Is Abbott Laboratories a Buy?
In the world of investing, sometimes boring is good. Diversified healthcare company Abbott Laboratories (NYSE: ABT) has been rewarding its shareholders with solid growth without the ups and downs that pharmaceutical stocks often deliver. Even though the stock is hitting new highs, is it a buy now?
Abbott Labs split into two companies at the beginning of 2013 when it spun off its research-based pharmaceutical business, which became AbbVie. The rationale for the division was that AbbVie's business would be high-risk and high-reward with high dividends, while Abbott Labs would be a diversified healthcare business not subject to the risks of bringing new drugs to market. The post-spinoff Abbott is a balanced company with four businesses that are all contributing well to the company's growth.
Four segments with steady underlying growth
The company's largest segment at 37% of 2018 revenue is medical devices, bolstered by the 2017 acquisition of St. Jude Medical and proving to be the company's strongest source of growth. Abbott Labs' broad portfolio includes pacemakers, implantable heart monitors, mini heart pumps, electrostimulators for the brain and spinal cord, stents, and blood glucose monitors. The segment produced 2018 sales growth of 9.1% on an organic basis -- in other words, excluding the effects of currency, acquisitions, and divestitures.
The diagnostics business delivered 25% of the company's revenue and had 6.7% organic growth. The acquisition of Alere in late 2017 added point-of-care diagnostic instruments, which provide results in minutes, to an existing product forming the core equipment of clinical laboratories.
Providing about 24% of revenue is the company's nutrition business. These are products like Similac infant formula, Ensure nutrition drink, and specialized products to sustain patients with conditions such as diabetes or who are recovering from surgery. Growth in this segment picked up last year thanks to strong sales in Asia and Latin America, with an organic sales increase of 5.2%.
Not all of Abbott's pharmaceutical business went with AbbVie in the split. The established pharmaceuticals business focuses on selling "branded generics" in emerging markets, where the demand for healthcare is expanding as the standard of living increases. This segment was 15% of Abbott's 2018 revenue with a healthy 7% organic growth.
What stands out about Abbott's business segments are the diversification and the balance. No one segment dominates the results, and there's no weak link. All businesses are contributing to growth and profits. Operating margins are consistent between the groups, ranging from 20% in established pharmaceuticals to 32% in medical devices.
Recent results
Put all those businesses together and you get a company that delivers consistent, although perhaps unspectacular, growth. In the most recent quarter, sales grew a muted 2% to $7.54 billion, held back by currency headwinds due to the fact that 63% of sales comes from outside the U.S. Organic sales growth, excluding currency exchange and a discontinued business, was a healthy 7.1%. Adjusted earnings per share, which include the effect of exchange rates, grew 6.8% to $0.63.
Looking forward, Abbott expects organic sales growth in 2019 of between 6.5% and 7.5% and adjusted earnings per share of between $3.15 and $3.25, which equates to 11% profit growth at the midpoint.
Growth prospects
Three of Abbott's product lines are boosting the company's growth now. FreeStyle Libre is the company's continuous glucose monitor that uses a small sensor about the size of two stacked quarters that is applied to the back of the upper arm, a big improvement over pricking a finger to draw blood. Worldwide sales last quarter grew over 40% to $380 million with a million and a half users, and the company is expanding its manufacturing capacity to meet demand. There's a second generation of the device being reviewed by the FDA and a third under development. Ultimately, sales of FreeStyle Libre could reach $5 billion annually.
Abbott's Alinity is a family of integrated, high-throughput systems for core laboratory diagnostics for blood chemistry and composition, cancer, drug use, and infectious diseases. The system is selling well in Europe and just rolling out in the U.S., with the full range of capability available by the end of the year. The core laboratory business had 10% sales growth last quarter, but that should expand further as Alinity gets traction, and the product line will have a long runway of growth.
The structural heart segment had 15% organic growth in Q1, largely because of MitraClip, an implant to repair leaky heart valves. That product is still in the early stages of adoption as well, with Abbott getting approval for new indications and expanding its sales force and clinical specialists to address an unmet need in minimally invasive mitral valve repair.
Abbott has a balance sheet and cash flow that would support growth through acquisitions. But when questioned about merger opportunities in recent quarters, Abbott officials have been clear that they haven't seen any appealing opportunities. Either valuations are too high or candidates don't fit their criteria, so the company has said flatly that acquisitions are not a high priority now. Instead, Abbott is focusing on retiring debt and improving organic growth, a direction that risk-averse investors should appreciate.
Dividends
Dividend yield isn't a big attraction for the stock, but dividend growth is a plus. Abbott pays a quarterly dividend of $0.32, which works out to an annual yield of 1.5%, not out of line with peers in the medical device industry. But Abbott is also a Dividend Aristocrat, having raised its payout for 47 consecutive years. Last year it boosted the dividend by a healthy 14%.
Risks and uncertainties
The attraction of Abbott stock for conservative investors is the steadiness and predictability of its business. Medical devices undergo clinical trials and are subject to FDA approvals, so there is always the risk of a failed trial or rejection of an application, but the stakes for each approval are much less than for a drug that's cost billions to develop. Abbott stock isn't likely to make big moves -- in either direction -- based on single events in its pipeline development.
The company is subject to competitive pressure, but that's where the company's balance and diversification are assets. With four consistently profitable segments of comparable size that are all contributing to growth, no one competitor can disrupt its business.
As with other companies in this industry, Abbott's business is mostly unaffected by economic cycles, making the stock attractive as a "defensive" holding.
Performance and valuation
Probably the biggest risk for Abbott shareholders is not a company-specific event, but that the entire industry gets marked down in a bear market or by worries over political threats to the healthcare industry. Abbott stock is vulnerable due to its relatively high valuation. Abbott sells for 29 times adjusted 2018 earnings and 26 times the midpoint of its guidance for adjusted earnings in 2019. That's quite pricey for a business that's delivering growth in the low double digits, and it's on the high end of the stock's historic range
Still, the market likes predictability and rewards companies that deliver it. The stock is up 16% this year after gaining 29% in 2018.
Expensive, but for a reason
Abbott Labs offers an attractive combination of predictable growth with lower risk than you'd typically find in the healthcare sector. The main reason an investor might hesitate to jump in is the valuation. The market has recognized the strengths of the business and has been willing to pay up for the shares. But the longer your investment time horizon is, the less relevant today's valuation will be. There are better values in healthcare, but for long-term investors, Abbott Labs is still a buy.
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Jim Crumly owns shares of AbbVie. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.