Dividend Growth Stock of the Month for January 2021: AbbVie (ABBV)

AbbVie (ABBV) is one of the two “child” companies from the split-up of Abbott Laboratories (ABT) in 2013. AbbVie became the owner of all of the big-name drugs, including Humira, a blockbuster anti-inflammatory that formed the core of the new company.

At the time, Abbott’s CEO said that the split would enable investors to better value what had become two distinct divisions of Abbott with different product lines. It’s been six years, plenty of time to see how things have turned out. Let’s take a look.

AbbVie’s Dividend Record

AbbVie’s dividend record is very good, given the company’s short life-span. The company has a high yield and has raised the dividend every year since it was created.

Its dividend growth rate is trending down from very high levels, which is not a particular concern. The increase for 2021 – already announced – is a healthy 10.2%.

Simply Safe Dividends (SSD) awards a safety score of 50 out of 100 points, a grade that it calls “borderline safe.” SSD lowered ABBV’s safety score in 2019 from 61 (“safe”) to 50 (“borderline safe”) upon the announcement of AbbVie’s intent to acquire Allergan in an $80 billion deal. The main reason for the reduced score was the increased debt that would result from the acquisition. The acquisition was completed in May, 2020. SSD reaffirmed the score of 50 when the acquisition closed, and again in November, 2020, stating the following:

Humira will remain a major driver for the business, accounting for close to 40% of the combined company’s sales. Due to this exposure and the upcoming loss of exclusivity in the U.S. market, … analysts continue to expect AbbVie’s revenue to begin declining after 2022. Coupled with AbbVie’s elevated leverage and potential need to make more acquisitions, it’s especially important for the company to successfully integrate Allergan[,] continue ramping up new products, and defend existing cash cows such as Botox and Humira as long as possible.

I classify AbbVie as a high-yield, fast-growth stock. The fact that AbbVie just raised its dividend by 10.2%, months after closing the Allergan deal, seems like a good sign that it will remain a strong dividend grower.

You may have noted in the table above that AbbVie is a Dividend Aristocrat (signaling 25+ years of dividend increases), even though it has only existed just under eight years. This is a judgement call by S&P, which maintains the Aristocrat list. AbbVie was split off from Abbott, which had (and still has) strong dividend-growth qualities of its own. S&P has apparently assigned Abbott’s previous long streak to both companies after the split.

AbbVie’s Business Model and Company Quality

ABBV is a global biopharmaceutical company. Its therapeutic areas of focus are immunology, oncology, neuroscience, eye care, virology, women’s health, and gastroenterology. In addition, it has an aesthetics portfolio (Botox) that came along as part of its acquisition of Allergan.

AbbVie’s results have been driven for years by the overwhelming success of a single drug, Humira, which treats rheumatoid arthritis and other immune-system disorders.

The company is losing patent protections on that drug.

That is what led to the acquisition of Allergan.

Humira accounted for over 55% of sales, and an even greater share of profits, in 2019.

It loses exclusivity in the U.S. in 2023.

The Allergan acquisition caused a spike in ABBV’s debt levels.

Management reaffirmed its commitment to the current dividend and plans to deleverage aggressively in the years ahead. As a result of the elevated leverage, S&P downgraded ABBV’s credit rating to BBB+, which is a low investment-grade rating. Management’s goal is to pay down $15-18 billion of debt by the end of 2021, with further deleveraging through 2023.

Fortunately, AbbVie’s high-margin business should continue generating excellent cash flow to support its deleveraging goals while continuing to cover its dividend.

AbbVie’s growth strategy is to continue to develop drugs in the immune-deficiency area. Two drugs already on the market – Rinvoq and Skyrizi – have had promising early success.

Most of AbbVie/Allergan’s product portfolio have shown defensive qualities in the pandemic, but Allergan also derives about a third of its revenue from its aesthetics business (e.g. Botox plastic surgery). The company’s belief is that the aesthetics portfolio will recover strongly from the slowdown caused by Covid-19.

Humira will remain a major driver for the business, accounting for close to 40% of the combined company’s sales. With the upcoming loss of exclusivity in the U.S. market, analysts expect ABBV’s revenue will begin declining after 2022.

AbbVie’s Financials

AbbVie gets an “A” financial grade from Value Line, which is their third-highest grade. Let’s look at specific financial categories and see if we agree.

Revenue, of course, is where all financials start for a company. AbbVie’s revenues show the impact of the addition of Allergan in 2020, taking a significant jump. The company’s revenues were growing steadily even prior to the acquisition.

