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Humira Fears Likely Overblown; Strong Total Returns Ahead

- By Ben Reynolds

(Published by Nicholas McCullum on April 11)

There is a remarkable amount of empirical evidence that suggests that stock spinoffs tend to outperform the market averages in the years following the spinoff. Interestingly, this trend is sometimes seen in both the parent company and the daughter company.

In 2013, AbbVie (ABBV) was spun off from Abbott Laboratories (ABT). Since the spinoff, AbbVie has materially outperformed the broader stock market as measured by the Standard & Poor's 500 Index.

ABBV Performance Since Spin-Off

Source: Yahoo! Finance

Despite this remarkable run-up, AbbVie has not become overvalued thanks to strong underlying earnings growth. AbbVie looks like an attractive investment right now. The company (along with Abbott) was ranked as a top 10 stock using The 8 Rules of Dividend Investing in the most recent Sure Dividend Newsletter.

AbbVie has now been an independent entity for more than four years.

Business overview

Since being spun off from Abbott Laboratories, AbbVie operates in only one core segment - pharmaceuticals. This exposes AbbVie to more risk than some other health care companies, who often diversify into the medical devices or consumer health subsectors.

AbbVie is a leader in the pharmaceutical industry with a market capitalization of $105 billion, ~28,000 employees, 21 research and manufacturing facilities around the globe and products that treat 30 million patients in 170-plus countries.

AbbVie targets five main sectors of the global pharmaceutical market: oncology, immunology, neuroscience, virology and focused investments. These segments are outlined in more detail below.

ABBV Abbvie - An Innovation-Driven, Patien-Focused, Specialty Biopharmaceutical Company

Source: AbbVie Presentation at the J.P. Morgan Healthcare Conference, slide 5

AbbVie's stock has outperformed the S&P 500 since its spinoff in 2013. The performance of AbbVie's security has been driven by the performance of AbbVie's business. Between 2013 and 2016, AbbVie grew its adjusted earnings per share from $3.14 to $4.82, which is an increase of 15.3% per year.

ABBV Outstanding Track Record of Execution and Top-Tier Growth Prospects

Source: AbbVie Presentation at the JPMorgan Healthcare Conference, slide 4

AbbVie is also a rewarding stock from a dividend perspective. While the current AbbVie has only existed since 2013, it benefits from the dividend history of its predecessor - Abbott Laboratories.

Because of this, both AbbVie and Abbott are included in the Dividend Aristocrats index - a group of companies with 25-plus years of consecutive dividend increases.

You can see the list of all 51 Dividend Aristocrats here.

Looking at the time period since the spinoff, AbbVie has grown its dividend by 60%, which is an impressive growth rate in such a short period of time.

ABBV Abbvie Offers Both Compelling Growth and Strong Capital AllocationABBV Abbvie Offers Both Compelling Growth and Strong Capital Allocation

Source: AbbVie Presentation at the JPMorgan Healthcare Conference, slide 14

Growth prospects and current events

The eyes of most AbbVie investors are set on Humira, an AbbVie drug that treats the following conditions:

Humira Treatment Diseases

Source: Humira Website

Humira is not only AbbVie's largest drug by sales, but it is also the highest-grossing drug in the world. AbbVie sold $16.1 billion of Humira in fiscal 2016, which contributed 63% to the company's overall sales.

The reason investors are concerned about Humira is because, like most pharmaceutical companies, AbbVie protects its drug portfolio with a web of patents. Humira's patents began expiring at the end of 2016, and many of the patents that haven't yet expired are being challenged in court.

With Humira's patents expiring, investors are worried that the drug's sales will decline due to competitive pressure from AbbVie's peers.

Despite these Humira-related concerns, AbbVie seems well-poised to continue growth. In last year's second-quarter conference call, AbbVie CEO Richard Gonzalez said the company would "vigorously defend" the intellectual property portfolio that protects Humira.

AbbVie management believes that Humira's sales will actually grow over the next few years, from $16.1 billion in 2016 to greater than $18 billion in 2020. Further, the company has eight key near-term growth assets that are expected to deliver between $25 billion and $30 billion in sales by 2020.

These expectations, if realized, will benefit investors in two ways. First, AbbVie will still own today's highest-grossing drug and that drug will still be growing sales at a good clip. Second, the new revenue that will be introduced from the eight new growth assets will diversify AbbVie's business model and reduce the company's future reliance on Humira.

