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AbbVie Begins Path to Strengthening Dividend Profile After Closing Allergan Acquisition

Shares of AbbVie (ABBV) have had a dividend yield above 5% for most of the past year, reflecting uncertainty about the biopharma company's growth profile.

AbbVie's rheumatoid arthritis drug Humira, which in 2019 accounted for over 55% of sales and an even greater share of profits, loses exclusivity in the U.S. in 2023.

That long-term hole will need to be filled by other revenue streams to continue supporting the dividend, driving AbbVie's decision last year to purchase drugmaker Allergan in an $80-plus billion deal.

After completing its transformative acquisition on May 8, AbbVie can begin working to prove that its long-term outlook remains favorable even as Humira revenue starts declining in a few years.

In June 2019, we downgraded AbbVie's Dividend Safety Score to Borderline Safe after the company announced plans to buy Allergan. Here's what we said:

As a result of this planned transaction, we are downgrading AbbVie's Dividend Safety Score from a rating of Safe to Borderline Safe. This isn't necessarily a reason to sell the stock if you own it but simply reflects the company's increased financial risk profile, at least over the short term.

A dividend cut still seems unlikely, but the deal will cause AbbVie's leverage to rise significantly, driving the downgrade. Management reaffirmed its commitment to the current dividend and plans to deleverage aggressively in the years ahead.

As the company's balance sheet improves and it demonstrates continued traction with its larger growth platform of drugs to offset future Humira declines, AbbVie's Dividend Safety Score would likely return to a Safe rating.

Please see our in-depth note here for full analysis of the merger and its implications for AbbVie's dividend safety.

Not much has changed since then, but we do have a little more financial information to analyze now that the dust is settling.

On May 14, AbbVie provided pro forma financial statements for the combined company.

As of March 31, the combined business carried about $90.9 billion of debt and had $6.2 billion of cash and investments. 

Based on analysts' estimates of EBITDA in the year ahead, AbbVie's net debt to EBITDA leverage ratio will be about 3.5x, nearly double its 2019 level.

(The financial charts on our website will reflect the combined company's numbers after AbbVie reports results next quarter. That's when you'll see leverage tick up.) 
Source: Simply Safe Dividends

As a result of the company's elevated leverage, Standard & Poor's downgraded AbbVie's credit rating one notch to BBB+ earlier this month. 

We also prefer to see lower leverage for biopharma companies, which must contend with patent losses, drug pipeline volatility, and the occasional need to acquire new medicines to support their long-term growth.

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

Ratings-firm Fitch expects annual free cash flow after dividends to total about $7 billion to $9 billion (a payout ratio ratio around 45-50%, in line with AbbVie's historical norm). 

That should be enough to help management meet their goal of paying down $15 billion to $18 billion of debt by the end of 2021, at which point leverage is expected to reach 2.5x.

"The robust cash flow generation of the combined company will be used to rapidly pay down debt, support a strong and growing dividend and pursue additional innovative mid- to late-stage pipeline assets. 

"We have committed to paying down $15 billion to $18 billion of combined company debt by the end of 2021, of which nearly $7 billion will be repaid by the end of May 2020. We expect to achieve a net debt-to-EBITDA ratio of 2.5x by the end of 2021 with further deleveraging through 2023."

– CFO Rob Michael

While the coronavirus pandemic has disrupted deleveraging plans for many businesses, it doesn't seem likely to interfere with AbbVie's ambitions.

AbbVie's business focuses on therapeutic products that treat serious diseases such as chronic viral infections and cancer. Deferring treatment for these patients is typically not recommended.

However, with many physician's offices closed, AbbVie did see a "modest impact" on the number of new patient starts.

Allergan's product portfolio enjoys similar defensive qualities, but it also derives about a third of its revenue from an aesthetics business (e.g. Botox plastic surgery).

Plastic surgeons, medical spas, and dermatology offices are the primary providers of those procedures. Many of them temporarily closed due to the pandemic and are therefore not performing procedures.

Based on an analysis on this business during the 2008-09 recession, recent trends in China, and the higher income of the aesthetics patient base, management expects demand to normalize quickly as quarantine restricts are relaxed.

Despite these near-term headwinds, management was confident enough to reaffirm AbbVie's full-year earnings guidance in early May and said they don't expect any changes to the firm's dividend growth profile.

Overall, AbbVie's dividend continues to look like a reasonable bet in at least the short- to medium-term. It's really just a matter of management executing on their deleveraging and diversification plans with Allergan now officially part of the company.

However, 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 (Humira's international sales fell 28% last year after losing protection in late 2018), 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.

Deleveraging the balance sheet and further reducing dependence on Humira are the key drivers we are watching to consider upgrading AbbVie's Dividend Safety Score to Safe. We will continue monitoring the company's progress.

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