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Abbott Laboratories (ABT)

Founded in 1888, Abbott Laboratories (ABT) is one of the world’s largest medical companies, with a portfolio of leading, science-based offerings in diagnostics, medical devices, nutritionals and branded generic pharmaceuticals. Abbott spun off its research-based pharmaceuticals business AbbVie (ABBV) in January 2013 and has four main business units today:

  • Medical Devices (38% of sales): devices to treat structural heart issues, such as stents, pacemakers, and implantable defibrillators, as well as products to monitor blood glucose levels.

  • Nutritional Products (26%): pediatric and adult nutritional formula such as Similac, Ensure, and Pedialyte. 

  • Diagnostic Products (21%): chemical systems to diagnose cancer, drug abuse, cardiac diseases, fertility issues, and infectious diseases, as well as therapeutic drug monitoring and instruments to automate and test DNA and RNA.

  • Established Pharmaceuticals (16%): branded generic drugs to treat a wide variety of conditions including: pain, fever, inflammation, migraines, dyslipidemia (high cholesterol), gynecological disorders, pancreatic insufficiency (diabetes), and hypertension (high blood pressure).

Abbott’s revenues are widely diversified across segments, and the company sells more than 10,000 different products. This creates very stable and predictable cash flow, far more secure than most standalone drug makers.

In addition to product diversification, Abbott’s business is truly global, with 65% of sales coming from outside the U.S. and 40% of revenue generated in faster-growing emerging markets where healthcare spending is outpacing the growth of GDP. 

Business Analysis

All of Abbott’s businesses have some unique competitive advantages. Roughly 50% of the company’s total sales are made directly to consumers, for example. These products primarily reside in the Abbott’s adult and pediatric nutrition segment and its branded generic drugs.

These businesses operate more like consumer packaged goods companies than traditional healthcare businesses in some ways. They benefit from Abbott’s decades’ worth of marketing spending to build up brand recognition, the company’s extensive investments in R&D to understand consumer preferences, and Abbott’s deep distribution relationships that help the company maintain prime shelf space where its products are sold.

With over 120 years of operational history, Abbott has acquired and reinforced dominant market share positions in many areas. Abbott is the world’s number one player in adult nutrition and is the U.S. leader in pediatric nutrition. The company’s 50 consumer nutrition brands are number one or number two in 25 countries.

Within branded generics, Abbott has leading positions in India, Russia, and several other Latin American countries. Abbott’s moat in this business is driven in part by the company operating in largely oligopolistic business segments. There are generally just three or four major players it must compete with in most markets, reducing pricing pressure.

In fact, Abbott’s generic drugs business is 100% focused in overseas markets. Since many of these markets have very weak distribution networks, the company has a big advantage courtesy of its strong relationships with local pharmacies and physicians.

Abbott’s strong brand recognition allows it to generate healthy margins, and because none of its drugs are patented, it doesn’t face patent expiration risk and the kind of ferocious competition that is a major concern for most patented drug makers.

The company’s medical devices and diagnostics businesses are a bit more challenging to maintain because they require heavier R&D investments to adapt to the industry’s faster pace of change. However, Abbott has still managed to hold leading market share in numerous key categories, such as LASIK, blood screening, cataract surgery, and amino-acid diagnostics.

New entrants have a hard time challenging Abbott because of the high amount of government regulation in these markets (e.g. pharmaceuticals, medical devices), the steep investment costs needed to develop competitive products (Abbott invests 6-7% of its revenue in R&D), the need for global distribution networks, and the protection provided by patents and trademarks.

Through organic reinvestment or bolt-on acquisitions, Abbott can quickly adapt to changing healthcare trends to remain relevant, plugging new products into its extensive distribution network.

Acquisitions have long played a role in Abbott's long-term growth strategy. The company's CEO Miles White, who has been with Abbott for more than 30 years, has made over 30 deals during his tenure. 

One of his best deals came in 2001 when Abbott paid close to $7 billion to acquire a division from chemical company BASF that included its treatment for rheumatoid arthritis. As you might have guessed, this blockbuster drug is now called Humira and has fueled much of AbbVie's success (spun off from Abbott in 2013). 

Most recently, Abbott made headlines with its 2017 acquisitions of St. Jude Medical for $25 billion (the company's largest deal ever) and Alere for $5.3 billion in 2017. 

St. Jude helped Abbott's medical device business achieve the same level of market leadership the company holds in its other businesses, providing Abbott with a slew of cardiovascular-related devices. Abbott now has a presence in nearly every aspect of cardiovascular care with #1 or #2 positions across numerous large and high-growth cardiovascular device markets. 

