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Abbott Labs: Balancing Growth and Profits

Richard Saintvilus

NEW YORK ( TheStreet) -- It's now been two full quarters since healthcare conglomerate Abbott Laboratories effectively separated itself from its drug business -- spinning off that segment into a new entity called AbbVie .

The spin-off, which was originally announced in late 2011, was a long-anticipated move, for which Abbott investors cheered. It came with plenty of expectations that the remaining portion of Abbott, which consists of the devices business, would post stronger growth results. But since the separation took effect in January of this year, questions have been raised as to which of the two companies presents the better value.

Shares of AbbVie, which have soared more than 30% on the year, have been one of the best performers within the sector. Abbott, meanwhile, has posted gains of 16%. It's not a terrible performance, but the stock has lagged behind Johnson & Johnson and Medtronic . Although second-quarter earnings results were better than expected, I didn't see enough to buy shares of Abbott today with my own money.

As with the April quarter, revenue growth, which registered at just 2% year over year, was another struggle. Even when adjusting for currency exchange rates, which pushes Abbott's growth rate to 4%, the company still missed estimates. By contrast, it pales in comparison to Johnson & Johnson, which recently posted year-over-year growth of 10%.

As with Johnson & Johnson, which has come to rely heavily on its drugs business, it is Abbott's nutrition business, which now accounts for 31% of the company's revenue, that continues to do all of the heavily lifting. Nutrition was up 8% year-over year. It's starting to appear as if Abbott's international expansion plans are paying dividends.

Management said the strong performance was due to geographic development programs that it projected would have spurred these type of results. In that regard, investors should be encouraged that revenue in both pediatric and adult products are growing better-than-expected at a high-single-digit pace.

To what degree this performance can continue remains to be seen. But for now, I'm not willing to bet against management's plan to achieve 20% operating margin in nutrition over the next two years. Unfortunately, though, this is the extent of the positives that I could draw from the quarter. Outside of the 8% increase in the diagnostics business, I was disappointed by Abbott's performance in its other businesses.

The medical devices business, where Abbott competes head-on with Johnson & Johnson, continues to struggle, registering no growth whatsoever. By contrast, Johnson & Johnson posted 12% growth in devices. I'm not going to bore you with details here about Johnson & Johnson's organic vs. non-organic growth. I've already written about it at length. But suffice it to say, even on an organic basis, Johnson & Johnson's 2% growth still outperformed Abbott.

Here again, for Abbott, it's a familiar dance. While the company does show solid improvements and strong momentum in its nutrition business, it's hard to recommend the stock, especially when the devices business, Abbott's largest division, is posting mediocre results. Meanwhile, revenue in Established Pharmaceuticals, or what the company calls "branded generics," was down 2% (as reported).

I pointed out earlier that the nutrition business now accounts for 31% of Abbott's total revenue. While it's certainly a good thing that the nutrition business happens to be performing so well, from a diversification perspective, relying so heavily on one segment points to a potential weakness in the company's business.

I'm not suggestion that the growth in nutrition is due for an abrupt end. But it makes for some restless nights, especially since -- despite the strong growth -- gross margin still declines by almost 1% year over year. It still looks as if management is trying to sort out the remnants of the recent AbbVie separation.

To that end, I'm willing to give Abbott some more time. But until more progress is made and Abbott become more balanced, I don't see how this stock makes sense at this level.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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