Abbott Earnings Preview: Nutritionals, Emerging Markets In Focus

Abbott Labs (NYSE:ABT) is scheduled to release its Q3 earnings on Wednesday, October 22. In the previous quarter, operational sales increased 3% over the prior year quarter to $5.55 billion, beating analysts’ estimates of $5.52 billion compiled by Thomson Reuters. Net income increased by 14.6% to $829 million or $0.54 per share, which was higher than the company’s own guidance of $0.50-$0.52 for the quarter. These earnings excluded charges for certain items such as amortization, cost-cutting measures and repatriation of ex-U.S. earnings, amounting to $369 million or $0.24 per share. In terms of business segments, the Diagnostics division outperformed others with year-over-year (y-o-y) operational sales growth of 5.5%, followed by Nutritionals (3%) and Established Pharmaceuticals (2.3%). Based on its performance in the second quarter, Abbott raised its full year 2014 EPS (earnings per share) guidance from $2.16-$2.26 to $2.19-$2.29. ^[1]

In the company’s third quarter earnings, we expect operational sales to grow in the mid-single digits, driven by continued growth in Diagnostics, improvement in Nutritionals and sustained low-single digit growth in Established Pharmaceuticals. In the beginning of the third quarter, Abbott entered into an agreement to sell its generic drug business in developed markets to Mylan in an all-stock deal. Consequently, the company will be reporting earnings from this business as discontinued operations in its Q3 financial report. The company’s management also stated in the previous earnings call that it expects adjusted gross margins to remain around 55% in the third quarter on account of its cost-cutting initiatives, improvements in Diagnostics and the diminishing impact of the supplier recall in Nutritionals.

We have a price estimate of $42 for Abbott Labs, which is in line with the current market price.

See our full analysis for Abbott Labs

International Sales To Drive Nutritionals

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. ^[2] Although no health issues were detected during later investigations, the recalls caused a significant disruption to the company’s sales in these countries. The company undertook several initiatives to turn around the business in the past couple of quarters, and they seem to be bearing fruit.

Global Pediatric Nutrition sales grew about 1% on a constant currency basis in the second quarter to $963 million, with about 60% of sales generated in international markets. In addition to the Similac Simple Pack launched late last year, Abbott introduced a new infant formula, Elova, in China in the last quarter. The sales disruption is estimated to have impacted the company’s international pediatric sales by $75 million in Q1 and by about $40 million in Q2 this year. We expect this to decline further in Q3 and help the business report robust sales growth.

In the adult nutrition business, we expect international markets to continue to drive top line growth. In the last year, sales have been driven by strong performance of the company’s flagship product Ensure and robust uptake in emerging markets such as India, China, Russia and Brazil. We expect the company to continue to do well in emerging markets in this quarter, and also expect the introduction of a new product, Enovo, to help improve sales in Japan, which is its largest adult nutrition market outside the U.S.

Established Pharmaceuticals Set For Growth

Established Pharmaceuticals sales have seen a low-to-mid single-digit decline in the last few years, owing to pricing pressure in developed markets such as Europe and Japan. The company announced several deals this year to streamline this business and focus on high-growth areas. In Q2 2014, sales grew 2.3% on a constant currency basis, driven by almost 10% growth in emerging markets, partially offset by a 4.7% decline in developed regions.

Abbott sold off the developed market assets of its generic drug business to Mylan in July. The deal, expected to close in the first quarter of 2015, is in line with the company’s strategy of focusing on emerging markets to revive growth in the business. By divesting its generic pharma business in established markets (which generated sales of about $2 billion in 2013), the company has re-positioned itself from a player in the low-margin, low-growth generic drug market in developed regions, to one focused on the high-growth opportunity in emerging markets such as India, China and Latin America.

Emerging Markets To Drive Sales

Emerging markets have delivered strong sales growth for Abbott in the last 18 months, barring a relatively subdued first quarter 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. ^[3] 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 as a result of the company’s focus on new products and the fact that the Nutritionals, Diagnostics and Established Pharmaceuticals businesses contribute more than 75% of the company’s overall sales.

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1. Abbott’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 16 2014 [↩]
2. China Asks Abbott to Recall Some Formula Products, WSJ, August 5, 2013 [↩]
3. Mapping China’s middle class, McKinsey & Company, June 2013 [↩]