The deal also put Abbott into a new market – neuromodulation – with breakthrough products that can make a life-changing difference for people with chronic pain, as well as movement disorders, such as Parkinson’s disease. 

Alere was acquired to significantly advance Abbott's global diagnostics presence. The company significantly broadened Abbott's point-of-care testing business, making it the world's leading diagnostics player in this fast-growing market. 

Bulking up its scale and breadth of products makes Abbott a more attractive partner for cost-conscious hospitals and health care providers, who generally prefer dealing with a small number of large vendors.  

In addition to the company's competitive advantages, Abbott has done an excellent job leveraging its large size and global ingredient sourcing to generate strong economies of scale, resulting in steadily-improving margins across its most important segments.

In fact, thanks to its quality management team, ongoing efficiency gains and cost cutting (from streamlining distribution channels and lower cost manufacturing plants) have helped Abbott generate above average margins around 15%.

Over time, further margin improvement seems likely. Part of the continued improvement will be from the $500 million in St. Jude cost synergies that management thinks it can achieve over the next three years.

Beyond profitability improvements, Abbott’s growth runway appears very long, courtesy of the rapid aging of the global population.
Source: Abbott Investor Presentation
In addition, its strong presence in the world’s fastest growing economies, where healthcare spending remains far below the world norm, means that its diversified business lines should generate steady growth for decades.
Source: Abbott Investor Presentation
Despite Abbott’s numerous attractive qualities, income investors need to be aware of several risks.

Key Risks
Like all medical companies, Abbott Labs faces a few key risks.

First of all, while the company operates as one of the big four medical device makers (Stryker, Medtronic, and Johnson & Johnson), which limits competition and helps boost margins, each of its competitors is well capitalized and has an excellent track record of innovation over time.

In other words, if a rival comes out with a revolutionary new device, it can win market share very quickly and force Abbott to go back to the drawing boards to improve its own product offerings.

Due to concerns over rising costs, there is also risk that healthcare providers will move to multi-line contracts, meaning bulk purchases of medical equipment that their patients need.

Since Abbott’s medical prowess is mainly in cardiac and diabetes equipment, this could give it a competitive disadvantage. Even the St. Jude acquisition won’t help offset this risk much because that purchase was mainly designed to strengthen its cardiac device business (although it did add neuromodulation for pain control as well).

Another risk to consider is Abbott’s big bet on strong growth in emerging markets, which comes with periodic bouts of volatility. While it's true that the long-term outlook for healthcare spending in these regions seems very positive, economic growth and currency exchange rates can fluctuate significantly over the short term. 

Finally, in terms of company-specific risks, Abbott's acquisitive growth strategy needs to be discussed. The company's large deals to acquire St. Jude and Alere have stretched Abbott's balance sheet, will significantly affect its future, and have gotten off to somewhat rocky starts.

Soon after Abbott's acquisition offer in early 2016, Alere came under investigation for corrupt sales practices in international markets, as well as some accounting issues. Alere failed to file financial statements, had to recall a major product because it didn't work, and lost Medicare reimbursement. Abbott wanted to back out of its agreement to acquire the business but ultimately settled to complete the deal at a somewhat lower price. 

Meanwhile, St. Jude, the company's largest acquisition ever, received a safety warning from the Food and Drug Administration about its heart pacemaker devices, which connect to monitors and mobile devices over the internet. A voluntary recall was issued for 465,000 of its "smart" pacemakers to have them receive firmware updates to keep them safe from hackers. 

Simply put, large acquisitions such as St. Jude Medical and Alere create financial and execution-related risks. They represent major capital allocation bets, and management’s strategic rationale needs to be proven right.

Overall, many of Abbott’s key risks are balanced out thanks to the company’s cash flow diversification and numerous opportunities for long-term growth (i.e. the company isn’t overly dependent on any one thing to go right).

Each of Abbott’s four unique segments has different risks and growth opportunities, and the company’s geographical diversification reduces overall regulatory risk in any given market as well.

Closing Thoughts on Abbott Laboratories

Abbott has proven itself to be one of the best long-term dividend growth stocks over the years, which is backed up by the company's impressive track record of paying consecutive quarterly dividends since 1924. 

Management needs to deliver meaningful value from Abbott's major acquisitions of St. Jude and Alere, but the company deserves the benefit of the doubt for now. 

Overall, Abbott's shareholder-friendly corporate culture, improving profitability, and highly diversified business model appear to position the company nicely to take advantage of some of the next century’s largest secular trends (especially in emerging markets).

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