Since making the split from AbbVie (Nasdaq:ABBV), Abbott Labs (NYSE:ABT) has had something of a mixed debut. The stock has not only lagged AbbVie to a meaningful degree this year, but also other med-tech stocks like Medtronic (NYSE:MDT) and Johnson & Johnson (NYSE:JNJ). While some of this can be tied to concerns about the infant nutrition business, the fact remains that the new Abbott isn't as high-growth or high-margin as some investors want to believe, and management has their work cut out to improve performance. I do like the company's recent M&A moves to bulk up the device business, but this doesn't look like a particularly cheap stock today.
Decent Q2 Earnings With Improving Margins
One of the big items on the Abbott Labs to-do list is to drive better margins, and the company certainly made some progress this quarter. Even so, lower-than-expected growth in emerging markets is likely to linger as a concern, and the company's device business is looking quite soft at the moment.
Overall revenue rose more than 2% as reported, or about 4% on a constant currency basis, missing estimates slightly. Nutrition led the way in terms of growth (up more than 8% cc) and absolute dollars (31% of the total), but still missed the sell-side target by about 2%. OUS growth was a robust 17%, but slowdowns in emerging markets are a bit of a concern for the industry. 

SEE: Strategies For Quarterly Earnings Season

Abbott's other business were more mediocre. Diagnostics revenue was up almost 8%, but device revenue was virtually flat and branded generics (“Established Pharmaceuticals) revenue was down 2% as reported and barely up in constant currency terms.
Margins were more positive. Gross margin declined almost a point from the year-ago level, but were still about a half-point higher than expected. Likewise, adjusted operating income was only up about 4%, but the operating margin was about 30bp better than expected and the SG&A/revenue ratio declined 70bp from last year.
No Joy In Devices, And Probably Not Much On The Way Immediately
Given the earnings we've seen so far (and analyst expectations for those who haven't reported), Abbott's weak results in devices aren't a big surprise. Even so, barely positive revenue in vascular probably won't improve immediately, and the company is looking at serious, sustained competitive pressures from the likes of Medtronic and Boston Scientific (NYSE: BSX) in drug-eluting stents, Medtronic, BSX, JNJ, Covidien (NYSE:COV), and Bard (NYSE:BCR) in peripheral, and many of the above in structural heart.
Diabetes was more mixed. The slight decline in revenue was unimpressive on its own, but quite good compared to the significant decline at JNJ and the declines expected at Roche (Nasdaq:RHHBY) as Medicare changes its reimbursement policies for glucose testing.
Building A Better Business Will Take Time
Abbott has a very good nutrition business which, along with Mead Johnson (NYSE:MJN) dominates the U.S. market for infant and adult nutrition. The company is also looking to gain share in China, a huge market that is likely to account for more than half of global growth in the next five years. While China is already cracking down on the high price of formula in the country (and Abbott has already responded with a price cut), and companies like Mead Johnson, Nestle (Nasdaq:NSRGY), and Danone (Nasdaq:DANOY) are serious competitors, I like Abbott's chances for share growth, not to mention the under-appreciated potential of adult nutrition (Ensure), which only recently launched in China.
There's work to do elsewhere, though. The company recently made two promising acquisitions in the peripheral vascular and vision care spaces, but I think the company could use some additional growth-oriented business platforms. Along similar lines, Abbott could really stand to beef up its automation capabilities in the diagnostics space. It's also important for the company to improve margins, as the overall margin picture isn't all that great relative to its peer group.
The Bottom Line
I'm not as enamored with Abbott as some investors, but that's largely tied to what I see as incomplete platforms in devices and diagnostics that are likely going to require further M&A and/or management attention. The nutrition business will patch over a lot of holes, though, and the EPD business should be a good business on balance.
Even with an expectation of mid-teens free cash flow growth over the next decade, Abbott shares don't look like a particular bargain. There's certainly upside if Abbott's emerging market nutrition business grows faster than expected and/or if the device business improves its growth and/or margins faster than I expect. As is, though, I think $36 to $37 is a pretty fair price for the stock.

Disclosure - As of this writing, the author owns shares of Roche.

Related Articles
  1. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  2. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  3. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  4. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  7. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  8. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  9. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  10. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center