The last couple of months have been amazing for pharmaceutical companies as their stocks prices have zoomed higher by 20-30%. Abbott Labs (NYSE:ABT) also rose significantly to converge with our $67 price estimate as the company’s earnings topped expectations backed by Humira and Nutritions.
With the stock price hovering around our price estimate, we find it prudent to discuss Abbott’s business model and see what factors could trigger an upside to our current price estimate. One observation is that if the company is able to increase its revenues from AndroGel, Synagis and Other segment with stable pharmaceutical margins, the stock value could surge by about 25% from our current price estimate.
The company is in the process of splitting its business into two distinct companies to unlock value. Abbott Labs will have products focused on generic, nutritional, diagnostic and vascular products, and the other “Abbvie” will be focused on research-based proprietary pharmaceuticals such as Humira. Our current model does not reflect the planned split.
1. Revenue From AndroGel, Synagis and Other: Revenue includes Abbott’s broad line of adult and pediatric pharmaceuticals including Synagis (treatment for respiratory syncytial virus), AndroGel (for males with low testosterone), Lupron (prostate cancer treatment) and anesthesia products.
2. Pharmaceutical EBITDA Margins: This represents Abbott’s earnings before interest, taxes, depreciation and amortization (EBITDA) for pharmaceuticals (adjusted for R&D and one-time items), expressed as a percentage of the division’s revenue.
25% Upside Scenario | $83 Trefis Price Estimate
1. Higher Revenue From AndroGel, Synagis and Other (+15%):
Revenue From AndroGel, Synagis and other division was $9 billion in 2007 and soared to $11.5 billion in 2011. We expect that these revenues will steadily increase going forward and eventually approach $16 billion by the end of the Trefis forecast period. As the segment is the largest revenue contributor and constitutes more than 36% of our price estimate, even a small out-performance with respect to our expectations will have a huge impact on Abbott’s valuation.
Abbott is banking on its several recent acquisitions, which have brought with them a large portfolio of pharmaceutical products and expanded presence in the fast-growing emerging markets, to drive long-term growth. In 2010, Abbott completed many acquisitions, including that of Solvay Pharmaceuticals and Piramal Healthcare. This has allowed average annual growth in revenues of close to 20% in the past two years. We believe these acquisitions complement Abbott’s global presence and brand and allow the segment’s sales to reach $16 billion by the end of the Trefis forecast period.
We are, however, slightly cautious about the unfavorable currency movement (a strong U.S. Dollar) and have assumed growth to remain at mid-single digit. However, if the company manages to maintain growth in this division and reach $20 billion in revenues, this could translate into a share price of $76, an upside of nearly 15% to our current price estimate of $67.
2. Stable Pharmaceutical EBITDA Margins (+10%):
Abbott’s Pharmaceutical EBITDA margin increased to 48% in 2011 from 46% in 2007 mainly due to favorable foreign exchange impacts. We expect pharmaceutical EBITDA margins to decline through the end of the Trefis forecast period due to a number of factors. The company will see most of its popular drugs, including Humira, Tricor and Kaletra, lose patent protection in the next few years. Further, as the company focuses on price sensitive emerging markets and as austerity measures by governments across the globe and increasing competition from cheap generics forces the company to cut prices, margins could decline from current levels.
However, Abbott’s recent acquisitions should help it improve margins by reducing duplication of R&D, marketing and salary expenses and by generating larger volume discounts. Further, the company’s strategy to manufacture drugs in low-cost markets such as India and China should result in stable margins. If this could more than offset the pricing pressure Abbott is expected to face and the company is able to maintain current margins of 48% by the end of the Trefis forecast period, this will represent a 10% upside to the Trefis price estimate.
Combining the 15% upside from the higher revenue from AndroGel, Synagis and other and the 10% upside stable pharmaceutical margins, we arrive at 25% upside or a price estimate of $83 for Abbott.