AbbVie (ABBV) is one of only 50 Dividend Aristocrats. It is also one of the highest yielding Dividend Aristocrats thanks to its 4.0% dividend yield. The stock also has a modest valuation with a discounted forward price-to-earnings ratio of 10.0.
On paper, AbbVie stock looks like a screaming buy.
However, delving deeper into the company, it is clear why the stock is cheap with such a high dividend yield. AbbVie faces a unique set of risks going forward.
AbbVie stock could handsomely reward investors willing to absorb the risk moving forward. As the saying goes, high risk sometimes equals high reward. Still, investors need to know that AbbVie is one of the riskier Dividend Aristocrats.
AbbVie – Business Overview
AbbVie is a global pharmaceutical giant. It has a $94 billion market cap. It has 28,000 employees and operates in more than 170 countries across the world.
[drizzle]ABBV operates one main business segment—pharmaceuticals. It focuses on a few key treatment areas, which are immunology, oncology, and women’s health.
Many other Big Pharma stocks have diversified operations across pharmaceuticals, medical devices, and/or consumer health care products. But AbbVie is concentrated on pharmaceuticals.
This is a risk that other pharmaceutical companies have mitigated by diversifying their businesses across product categories. But AbbVie has gone “all-in” on pharmaceuticals. This has paid off thus far, with the success of Humira.
Put differently however, the pharmaceutical business is under intense scrutiny right now based on the issue of high drug prices. In addition, blockbuster drugs can lose patent protection, exposing pharmaceutical companies to the dreaded “patent cliff”.
AbbVie’s main risk going forward is that its most important drug, Humira, is losing patent protection. Humira will lose patent protection in the U.S. at the end of this year, and in Europe it will go off patent in 2018. This is a major risk for AbbVie shareholders because Humira itself represents 61% of the company’s total revenue.
Growth Prospects
Humira has been nothing short of a blockbuster for the company. Revenue from Humira increased 19% last year, to $14 billion. It is a drug used to treat a variety of conditions including rheumatoid arthritis, plaque psoriasis, Crohn’s disease, ulcerative colitis, and more.
The good news is that AbbVie management has a well-defined plan to replace lost Humira revenue with new products. AbbVie expects Humira will generate approximately $18 billion of revenue by 2020. Beyond 2020, the company expects to generate $25-$30 billion from its suite of new drug launches.
AbbVie’s future portfolio is focused on eight late-stage drugs which the company believes are low-risk assets.
Source: Source: Jefferies Healthcare Conference, page 5
In addition to internal research and development, AbbVie is turning to acquisitions to drive future growth. Last year, AbbVie acquired Pharmacyclics, Inc., a biopharmaceutical company that develops and commercializes new therapies for cancer patients.
This was a massive deal; AbbVie spent $20.8 billion to acquire Pharmacyclics. But the reason AbbVie was willing to do the deal is because it gave the company Pharmacyclics’ crown jewel drug, Imbruvica. Imbruvica is a highly effective treatment for hematologic malignancies.
The acquisition is already paying off. Revenue from Imbruvica soared 65% last quarter, versus the same quarter in 2015. To be sure, Imbruvica’s $437 million in quarterly revenue pales in comparison to Humira’s $2.6 billion. Still, the hope is that it will continue to grow at very high rates to soon eclipse $1 billion.
Competitive Advantages & Recession Performance
AbbVie’s main competitive advantage is its research and development. The company spends around $3 billion each year on R&D. This spending is crucial for pharmaceutical companies to continue innovating new therapies. Innovation is at the core of AbbVie’s corporate mission.
Source: Jefferies Healthcare Conference, page 3
For AbbVie, the task is even more important because the company is so reliant on Humira. If it is to continue increasing dividends to retain its Dividend Aristocrat status, its R&D spending needs to be effective.
Fortunately for shareholders, ABBV’s R&D is a source of strength for the company. It has increased its R&D spend in recent years to prepare for the loss of Humira. This spending is starting to show some promise, as AbbVie has a robust pipeline with dozens of new products over the next several years.
Source: 2016 R&D Day Presentation, page 8
As a result, AbbVie’s R&D is a competitive advantage.
One of the reasons why AbbVie has a heightened level of risk is because it lacks additional competitive advantages beyond its R&D. Once a drug loses patent protection, competition inevitably intensifies into that product category.
AbbVie cannot be evaluated on its recession performance, because the company was part of Abbott Laboratories (ABT) during the Great Recession. However, it stands to reason the company would hold up fairly well during a recession. Prescription drugs and medical supplies are things consumers cannot do without, even when money is tight.
Valuation & Expected Total Return
AbbVie faces significant risks going forward, but the trade-off is that investors willing to buy today are getting a good value. AbbVie stock trades for a price-to-earnings ratio of 15. This is much cheaper than the S&P 500 Index, which has a price-to-earnings ratio of 24.5.
The stock is even more attractive when evaluated by adjusted earnings-per-share, which excludes one-time items like acquisition and restructuring costs. It also adjusts for currency fluctuations. On this basis, AbbVie stock is valued at a price-to-earnings ratio of 12.
In addition, ABBV stock pays a 4.0% dividend yield.
As a result, if everything goes according to plan, shareholders could earn 12%-15% annualized returns, from earnings growth and the dividend yield. Any expansion of the price-to-earnings ratio would add to future returns.
However, in AbbVie’s case, these growth rates are not set in stone. A lot remains to be seen whether the company’s forecasts are attainable. It will all depend on how fierce the competition is once Humira goes off patent.
Final Thoughts
AbbVie has done an excellent job growing its dividend since it was spun off from Abbott. According to the company, AbbVie increased its dividend by 60% since 2013.
That being said, what matters is what happens going forward. AbbVie management has a difficult task ahead of it. With a cheap stock and a hefty 4.0% dividend, the potential rewards are compelling. Nevertheless, investors should prepare for a bumpy ride for this Dividend Aristocrat.
An a strictly quantitative basis, the company scores very well using The 8 Rules of Dividend Investing. Investors should understand the qualitative patent risks of AbbVie before investing, however.
Article by Bob Ciura
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