(Source of all graphics in this section: Simply Safe Dividends)

As mentioned earlier, analysts expect revenue growth to reverse in 2023, after patent protections for Humira expire in the USA. AbbVie works continually to get Humira approved for more indications, in order to extend its profitable life.

Return on Equity (ROE) is a standard measure of financial efficiency. ROE is the ratio of profits to shareholders’ equity.

The average ROE for all Dividend Champions, Challengers, and Contenders is about 15%, which is similar to the ROE for S&P 500 companies generally.

For AbbVie, there is a lot of noise in the data, with extreme highs and lows, which I attribute to accounting idiosyncrasies from year to year. For that reason, I do not attach much significance to this particular metric for this company.

Debt-to-Capital (D/C) ratio measures how much a company depends on borrowed money. Companies finance their operations through a mixture of debt, equity (new shares), and their own cash flows.

A typical D/C ratio for a large, healthy company is 50%, meaning equal dependence on debt and equity. Debt is an indicator of financial risk. All else equal, stocks with high D/C ratios are riskier than those with low D/C ratios.

AbbVie’s use of debt has been high since its creation, with its D/C ratio running over 80%. That helps account for its low investment-grade credit rating as well as its mid-grade dividend safety score.

Operating margin measures profitability: What percentage of revenue is turned into profit after subtracting cost of goods sold and operating expenses?

Per recent research, typical operating margins for S&P 500 companies have been in the 11-12% range. AbbVie’s results are much higher, with margins in the 30%-plus range.

Earnings per Share (EPS) is the company’s officially reported profits per share. We want to see if a company has had years when it officially lost money, or if its earnings are steadily increasing, declining, or flat.

AbbVie has been profitable since its creation, with an obvious trend of earnings growth, including forecasts into next year.

Free Cash Flow (FCF) is the money left over after a company pays its operating expenses and capital expenditures. Whereas EPS is subject to GAAP accounting rules, which shift money around (as with depreciation rules pertaining to capital equipment, for example), cash flow is a more direct measure of money flowing through the company on a real-time basis. FCF is the cash that a company has available for dividends, stock buybacks, and debt repayment.

AbbVie has been a cash-generating machine. That, of course, has helped it attain its fast dividend growth over the past few years.

Share Count Trend shows whether the company’s outstanding shares are increasing in number, decreasing, or remaining flat.

I like declining share counts, because the annual dividend pool is spread across fewer shares each year. By retiring its own shares, the company is investing in itself, expanding each remaining share into a larger piece of the pie, and improving all of the per-share statistics.

AbbVie’s share count has been slowly declining for several years until 2020, when we see an 8% jump in shares associated with the Allergan acquisition, bringing the share count about back to where it was when the company was created.

Here is a summary of the items above:

I think Value Line has it about right, perhaps a bit generous, with its A grade (two from their top level). I note that they rate AbbVie as 9th among 11 total peer companies on financial strength.

AbbVie presents a varied record across its financials. Some categories (profitability, earnings, and cashflow) are excellent, while its debt situation is not good at all, and its future gets cloudy a couple of years out due to the patent expirations on Humira and the uncertainty about the company’s ability to replace the revenue they will probably lose when that happens.

AbbVie’s Stock Valuation

I use four models in valuing companies, then average the results. See Dividend Growth Investing Lesson 11: Valuation.

Models 1 and 2: FASTGraphs relative P/Es

These two models compare the stock’s current price to (1) FASTGraphs’ basic estimate of its fair value, and (2) the stock’s own 5-year average valuation.

The orange line is Model #1, FASTGraph’s default valuation line based on a standard price-to-earnings ratio. Usually that is 15, but with ABBV it has been set to 19.4 to reflect ABBV’s fast growth. The blue line is Model #2, based on ABBV’s own average 5-year P/E, which is 13.9.

The black line is ABBV’s actual price. The right end of the line, most recent price, represents its current valuation, which is 10.4. Just from simple observation, we can tell that ABBV’s valuation is below both the blue and orange reference lines.

To put numbers on those observations, I compute valuation ratios, which are the ratios of the actual price to the fair price references. Here is the formula:

Valuation Ratio for FASTGraphs = Actual P/E divided by Reference P/E

Here are the valuation ratios for ABBV.

