Abbott Labs (NYSE:ABT) is scheduled to release its Q2 2014 earnings on Wednesday, July 16. In the previous quarter, sales declined by 2.5% year-over-year (y-o-y) to $5.24 billion, owing to sustained weakness in the Nutritionals and Established Pharmaceuticals (generic drugs) businesses as well as an unfavorable foreign exchange impact. The Diagnostics division was again the star performer for the healthcare major, as its operational sales increased almost 5% y-o-y to $1.12 billion, driven by double-digit growth of Core Laboratory sales in the U.S. and Molecular Diagnostics sales in international markets. Vascular and Medical Optics reported operational sales growth of 1% and 10%, respectively, while Diabetes Care sales declined about 10%. On the cost side, Abbott’s adjusted gross margin declined to 54% from 55.4% in the previous quarter. It was impacted by increasing competition, foreign exchange rates and the supplier recall in Nutritionals last year. 
In the company’s second quarter earnings, we expect operational sales to grow in the mid-single digits, driven by continued growth in Diagnostics and a marginal improvement in Nutritionals as well as Established Pharmaceuticals. Abbott’s management stated in the previous earnings call that the company expected adjusted gross margins to improve to about 54.5% in the second quarter of 2014 on account of its cost-cutting initiatives and diminishing impact of the supplier recall in Nutritionals. We expect gross margins to match company estimates.
We have a price estimate of $40 for Abbott Labs, which is in line with the current market price.
Nutritionals Expected To Improve
In August 2013, Abbott was asked by regulators in China, Vietnam and Saudi Arabia to recall some of its baby formula products on concerns that they contained bacteria that cause food poisoning.  Although no health issues were detected during later investigations, the recalls caused significant disruption to the company’s sales in these countries. The sales disruption is estimated to have impacted the company’s international pediatric sales by $75 million in the first quarter this year.
Another factor for weak growth in Nutritionals revenue last quarter was a decline in U.S. sales. This was because of Abbott’s exit from certain non-core business lines in the country to improve margins in the segment and a weak retail sentiment due to a harsh winter. Although international adult nutrition sales in Q1 2014 increased 12.4% on an operational basis over the prior year quarter, a 2.7% decline in the U.S. markets offset most of those gains.
Going forward, we expect the company to focus on expanding international sales further by introducing new products, especially in markets such as China, India and Japan. Abbott launched its flagship Similac infant formula product in enhanced packaging (Triple [ph] Pack) for the online market in China earlier this year and also introduced a new baby product, Eleva, in the country in April. We expect these new products to contribute to sales growth in the division this quarter.
Emerging Markets To Drive Sales
Emerging markets delivered strong sales growth for Abbott in 2013, but their performance was rather subdued in Q1 this year. This was because of a temporary plant shutdown which caused a supply shortage of some important generic drug products in the women’s health portfolio. It was also impacted by the supplier recall in nutritional products, initiated in August last year. As the temporary supply side issues are resolved, supported by the three new manufacturing facilities opened by the company, we expect sales from emerging markets to improve significantly going forward and drive overall growth.
Emerging markets such as China, India, Russia and Brazil continue to grow at a faster rate than most developed economies, and have a rapidly growing middle class population. McKinsey & Company predicts that the urban household income in China will double by 2022 and that the majority of its urban consumers will earn between $9,000 and $34,000 annually by that time.  As the middle class continues to grow in these markets, people are likely to increase their discretionary spending on nutritional products (such as food supplements) and point-of-care diagnostics. We expect Abbott to be one of the biggest beneficiaries of this rise in discretionary spending in the near future because of the company’s focus on innovating new products and the fact that the Nutritionals, Diagnostics and Established Pharmaceuticals businesses contribute more than 75% of the company’s overall sales.Notes: