Abbott Posts Broadly Positive Results, Currency Headwinds Notwithstanding

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ABT: Abbott Laboratories logo
ABT
Abbott Laboratories

Abbott Laboratories (NYSE:ABT) reported second-quarter sales of $5.2 billion, an increase of 2.2% as reported or 10.7% on an operational (constant currency) basis. [1]  Adjusting for both currency effects and acquisitions, sales were up by a respectable 6.4%. Results were broadly positive across its operating segments, though Diagnostics and Branded Generics led the way. Gross profitability was better than expected, due to improvements in Diagnostics and Nutrition.  The company’s focus on emerging markets continues to be a key driver. Sales from emerging markets in the quarter grew 20.6% on a constant currency basis; as reported, this metric was a still sizable 10.0%, though the 10.6 percentage-point impact of currency effects is indeed striking. This, of course, is the case for most U.S. companies with global operations.

In Abbott’s conference call with investors, [2] management shared a great deal of information about its operating segments. That said, a key focus of analysts on the call was management’s corporate development (i.e., M&A) initiatives.  Since separating from Abbott’s core pharmaceutical business, now the publicly traded AbbVie (NYSE:ABBV), the company has refined its focus on its four operating segments, selling its branded, developed markets generics business to Mylan (Nasdaq:MYL) and its animal pharmaceuticals business to Zoetis (NYSE:ZTS). Having thus narrowed its focus on its four key sizable businesses, the company is actively building out this foundation. As likely as a pending transaction may seem, however, management is clearly displaying discipline, all the more so given elevated valuations in the present deal environment.  Below we take a closer look at both the quarterly results and potential strategic activity.

We have a price estimate of $45 for Abbott Labs, which is at a discount of nearly 15% to the current market price.

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Nutrition Grows Globally, Though Key Markets Were Constraining

The Nutrition segment is Abbott’s largest business, accounting for 31% of its valuation (according to our estimates) and $1.7 billion in sales (32.7% of the total) in the second quarter.  Sales grew 3.9% in the second quarter on a constant currency basis, reflecting double-digit growth in China and Latin America that was offset by market disruptions in Vietnam (a sizable business for the company) and elsewhere.   Sales in the U.S. (42% of this global business) were essentially flat, due largely to competitive and market dynamics. The Nutrition business is founded on Adult and Pediatric products.  Key to the former sub-segment (44% of segment sales) is the Ensure potable dietary supplement marketed globally under various names worldwide; key to the latter sub-segment (56% of segment sales) is the Similac infant formula product line, also marketed globally under various names. The company is actively promoting the business with a focus on its global footprint, having invested last year in a large hub in China and recently launched new organic and non-GMO offerings.

Medical Diagnostics Delivered Growth Broadly Across Its Businesses

Accounting for 25% of the company’s valuation (per our estimates), the Medical Diagnotics segment generated $1.2 billion in revenue in the second quarter, an increase of 8.7% on a constant currency basis.  The Core Laboratory sub-segment (80% of segment sales) grew 8.4% year to year, driven by share gains in both the U.S. and abroad.  Abbott is top-ranked in the market for immuno-assay  and blood screening systems, and current growth is led by Russia and China. The Molecular Diagnostics sub-segment (10% of segment sales) also grew 8.4%, largely on the strength of infectious disease testing, which represents over half of the business. In turn, the Point of Care sub-segment (the remaining 10% of segment sales) grew 11.6% on a constant currency basis and 9.8% as reported. (U.S. sales account for over 80% of total segment sales) Typical of its offering is the new i-STAT handheld blood test system intended to detect early stage pregnancies in emergency medical situations. It has just received its U.S. FDA approval and is ready to go to market.

Medical Devices Results, Though Solid, Were More Mixed

The Medical Devices segment accounts for 24% of the company’s valuation, according to our estimates. This is divided between its Vascular offering (13% of the valuation) and its Diabetes offering (11% of the valuation). Segment sales increased 3.1% on a constant currency basis to $1.3 billion. Due to its global presence, however, reported revenue growth was a negative 6.1%. Vascular products, which account for 56% of segment sales, grew 3.2% on an operational (i.e., constant currency) basis, driven by the company’s MitraClip structural heart device. The Diabetes Care sub-segment (22% of segment sales) grew 5.3% year to year, benefiting from the launch of its FreeStyle Libre Flash glucose monitoring system in Europe. This innovative system replaces the pin-pick based alternatives diabetes patients currently use with a scanning based technology and has generated very strong demand. This is understandable given the invasive and painful nature of the present technology. In fact, it is capacity constrained, for the near term, anyway.  The company is awaiting U.S. FDA approval for the system as it ramps up added manufacturing capacity. Lastly, the Medical Optics sub-segment (22% of segment sales) was the relative laggard, posting 0.8% year-to-year growth on a constant currency basis in the quarter. On the face of pending product launches, market dynamics are an inhibitor of growth. Note, however, that the company is a leader in market for both lasik and cataract surgical systems. We thus expect improvement.

Established Pharmaceuticals Posts Robust Growth From Recent Acquisitions

Accounting for roughly 20% of our estimated valuation, Established Pharmaceuticals readily demonstrates the company’s proactive and dynamic strategies in managing its operating assets.  Sales in the quarter grew 46% year-on-year on a constant currency basis. Adjusting for both currency effects and acquisitions, sales grew by double digits.  The segment is effectively the stub of the sizable pharmaceutical business Abbott had prior to the spinoff of its core pharmaceutical business (now AbbVie) in 2012, when the company elected to focus on its generics business.  The company subsequently sold its major-market branded generics business to Mylan to focus on emerging markets. And in the past year, it acquired CFR Pharmaceuticals and Veropharm to extend penetration in Latin America and Russia, respectively.

With a Favorable Outlook, Abbott Mulling Opportunistic Acquisitions

Management reiterated its full-year guidance for high single digit constant currency revenue growth and earnings per share between $2.10 and $2.20. Profitability is expected to remain steady with a gross margin of 58% and R&D and SG&A at roughly 6.5% and 32% of revenues, respectively.  Guidance for the third quarter suggests a continuation of present conditions. On an operational basis, revenue is expected to grow at a low double digit rate, year to year, and earnings per share are expected to be $0.52 to $0.54.  The company has guided for gross margins of around 57% with R&D and SG&A at roughly the full year rates as a percentage of sales. In management’s responses to analysts queries in the earnings call (cited above), it is clear that upside in profitability is expected. However, the volatility in currency rates prevented any mid-year increase in guidance. Analysts are clearly focused as well on potential M&A activity, and management is actively assessing opportunities. Looking across its Pharmaceutical and Device segments, in particular, the potential for multiple tuck-in acquisitions is very high. The lack of recent activity on this front is a reflection of both management’s discipline and the high valuations commanded in the current deal environment.

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Notes:
  1. Abbott Earnings Release, Second Quarter 2015 []
  2. Available on the company website and Seeking Alpha []