Why Did Abbott’s Stock Plummet Recently?
Over the last one month, Abbott’s (NYSE: ABT) stock has declined more than 10%. The market has been relatively benign during this period, with the mean daily return totalling 1.8% for NYSE index, -2% for S&P 500 and -1.8% for DJIA. We believe that the change in price reflects concerns regarding risk on account of upcoming deals with St. Jude and Alere. If these deals go through Abbott’s financial leverage will significantly increase. However, we believe the fundamentals of the company are strong given its diversified business and geographic presence. Abbott is a strong player in cardio-vascular devices segment. St. Jude’s acquisition would position Abbott in a leadership position in this market.
Our price estimate of $47.50 for Abbott is 14% above the current market price
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Abbott is set to acquire St. Jude Medical (subject to regulatory approvals) in a deal valued at about $25 billion. Further, the deal with Alere has gone to court and recently the two companies have agreed on mediation. It is being speculated that Abbott is dragging its feet and wants to back-out. The primary concern is that if both the deals go through, Abbott’s leverage will increase significantly which will imply higher risk. This would get reflected in the cost of capital of the company. Debt is cheaper than equity. But as leverage increase investors, creditors require higher returns to compensate for increased risk due to higher debt burden. The table below estimates the change in cost of equity in case the two deals go through:
The higher cost of equity reflects increased risk as debt increases. We have used CAPM for calculation of cost of equity and, have assumed risk free rate of 1.71% and market risk premium of about 4.86%.
Debt May Get Costly
There is speculation of the possibility of Federal Reserve increasing its target funds rate by the end of this year. If it happens, it will signal the end of an era of cheap liquidity. Furthermore, the credit rating agencies have expressed concern on the prospective deals with St. Jude and Alere and, have kept Abbott on negative watch-list. A rating downgrade in combination with a hike in interest rate would make debt costlier for Abbott. Also, as the rate hike becomes a reality, there would be a shift in investments from equities to debt instruments. In such a scenario, the equities that are being perceived riskier tend to see greater outflow.
Why We Are Not Changing Our Forecast?
We believe the fundamentals of Abbott are strong. The company has diversified sources revenue. The deal with St. Jude would bolster Abbott’s position in cardio-vascular segment. Abbott continues to launch strong innovative products in cardio segment, a recent example being bioresorbable stent Absorb. With acquisition of St. Jude Medical it will have a complete portfolio of products in this segment and position the company in the leadership position in a $30 billion market. Furthermore, there is no certainty that the Alere acquisition will close. The recent price decline is more of a short-term phenomenon.
See the links below for more information and analysis about Abbott:
- Why is Abbott acquiring St. Jude?
- What’s Abbott’s Fundamental Value Based On Expected 2016 Results?
- What is Abbott’s Revenue And Gross Profit Breakdown?
- How Has Abbott’s Revenue Mix Changed In The Last 5 Years?
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