AbbVie (ABBV) is one of the more controversial dividend aristocrats for several reasons. As a relatively new spin-off (2013), the company has a much shorter dividend growth track record than traditional aristocrats.
The bigger challenge, however, is AbbVie’s profit drivers. Most dividend aristocrats possess the characters we desire when searching for safe dividend stocks. They have entrenched market positions, compete in slow-changing industries, and generate cash flow from many different products and industries.
In AbbVie’s case, over half of its business is concentrated in one product. While this can work for some companies that have powerful brands (e.g. Clorox or Coca-Cola), it’s a risk in AbbVie’s market of branded pharmaceutical drugs and makes the stock less desirable for our Top 20 Dividend Stocks portfolio.
However, the stock’s safe 4.1% dividend yield, relatively cheap forward earnings multiple of 11.1, and above-average earnings growth prospects over the next few years make it worth a closer look.
AbbVie was spun off from Abbott Laboratories on January 1, 2013, as a standalone biopharmaceutical company. Approximately 61% of the company’s revenue comes from sales of Humira, a drug that treats arthritis. Some of its other major drugs are Imbruvica, which treats leukemia, and Viekira, which treats hepatitis C. The company reported nearly $23 billion in sales last year and sells its drugs in over 170 countries.
The branded pharmaceuticals industry has extremely high barriers to entry and offers potential for juicy profit margins – AbbVie generated a 33% operating margin last year and targets a 50% margin by 2020. Major pharma players invest billions of dollars and years of time in research and development to commercialize breakthrough drugs.
While the success rate is low, a successful drug can generate billions in profits that are protected for many years as a result of the intellectual property owned by the manufacturer. As seen below, AbbVie’s primary markets combine to reach nearly $200 billion in size, providing the company with many different opportunities for growth.
Source: AbbVie Investor Presentation
AbbVie’s management team expects the company to reach $37 billion in sales by 2020, which would represent more than a 60% increase from 2015’s revenue level. Of this total, roughly half of total sales would come from the company’s arthritis drug Humira, and another 13.5% would come from sales of leukemia drug Imbruvica.
AbbVie also expects to launch over 20 new products by 2020 to reach to its goals and believes that its current pipeline has potential to achieve revenues of nearly $30 billion by 2024. As growth continues, operating margins are expected to expand by 100-200 basis points per year to drive double-digit earnings growth.
The company’s success will hinge on the success of its drug pipeline and its ability to protect cash flows from Humira for as long as possible from biosimilar competitors.
AbbVie’s Key Risks
We prefer to invest in pharmaceuticals that have diversified streams of income from their drugs. It’s very hard for a complete outsider to forecast the timing and profitability of a company’s drug pipeline, so finding businesses with enough diversification helps reduce this risk.
Johnson & Johnson is a great example. While pharmaceuticals drive over half of the company’s profits, it is well diversified by drug and gets reliable cash flows from its consumer products and medical devices segments. The flop of any one drug will not endanger the business. You can read our analysis of Johnson & Johnson by clicking here.
On the other hand, AbbVie is much more concentrated. Sales of Humira accounted for over 60% of sales last year and are expected to represent nearly 50% of revenue by 2020 as well. AbbVie’s composition of matter patents for Humira expire in the U.S. and Europe in December 2016 and October 2018, respectively.
However, the company hopes that it can litigate against biosimilar manufacturers of Humira for at least four or five years based on industry norms and its non-composition of matter patents. These patents covers area such as manufacturing and formulation and do not begin to expire until 2022.
The company obviously hopes to use these patents to litigate against new biosimilar competition for Humira, and it was successful earlier this year in defending against a patent review case filed by Amgen last year. If successful, AbbVie believes it can maintain strong profitability in the U.S. through 2022, but there is plenty of skepticism surrounding the matter.
Regardless of the ultimate timing, branded drugs cannot maintain their high profit margins forever. As patents expire, lower-cost competition emerges with knock-offs that quickly erode sales and margins. If new drugs have not been successful in the pipeline, earnings can erode very quickly.
This is a key point of controversy surrounding the stock. While management believes Humira sales can exceed $18 billion in 2020, some analysts see Humira revenue coming up at least 30% short of management’s ambitions. AbbVie’s forecast assumes that biosimilar versions of Humira will stay out of the U.S. until 2022, whereas some analysts see competition emerging in 2019.
In addition to the risk posed by Humira’s large contribution to company profits, the Food and Drug Administration (FDA) can also pose unexpected challenges. For example, during one week in October 2015, AbbVie’s stock fell by more than 10% after the FDA warned that AbbVie’s Viekira treatment caused liver injury to a small number of patients.
You just never know what might crop up any given week as it relates to new competition, unexpected developments in the drug pipeline, litigation, or other issues with existing treatments. For these reasons, we generally prefer to invest elsewhere in the market.
Dividend Analysis: AbbVie
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. ABBV’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
For the time being, AbbVie’s dividend payment is extremely safe. The company received a Dividend Safety Score of 78, which is excellent and places it in the top quartile of dividend-paying stocks.
