Thesis Summary

AbbVie Inc. (ABBV) seems, on the surface, like an incredibly undervalued stock offering a 4.75% dividend yield with a payout ratio of under 50%. Upon further inspection though, it becomes clear that due to is dependence on HUMIRA, its best days may be behind it. Still, considering the dividend and growth prospects, I rate AbbVie a strong buy with a price target of $135 according to my 10-year DCF valuation.

Source: Siemens Digital Industries Software

Company Overview

ABBV is a pharmaceutical company operating worldwide. The company develops and commercializes drugs, of which HUMIRA is the most popular. In 2019, despite the loss of revenues internationally, HUMIRA still accounted for 58% of revenues. Some of their other popular products include SKYRIZI, IMBRUVICA, and VENCLEXTA. During the last few years, the company has experienced significant changes and price volatility. Below, we can see some selected financial data to gain some perspective of what’s been going on at ABBV:

Source: 10-K

Taking into account the latest data, revenues over the last 5 years have increased at a rate of around 10% CAGR. Earnings, on the other hand, have taken a different route. After peaking in 2016, EPS only recovered significantly in 2019 when the company achieved a $5.30/share. However, during this time, the company was capable of maintaining dividend growth.

As far as the balance sheet goes, we see some variation in assets over the years, though liabilities remain quite stable up until 2019. This is when AbbVie finally acquires Allergan, for around $60 billion, and we can see the effect of this merger reflected on the balance sheet as an increase in long-term debt and assets.

With a company like AbbVie, looking at past performance will not necessarily be a good indication of future returns. For one, the company has just undergone a huge change with the recent merger. But, more importantly, the company’s main earner, HUMIRA, is under threat in Europe and will soon suffer the same fate in the U.S. While the dividend looks very attractive and secure right now, we must take this into account when valuing AbbVie.

Dividend and Growth Prospects

Based purely on the numbers, it would be very hard to find a better dividend than this one. At today’s price, AbbVie offers a 4.75% yield with only a 45% payout ratio. The company has a good track record of growth, growing the dividend by around 20% over the last 5 years and the company has grown the dividend every year since its inception, which was in 2012. Furthermore, with such a low payout ratio, the company has been able to grow its dividend despite stagnating earnings, as we saw in the 2016-2018 period. However, the question remains; how will AbbVie sustain the dividend when HUMIRA is no longer under patent protection?

AbbVie has known this day will come for quite a while and has been preparing for this. The acquisition of Allergan is just the latest in a series of moves to increase its pipeline and product offerings. To understand the scale of the acquisition, bear in mind, Allergan had revenues of just over $16 billion in 2019. The company’s main product is Botox, for which AbbVie recently obtained FDA approval for a label expansion.

On top of this, AbbVie does have a set of drugs that are performing very well in terms of growth. In the last quarter, IMBRUVICA grew by around 20%. SKYRIZI grew by 39% and RINVOQ 160% vis-a-vis the last quarter. The company also has at least three new drugs in its pipeline; Novitoclax, ABBV-951, and Veliparib.

Source: Investor Presentation

Lastly, the company has announced a partnership with Genmab (GMAB) to develop cancer treatments and has also talked about entering the “corona race”. Through a partnership with Harbour BioMed, Utrecht University, and Erasmus Medical Center, the company is looking to develop an anti-body based treatment/cure for the disease.

Risks

The risks of investing in AbbVie are quite similar to those of investing in any other pharmaceutical company. Primarily, these are loss of market share due to the loss of patent and failure to bring a drug to market after investing a substantial amount of resources. So far, AbbVie has a good track record of bringing drugs to market. In their investor presentation, they cite 14 major approvals since 2013. As far as the first point goes, the company is in a very tough situation with HUMIRA. To put this into numbers, the patent ran out in 2018 in Europe. This led to a decrease in international revenues of 31.1%, which was offset by continued strength in the United States. With HUMIRA accounting for 58% of revenues, this could mean a significant drop in growth, especially when the patent runs out in 2023.

Given all of this, I have attempted to quantify the effects of both AbbVie’s growth initiatives and the increased competition HUMIRA will face arriving at a target price based on a 10-year DCF valuation.

Valuation

Given the strong growth of HUMIRA in the domestic market, I have assumed that it can maintain the growth of around 5% until 2023. At that point, I have estimated revenues from HUMIRA to drop by around 20% and remain somewhat flat. This will be partly offset by the launch of the three new drugs mentioned above. The growth for the rest of the other main products, IMBRUVICA, SKYRIZI, and RINVOQ, I have assumed will continue at similar rates and taper off starting around year five. Compared to consensus revenue and EPS estimates, I forecast sharper growth until 2023 followed by a sharper decline. I have also lowered the EBITDA margin down to 30% by 2026 at which point, it remains the same.

Source: finbox.com

Plugging this information into Finbox, we obtain the above results. Revenue CAGR for the next 10 years comes out to around 4.8% and we get an overall EBITDA margin of 40% for the period. At a discount rate of 8.5% and a Terminal Revenue Multiple of 6, this implies a target price of $135.15, which is a 36.1% upside.

Takeaway

The above valuation tries to quantify the impact of the impending HUMIRA patent expiry and other growth factors. However, this is incredibly hard to put into numbers, especially when it comes to the latter. I would say the above valuation errs on the side of caution as it assumes lower profitability and it implies that the company won’t be able to produce another hit like HUMIRA, which it well could. Even if this doesn’t happen, the company is so cheaply priced that the dividend remains incredibly attractive and sustainable. AbbVie is a strong buy in my book and I will be adding it to my portfolio.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ABBV over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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