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.
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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.