AbbVie’s free cash flow payout ratio over the last 12 months is a healthy 49%, which is roughly in line with the company’s payout ratios realized since it was spun off in 2013. Given AbbVie’s strong outlook over the next few years for continued growth, we think its payout ratio is very healthy for the time being.
In addition to its healthy payout ratio, AbbVie has generated sales growth in each of the last five years. We don’t have data that goes back to the last recession, but pharma companies are generally recession-resistant because consumers still need to treat their illnesses regardless of how the economy is doing. The bigger risk to sales cyclicality is patent expirations of major drugs such as Humira. AbbVie needs to develop new drugs that can eventually replace those sales or else it could see a steep revenue decline that could endanger the dividend.
As we mentioned earlier, pharma manufacturers generate excellent free cash flow when they successfully commercial a major drug. Years of research and development spending has already been realized, so the company gets to enjoy healthy profits. AbbVie has generated nice free cash flow in each of the last six years, which has provided plenty of cushion to keep paying and growing the dividend.
Few businesses can generate operating margins in the teens, much less in the 30% range like AbbVie has done. Management expects margins to hit 50% by 2020, highlighting the extreme profitability enjoyed by pharma companies. High returns allow companies to compound their earnings faster and are usually a sign of competitive advantage (intellectual property and drug development expertise, in this case).
Some investors have expressed concern about AbbVie’s balance sheet. At first glance, the company’s $31.7 billion debt burden, largely resulting from AbbVie’s $21 billion acquisition of Pharmacyclics in 2015, does raise some eyebrows.
However, AbbVie could cover all of its debt using the $8.4 billion it has in cash and about 3.1 years’ worth of earnings before interest and taxes (EBIT), which is reasonably healthy. Standard & Poor’s and Morningstar have given the company A and A- credit ratings, respectively. We would like to see AbbVie reduce its debt over the next few years while it is generating strong free cash flow from Humira. If Humira’s revenue unexpectedly shrinks over the next five years, the balance sheet could become strained.
Overall, AbbVie’s dividend looks very safe at the moment. The company has a healthy payout ratio, generates plenty of free cash flow, and is enjoying double-digit earnings growth.
However, the trajectory that Humira’s revenue takes beyond the next few years, coupled with developments in AbbVie’s drug pipeline, will significantly impact the safety of the dividend from 2020 and beyond.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
AbbVie’s Dividend Growth score of 89 is excellent. The company last increased its dividend by 12% in October 2015 and is included on the dividend aristocrats list despite being spun off at the start of 2013, when it continued its dividend growth streak as an independent business.
Abbott Laboratories, which spun off AbbVie, has a dividend growth streak of more than 40 consecutive years and is the reason why AbbVie is considered a dividend aristocrat. With that said, AbbVie has increased its dividend by 42% since 2013 with increases each year.
We believe AbbVie will continue recording at least a high-single dividend growth rate for the next few years. Growth will be fueled by the company’s reasonable free cash flow payout ratio of 49% and strong business fundamentals as drug sales and margins are expected to increase significantly through 2020.
The main wild card impacting future dividend growth beyond the next few years is the rise of Humira competition, which could come as early as 2019 or as late as 2022. We will re-evaluate AbbVie’s dividend growth potential as that time draws nearer.
ABBV’s stock trades at 11.1x forward earnings estimates and has a dividend yield of 4.1%. For a stock with above-average growth prospects over the next few years, it appears to be very reasonably priced.
The seemingly low expectations attached to the stock are a reflection of investors’ concerns about AbbVie’s concentration in its Humira drug, which is set to experience competition in the U.S. market sometime over the next three to six years. With its European patent set to expire in 2018 as well, growth in international markets could also slow.
However, Evercore ISI’s analyst Mark Schoenebaum estimated that AbbVie’s 2020 guidance for sales and margins implies adjusted earnings per share of approximately $8.80. He applied a 16x P/E ratio to his estimate of 2020 earnings and discounted it back to 2015 using a 9% discount rate. The stock price resulting from his analysis was about $100 per share, which is nearly 100% higher than AbbVie’s most recent closing price.
With expectations for double-digit earnings growth through 2020, AbbVie’s total return potential certainly looks attractive at first glance. However, dividend investors must be willing to accept the higher uncertainty surrounding the company’s cash flows beyond 2020.
While the market’s expectations seem to bake in a good amount of caution today, it’s still hard to get comfortable with AbbVie’s competitive landscape over the next five years. The key issue is how long the company’s Humira drug can profit in the U.S. before biosimilar competition emerges. The difference of just a few years could really make or break the stock’s performance over the coming years.
Unfortunately, we don’t have an edge when it comes to analyzing this risk, nor do we have a comfortable method of evaluating AbbVie’s large pipeline of new drugs that will launch over the next five years. The stock looks set to be a big winner if it delivers on management’s 2020 goals (it trades for less than 7x implied 2020 earnings per share today), but we would ultimately prefer to stick with other blue chip dividend stocks that offer greater profit diversification and a slower pace of industry change.