Abbott Laboratories (ABT, Financial) is a diversified health care corporation. The company is a market cap of $66 billion. The company is truly globally diversified, generating nearly 70% of revenues internationally through the first three quarters of its fiscal 2014. The last time I analyzed Abbott Laboratories, I was impressed with the company’s strong 12% EPS growth in its most recent quarter. Find out what makes Abbott Laboratories a strong investment in part 41 of the Dividend Aristocrats In Focus series. Abbott Laboratories’ business operations are analyzed below.
Business overview
Abbott Laboratories operates in four primary segments: Nutrition, Diagnostics, Established Pharmaceuticals and Medical Devices. Each segment’s percentage of total revenue contributed through the first three quarters of fiscal 2014 is shown below to give an idea of the comparative size of each segment:
- Nutrition: 35% of revenue
- Diagnostics: 23% of revenue
- Established Pharmaceuticals : 15% of revenue
- Medical Devices: 27% of revenue
The Nutrition segment manufactures and markets Ensure, Pedialyte, Similac, Zone Perfect, Elecare and other health-oriented nutrition products for every stage of human life from being an infant to old age. The Nutrition segment is Abbott Laboratories’ largest, responsible for over 1/3 of total revenue.
The Diagnostics segment manufactures and sells various instruments, tests and diagnostic equipment to blood banks, laboratories and other health care facilities throughout the world.
Abott Laboratories’ Established Pharmaceutical segment is going through a transition. Abbott Laboratories announced it was selling its developed market pharmaceutical business to Mylan for $5.3 billion. The company recently completed the acquisition of CFR Pharmaceuticals for about $3.3 billion. CFR Pharmaceuticals is a Latin American pharmaceutical business. These moves restructure Abbott’s pharmaceutical division so it has significantly more exposure to quickly growing emerging markets.
The Medical Devices segment is Abbott’s second largest, generating 27% of total revenue so far this fiscal year. The segment manufactures and sells optical, vascular, and diabetes care devices and equipment to health care providers.
Competitive advantage
Abbott Laboratories is a diversified health care business. As a result, it has multiple competitive advantages. The company’s strong brand portfolio in its Nutrition segment has given it the leading worldwide market share in adult nutrition and the top market share in U.S. pediatric nutrition. Abbott has grown its brands over a long period of time. The company was founded in 1888 and continues to grow throughout the world.
In addition to its strong brands, Abbott Laboratories is one of the leaders in global health care. The company’s expertise in operating throughout the world has made it the leading pharmaceutical company in India, a Top 10 pharmaceutical company in Latin America, a Top 5 generic pharmaceutical company in Russia.
Abbott Laboratories' long history and global reach give it a unique competitive advantage that new entrants to the market cannot replicate. Abbott Laboratories has been building contacts, distribution and expertise in health care for more than 125 years. The company’s operational know-how is supplemented by its intellectual property portfolio, strong brands and global reach and scale.
Growth prospects
Abbott Laboratories has managed to grow revenue per share by about 6.5% since the spin-off of AbbVie (ABBV, Financial) on January 1, 2013. The company’s growth is being driven by an aging population in the developed world as well as rapid growth in emerging markets. Abbott Laboratories has positioned itself well to take advantage of growth in emerging markets.
The company grew emerging market sales 15% in the third quarter of fiscal 2014. Better yet, Abbott Laboratories currently generates 50% of sales in emerging markets. The company’s future growth is dependent on rising GDP in emerging markets. As consumers in these markets see increases in their income, they will continue to demand better health care products. Abbott Laboratories is situated to provide these health care products to consumers in emerging markets.
Going forward, I expect solid growth from Abbott Laboratories, of at least 6.5% a year, but likely higher as the company continues to gain ground in emerging markets though both organic growth and strategic acquisitions. I believe EPS growth of 8% to 12% per year over the next several years is the most likely outcome for Abbott Laboratories.
Dividend analysis
Abbott Laboratories has a current dividend yield of 2%. The company has a conservative payout ratio of 40% as well. Going forward, I expect Abbott Laboratories to grow its dividend payments by 8% to 12% a year, in line with expected EPS growth. If the company can grow EPS at 10% a year, it will have the following yields on cost in the future:
- Yield on cost in 3 years of 2.7%
- Yield on cost in 5 years of 3.2%
- Yield on cost in 10 years of 5.2%
Recession performance
Most health care companies performed well throughout the Great Recession of 2007 to 2009. It is much more difficult for consumers and health care professionals to cut back on health expenditures than it is to cut back on luxury spending like travel, for example. As a result, Abbott Laboratories grew EPS each year throughout the Great Recession. The company’s EPS from 2007 through 2009 are shown below to give an idea of how well the company performs during recessions:
- 2007 EPS of$2.84
- 2008 EPS of $3.03
- 2009 EPS of $3.72
Despite strong operating performance in recessions, Abbott’s stock price fell about 30% during the Great Recession. The underlying business’ growth through that time period hopefully gave shareholders the confidence to hold the stock despite temporary losses.
Valuation
Abbott Laboratories is trading at a P/E ratio of about 19.5 times expected 2014 EPS. The S&P 500 is trading at a P/E ratio of about 19.7. I believe Abbott Laboratories’ expected growth rate of 8% to 12% a year will greatly exceed the S&P 500’s growth rate going forward. In addition, Abbott Laboratories has a current dividend yield of about 2%, which is slightly greater than the S&P 500’s dividend yield of 1.9%.
Due to Abbott’s better expected growth rate, the company should trade at a premium to the S&P 500. Abbott Laboratories currently trades in line with the S&P 500’s P/E ratio. I believe that Abbott Laboratories is somewhat undervalued at this time relative to the S&P 500 due to the company’s strong competitive advantages and solid growth prospects.
Final thoughts
Abbott Laboratories ranks in the Top 20 based on The 8 Rules of Dividend Investing. The company’s solid expected growth rate, decent dividend yield, fairly low payout ratio and low price standard deviation of just 19.8% make it a solid investment going forward. The Dividend Aristocrats Index is full of health care companies. Abbott Laboratories is a Top 25 stock based on The 8 Rules of Dividend Investing, along with fellow health care businesses BDX, Johnson & Johnson, CR Bard, and Medtronic.
