There is a remarkable amount of empirical evidence that suggests that stock spin-offs tend to outperform the market averages in the years following the spin-off. Interestingly, this trend is sometimes seen in both the parent company and the daughter company.
Seth Klarman: Investing Is Art First, Craft Second And Science Third
Source: Yahoo! Finance
Despite this remarkable run-up, AbbVie has not become overvalued thanks to strong underlying earnings growth. AbbVie looks like an attractive investment right now. The company (along with Abbott) was ranked as a top 10 stock using The 8 Rules of Dividend Investing in the most recent Sure Dividend Newsletter.
AbbVie has now been an independent entity for more than four years. This article will analyze the investment prospects of AbbVie in detail.
Since being spun-off from Abbott Laboratories, AbbVie operates in only one core segment – pharmaceuticals. This exposes AbbVie to more risk than some other healthcare companies, who often diversify into the medical devices or consumer health subsectors.
AbbVie is a leader in the pharmaceutical industry, with a market capitalization of $105 billion, ~28,000 employees, 21 research and manufacturing facilities around the globe, and products that treat 30 million patients in 170+ countries.
AbbVie targets five main sectors of the global pharmaceutical market: oncology, immunology, neuroscience, virology, and focused investments. These segments are outlined in more detail below.
Source: AbbVie Presentation at the J.P. Morgan Healthcare Conference, slide 5
AbbVie’s stock has outperformed the S&P 500 since its spin-off in 2013. The performance of AbbVie’s security has been driven by the performance of AbbVie’s business. Between 2013 and 2016, AbbVie grew its adjusted earnings-per-share from $3.14 to $4.82, which is an increase of 15.3% per year.
Source: AbbVie Presentation at the J.P. Morgan Healthcare Conference, slide 4
AbbVie is also a rewarding stock from a dividend perspective. While the current AbbVie has only existed since 2013, it benefits from the dividend history of its predecessor – Abbott Laboratories.
Because of this, both AbbVie and Abbott are included in the Dividend Aristocrats index – a group of companies with 25+ years of consecutive dividend increases.
Looking at the time period since the spin-off, AbbVie has grown its dividend by 60% – which is an impressive growth rate in such a short period of time.
Source: AbbVie Presentation at the J.P. Morgan Healthcare Conference, slide 14
Growth Prospects & Current Events
Right now, the eyes of most AbbVie investors are set on Humira. Humira is an AbbVie drug that treats the following conditions:
Source: Humira Website
Humira is not only AbbVie’s largest drug by sales, but it is also the highest-grossing drug in the world. AbbVie sold $16.1 billion of Humira in fiscal 2016, which contributed 63% to the company’s overall sales.
The reason why investors are concerned about Humira is because, like most pharmaceutical companies, AbbVie protects its drug portfolio with a web of patents. Humira’s patents began expiring at the end of 2016, and many of the patents that haven’t yet expired are being challenged in court.
With Humira’s patents expiring, investors are worried that the drug’s sales will decline due to competitive pressure from AbbVie’s peers.
Despite these Humira-related concerns, AbbVie seems well-poised to continue growth. In last year’s second quarter conference call, AbbVie’s CEO Richard Gonzalez said the company would ‘vigorously defend’ the intellectual property portfolio that protects Humira.
AbbVie management believes that Humira’s sales will actually grow over the next few years, from $16.1 billion in 2016 to greater than $18 billion in 2020. Further, the company has eight key near-term growth assets that are expected to deliver between $25 billion and $30 billion of sales by 2020.
These expectations, if realized, will benefit investors in two ways. First, AbbVie will still own today’s highest grossing drug and that drug will still be growing sales at a good clip. Secondly, the new revenue that will be introduced from the eight new growth assets will diversify AbbVie’s business model and reduce the company’s future reliance on Humira.
Source: AbbVie Presentation at the J.P. Morgan Healthcare Conference, slide 13
If the concerns surrounding Humira’s sales prove overblown (as management expects) investors will likely realize considerable upside. Even if AbbVie’s flagship drug experiences a moderate sales decrease, the company will likely still deliver strong performance as its other growth assets are brought to market.
Competitive Advantage & Recession Performance
AbbVie’s competitive advantage comes from its drug portfolio and the intellectual property that prevents its drugs from being copied by competitors. The perceived erosion of the intellectual property protecting Humira is the main reason why AbbVie presents such compelling value today.
