70% of the revenue is in foreign currencies (non USD), a strong dollar is negative for earnings while a weak USD is positive. As of writing, the USD has strengthened against most currencies because the USD is the world’s reserve currency.

One other risk might be a bit peculiar for many readers: the fact that many shareholders own the stock for the dividend. This has the potential of attracting the wrong shareholders – the ones who have a tendency to think of the stock more like a bond – not equity. Benjamin Graham wrote in the Intelligent Investor that this might attract “ignorant coupon clippers – not business owners”. We can look no further than to the world’s biggest oil integrated, ExxonMobil (in XOM the BOD has continued rising the dividend at the risk of making the balance sheet fragile).

Abbott is not immune to a crisis. Long forgotten is that it had a major crisis back in the 1970s when a ban of some artificial sweeteners meant Abbott had to recall millions of bottles. No company is foolproof or immune for disruption.

Valuation:

GAAP EPS for 2019 is 2.1, indicating a TTM PE of about 30. The non-GAAP number, however, is higher at 3.1. Abbott uses mostly non-GAAP for reporting because it presumably resembles better the performance of the ongoing operations. Free cashflow is more or less on the same level as GAAP EPS. In other words, Abbott is not cheap, but it rarely is.

Conclusion:

Abbott is a company that never is a “sell” unless it’s extremely overvalued. I add on significant pullbacks. The revenue stream is fairly diversified in terms of both products and geography, Abbott has tailwind from increased healthcare spending, emerging markets are likely to grow faster than developed markets and Abbott can sustain weak economic conditions better than most companies. Overall, I believe Abbott can deliver about 10% over the next decade(s).

(This article was published 29th of March 2020.)

Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.  

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