The last couple of months have been impressive for pharmaceutical companies as stock prices have zoomed higher by 20-30%. Abbott Labs (NYSE:ABT) also rose significantly to exceed our $67 price estimate before slumping to $65 as many were disappointed with Humira’s sales in the third quarter. Also, the company recorded a decline in pharmaceutical margins, as expected.
Below we discuss Abbott’s business model and examine the stock’s dependence on Humira and pharmaceutical margins. One observation is that if the company sees a steep decline in Humira revenues as well as pharmaceutical margins, the stock value could decline by about 10% from our current price estimate.
1. Revenue From Humira: This is total worldwide sales of Abbott’s Humira, generic name adalimumab, which is the second best-selling drug in the world with revenues exceeding $8 billion globally in 2011. Humira is estimated to treat nearly 500,000 patients worldwide each year and is approved in more than 80 countries.
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.
10% Downside Scenario | $60 Trefis Price Estimate
1. Lower Revenue From Humira (-5%):
Revenues from Humira were $3.3 billion in 2007, which increased to $8.5 billion in 2011 due to the launch of Humira in five additional indications. New indications are new applications of a drug for an existing prevention, diagnosis or treatment of a disease.
While the drug has shown consistent double digit growth rates in the last couple of quarters, we expect revenues to increase slightly over the next two years to top $10 billion by 2013. Thereafter, we expect revenues to gradually decline as competition penetrates the market. Pfizer is getting ready with its oral drug tofacitinib while Roche recently reported better efficacy results for monotherapy RA patients. Recently, Belgium-based company Ablynx also claimed to show benefits over Humira. With this competition, we foresee a sharp decline in revenues by the end of Trefis forecast period post-U.S. patent expiry in December 2016 (including a year’s extension).
Between 2013 and 2016, we expect a gradual decline despite growing competition as it may be difficult to change a physician’s prescription habits for biologics. Also, the company is banking on expanding the drug’s base to new indications to overcome increasing competition from new entrants. However, if our belief is proved wrong and the company fails to get these approvals, it could limit the growth or even result in declining growth for Humira.
Consequently, revenues from Humira could decline to $3 billion by the end of our forecast period. This could translate in 5% downside to our current price estimate of $67 as the drug is the single largest revenue contributor and constitutes more than 13% of our price estimate. Hence, even a small under-performance with respect to our expectations will have a big impact on Abbott’s valuation.
2. Lower Pharmaceutical EBITDA Margins (-5%):
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 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 and the strategy to manufacture drugs in low-cost markets such as India and China should help it limit the decline.
However, as witnessed in the recent past, a strong U.S. dollar can put more strain on margins as many countries have seen a sharp depreciation in their currencies. Further, a continuance in European austerity measures could hurt margins more than we currently anticipate. If these factors abet the decline in margins and the margins drop below 40% by the end of Trefis forecast period (as against our expectations of close to 43%), this will represent a 5% downside to our price estimate.
Combining both scenarios, a 5% downside from lower revenue from Humira and a 5% downside from lower pharmaceutical margins, we arrive at 10% downside or a price estimate of $60 for Abbott.