  • Model 1: Based on default (orange) line: 10.4 / 19.4 = 0.54
  • Model 2: Based on historical (blue) line: 10.4 / 13.9 = 0.75

Both of these results are extreme, especially the first one. I sometimes place a “cap” over or under extreme valuations. I will do that here, adjusting both models to 0.80. My main reasons for doing this are the noise that we saw in ABBV’s financials, coupled with the uncertainty around the company’s ability to replace the revenue it will lose when Humira goes off patent in 2023.

Model 3: Morningstar Star Rating. Morningstar ignores P/E ratios. Instead, they use a discounted cash flow (DCF) method for valuation. Many investors consider DCF to be the best method of assessing stock valuations.

Morningstar analysts create detailed projections of the company’s future cash flows. Each year’s number is discounted back to the present to reflect the time value of money, then they are added up. The resulting net present value of all future cash flows is considered to be the fair price for the stock today. They update their estimates periodically. They express their result with a valuation ratio, the same as I did above with the first two models.

Morningstar’s valuation ratio is 1.09, suggesting that they see the stock as fairly valued (to be specific, 9% above their calculated fair value, which would be within a “fair” price range).

Model 4: Current Yield vs. Historical Yield. Last, we compare the stock’s current yield to its historical yield. This approach is based on the idea that if a stock’s yield is higher than normal, it suggests that its price is undervalued (and vice-versa).

AbbVie’s current yield is 4.9% compared to its 5-year average of 4.2%. That gives us a valuation ratio of 0.86.

Valuation Summary:

Putting the valuation models together, I arrive at a valuation ratio of 0.89, indicating that AbbVie is undervalued. I usually consider the fair-value range for a stock to be in the 0.90-1.10 band of valuation ratios. AbbVie falls just outside that band.

Given AbbVie’s recent close at $105, that would put its fair value at $118, with the top of the range at $130 and the bottom at $106. Given that AbbVie is selling just below that now, I see no reason to go to the top of the range. Therefore, my top buy price would be the fair value itself, or $118.

Fair value = $118. Top buy price = $118.

Miscellaneous Factors

Beta

Beta measures a stock’s price volatility relative to the S&P 500. I like to own stocks with low volatility, because they are easier to live with.

AbbVie’s 5-year beta of 0.73 compared to the market as a whole (defined as 1.0) means that its price has moved quite a bit less than average. This is a positive factor.

Analyst’s Recommendations

Thomson Reuters’ IBES database compiles Wall Street analysts’ current recommendations. This is their latest summary of 22 analysts covering AbbVie:

The average recommendation of “buy” is a positive factor.

The Bottom Line on AbbVie

Positives:

  • High yield (4.9%) plus fast dividend growth rate (5-year DGR of 20% per year). Increase of 10.2% already announced for 2021.
  • Good (but not great) business model. Dominates category with Humira, but Humira is coming off its US patent protections in 2023, which portends revenue shrinkage in 2023 and beyond.
  • Fast revenue, earnings, and cash growth. Highly profitable company.
  • Low beta and high analyst rankings.
  • Undervalued.

Negatives:

  • Dividend safety score from Simply Safe Dividends is “borderline safe.” That’s one of the trade-offs for the high yield.
  • Losing patent protection on Humira is 2023.
  • Very high debt with low (but investment-grade) credit rating of BBB+.

For me, the bottom line is that AbbVie is an “interesting” stock. We’ve all heard the proverb, “May you live in interesting times.” Sometimes that is meant positively, but at other times it is meant ironically, almost as a curse.

With AbbVie, the conundrum comes with its high yield and fast dividend growth rate, countered by its high debt and coming loss of patent protection on Humira. AbbVie’s ratings are interesting: S&P grants an investment-grade rating, but a low one. Simply Safe Dividends grants a safe rating, but a borderline one.

I think that AbbVie is, well, an interesting candidate for a dividend-growth investor who wants a high-yield, fast-growth stock. Just be aware of the risks involved.

This is not a recommendation to buy, hold, sell, trim, or add to ABBV. Any investment requires your own due diligence. Always be sure to match your stock picks to your personal financial goals.

Other Reading on ABBV

Mike Nadel, We Just Bought Broadcom, AbbVie, and Amgen for Our Income Builder Portfolio (December, 2020)

Jason Fieber, Undervalued Dividend Growth Stock of the Week: AbbVie (November, 2020)

Jason Fieber, Warren Buffett’s Latest Trades: 10 Buys, 10 Sells (November, 2020) – Buffett bought >20 million shares of AbbVie

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Source: Dividends and Income