AbbVie has an additional competitive advantage that comes from its impressive research & development budget. AbbVie’s R&D spend over the past 3 fiscal years is eye-popping:
- 2014: $3.3 billion
- 2015: $4.3 billion
- 2016: $4.4 billion
As a pharmaceutical company, AbbVie would be expected to perform exceptionally well during periods of economic recession. People will continue to purchase medicine regardless of the behavior of their local economy.
While AbbVie did not exist as a publicly-traded entity during the last recession, we can proxy AbbVie’s recession resiliency by investigating Abbott Labs’ performance during the financial crisis of 2008-2009. Abbott’s earnings-per-share trend during that period can be seen below.
- 2007 earnings-per-share of $2.84
- 2008 earnings-per-share of $3.03 (6.7% increase)
- 2009 earnings-per-share of $3.72 (22.8% increase)
- 2010 earnings-per-share of $4.17 (12.1% increase)
Abbott Labs increased its earnings-per-share during each year of the financial crisis. These increases were not small, either – Abbott’s earnings increased by a cumulative 46.8% during this time period.
I would expect AbbVie to be similarly recession-resistant.
Valuation & Expected Returns
AbbVie’s future shareholder returns will come from valuation changes, current dividend yield, and earnings-per-share growth.
AbbVie’s trailing twelve-months adjusted earnings-per-share is $4.82. AbbVie currently trades at $65.54, which is equivalent to a price-to-earnings ratio of 13.6 using adjusted earnings. AbbVie is expected to deliver $5.50 in 2017 earnings-per-share, which means the company trades at a very modest 11.9x forward price-to-earnings ratio.
The following diagram compares how AbbVie’s current valuation compares to its historical valuation. Valuation numbers from before AbbVie’s spin-off in 2013 were taken from Abbott Labs’ security.
Source: Value Line
AbbVie’s current price-to-earnings ratio is lower than any average annual price-to-earnings ratio since its spin-off, other than 2016. It is also lower than most of pre-spin-off Abbott’s valuations, but that makes sense because Abbott operates a much more diversified business model.
Comparisons aside, a 13.6x price-to-earnings ratio is much too low for a company with such strong growth prospects. AbbVie’s management expects growth of 14% per year moving forward. The only reason that AbbVie’s multiple is so low is because of the Humira fears. Any catalyst that proves these fears overblown will dramatically increase AbbVie’s price-to-earnings ratio. Thus, valuation changes will likely be a positive contributor to the total returns of current AbbVie shareholders.
Another contributor to shareholder returns is current dividend yield. AbbVie’s most recent quarterly dividend was in the amount of $0.64, which is good for an annual payout of $2.56. Today’s stock price of $65.54 means that current AbbVie investors benefit from a juicy 3.9% dividend yield – nearly twice the dividend yield of the S&P 500 Index.
The last contributor to AbbVie’s total returns is the company’s earnings-per-share growth. AbbVie has compounded earnings at 15% per year since the spin-off, and management expects 14% per year moving forward. We believe a range of 10%-12% is more likely and will still deliver strong shareholder returns. AbbVie’s earnings-per-share growth will be boosted by the company’s recently announced $5 billion share repurchase program, which is ~4.8% of the company’s current market capitalization.
With all this in mind, AbbVie has strong double-digit total return potential composed of:
- 3.9% dividend yield
- 10%-12% earnings-per-share growth
For expected total returns of 13.9%-15.9% before the effect of valuation changes (which may be considerable depending on the fate of Humira).
AbbVie presents a compelling value at today’s prices.
The company has grown its adjusted earnings-per-share at a rate of ~15% since the spin-off, and management is expecting growth of around 14% per year going forward.
Despite these rapid growth rates, AbbVie is trading at an adjusted price-to-earnings ratio of just 13.6 because of fears surrounding the Humira patent expirations. If these fears prove overblown (which I expect), AbbVie’s valuation will surge and today’s investors will be handsomely rewarded.
Quantitatively, AbbVie’s low price-to-earnings ratio, high dividend yield, and robust earnings-per-share growth make it a favorite of The 8 Rules of Dividend Investing. At today’s prices, Abbvie is a buy.
Article by Nicholas McCullum – Sure Dividend