ABBV De-Risked Growth Assets Alone Position AbbVie for Substantial Growth Beyond 2020

Source: AbbVie Presentation at the JPMorgan Healthcare Conference, slide 13

If the concerns surrounding Humira's sales prove overblown (as management expects) investors will likely realize considerable upside. Even if AbbVie's flagship drug experiences a moderate sales decrease, the company will likely still deliver strong performance as its other growth assets are brought to market.

Competitive advantage and recession performance

AbbVie's competitive advantage comes from its drug portfolio and the intellectual property that prevents its drugs from being copied by competitors. The perceived erosion of the intellectual property protecting Humira is the main reason AbbVie presents such compelling value today.

AbbVie has an additional competitive advantage that comes from its impressive research and development budget. AbbVie's R&D spend over the past three fiscal years is eye-popping:

  • 2014: $3.3 billion.
  • 2015: $4.3 billion.
  • 2016: $4.4 billion.

As a pharmaceutical company, AbbVie would be expected to perform exceptionally well during periods of economic recession. People will continue to purchase medicine regardless of the behavior of their local economy.

While AbbVie did not exist as a publicly traded entity during the last recession, we can proxy AbbVie's recession resiliency by investigating Abbott Labs' performance during the financial crisis of 2008-2009. Abbott's earnings-per-share trend during that period can be seen below.

  • 2007 earnings per share of $2.84.
  • 2008 earnings per share of $3.03 (6.7% increase).
  • 2009 earnings per share of $3.72 (22.8% increase).
  • 2010 earnings per share of $4.17 (12.1% increase).

Abbott Labs increased its earnings per share during each year of the financial crisis. These increases were not small, either. Abbott's earnings increased by a cumulative 46.8% during this time period.

I would expect AbbVie to be similarly recession-resistant.

Valuation and expected returns

AbbVie's future shareholder returns will come from valuation changes, current dividend yield and earnings-per-share growth.

AbbVie's trailing 12-months adjusted earnings per share is $4.82. AbbVie trades at $65.54, which is equivalent to a price-earnings (P/E) ratio of 13.6 using adjusted earnings. AbbVie is expected to deliver $5.50 in 2017 earnings per share , which means the company trades at a very modest 11.9x forward P/E ratio.

The following diagram compares how AbbVie's current valuation compares to its historical valuation. Valuation numbers from before AbbVie's spinoff in 2013 were taken from Abbott Labs' security.

ABBV AbbVie Valuation Analysis

Source: Value Line

AbbVie's current P/E ratio is lower than any average annual P/E ratio since its spinoff, other than 2016. It is also lower than most of pre-spinoff Abbott's valuations, but that makes sense because Abbott operates a much more diversified business model.

Comparisons aside, a 13.6x P/E ratio is much too low for a company with such strong growth prospects. AbbVie's management expects growth of 14% per year moving forward. The only reason AbbVie's multiple is so low is because of the Humira fears. Any catalyst that proves these fears overblown will dramatically increase AbbVie's P/E ratio. Thus, valuation changes will likely be a positive contributor to the total returns of current AbbVie shareholders.

Another contributor to shareholder returns is current dividend yield. AbbVie's most recent quarterly dividend was in the amount of 64 cents, which is good for an annual payout of $2.56. Today's stock price of $65.54 means that current AbbVie investors benefit from a juicy 3.9% dividend yield - nearly twice the dividend yield of the S&P 500 Index.

The last contributor to AbbVie's total returns is the company's earnings-per-share growth. AbbVie has compounded earnings at 15% per year since the spinoff, and management expects 14% per year moving forward. A range of 10% to 12% is more likely and will still deliver strong shareholder returns. AbbVie's earnings-per-share growth will be boosted by the company's recently announced $5 billion share repurchase program, which is ~4.8% of the company's current market capitalization.

With all this in mind, AbbVie has strong double-digit total return potential composed of:

  • 3.9% dividend yield.
  • 10% to 12% earnings-per-share growth.

For expected total returns of 13.9% to 15.9% before the effect of valuation changes (which may be considerable depending on the fate of Humira).

Final thoughts

AbbVie presents a compelling value at today's prices.

The company has grown its adjusted earnings per share at a rate of ~15% since the spinoff, and management is expecting growth of around 14% per year going forward.

Despite these rapid growth rates, AbbVie is trading at an adjusted P/E ratio of just 13.6 because of fears surrounding the Humira patent expirations. If these fears prove overblown (which I expect), AbbVie's valuation will surge and today's investors will be handsomely rewarded.

Quantitatively, AbbVie's low P/E ratio, high dividend yield, and robust earnings-per-share growth make it a favorite of The 8 Rules of Dividend Investing. At today's prices, Abbvie is a buy.

Disclosure: I am long AbbVie.

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