Abbott Labs’ dividend strength is top-notch (NYSE:ABT)

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By the Valuentum team

Dividend Aristocrat Abbott Laboratories (NYSE:ABT) is one of our favorite healthcare names, with a long history dating back to its incorporation in 1900. We’re big fans of its line of products that ranges from gastroenterology and women’s health products, laboratory systems and diagnostic flow testing products to infant formula, including the Similac brand and medical devices for the heart and beyond. Despite its fantastic portfolio, Abbott still remains vested as it seeks to continue to diversify its product portfolio across its four reportable segments: Established Pharmaceuticals, Diagnostics, Nutritionals and Medical Devices.

Although we generally view acquisitions by strong and exciting dividend payers such as Abbott in a cautious light because they add leverage to the balance sheet, the company has a strong integration track record, as evidenced by the effective integration of St. Jude Medical (which Abbott acquired in 2017) with Abbott’s operations over the past few years. The deal, in particular, provided Abbott with significant growth opportunities as it absorbed key revenue-generating segments, including STJ’s heart failure and traditional CRM segments. The COVID-19 pandemic has seen demand for Abbott’s diagnostic offerings increase.

Abbott’s dividend increases over the past few years have been quite substantial, and the company is reporting a very handsome 1.7% at the time of this writing. At Valuentum, we calculate what we call a Dividend Cushion ratio for each general industrial company in our coverage universe. The Dividend Cushion Cash Flow Bridge, shown in the image below, illustrates the components of the Dividend Cushion ratio and highlights in detail the many factors behind it. Abbott’s Dividend Cushion Cash Flow Bridge reveals that the sum of the company’s 5-year cumulative free cash flow generation, as measured by operating cash flow less all capital expenditures, plus its net cash/debt position on the balance sheet, as of the last financial year, is greater than the sum of the expected cash dividends paid over the next 5 years.

The Dividend Cushion Cash Flow Bridge combines forward-looking analysis with a company's financial health to assess dividend coverage.

The Dividend Cushion Cash Flow Bridge combines forward-looking analysis with a company’s financial health to assess dividend coverage (Valuentum)

Since the Dividend Cushion ratio is forward-looking and reflects the trajectory of the company’s free cash flow generation and dividend growth, it reveals whether there will be a cash surplus or deficit at the end of the year. the 5-year period, taking into account the leverage effect on the balance sheet, the main source of risk. On a fundamental basis, we believe that companies that have a strong net cash position on the balance sheet and generate a significant amount of free cash flow are better able to pay and grow their dividend over time. Companies that are buried under a mountain of debt and do not sufficiently cover their dividend with free cash flow are more at risk of a dividend cut or a suspension of growth, all other things being equal, our opinion. Generally speaking, the more positive the “blue bar” to the right, the more sustainable a company’s dividend, and the more negative the “blue bar” to the right, the less sustainable a company’s dividend.

Abbott Key Investment Considerations

Abbott Investment Considerations


The new Abbott isn’t much different from the old Abbott (pre-AbbVie spin-off), minus the hit drug Humira and other members of its drug line. It remains aligned with favorable long-term healthcare trends in developed and developing markets. The company is over 125 years old. About 65% of its sales are now generated outside the United States.

It is estimated that more than 16% of the world’s population will be 65 or older by 2050, providing significant opportunities across Abbott’s portfolio. Demand for the company’s diagnostic offerings has exploded during the COVID-19 pandemic and remains robust. For example, in the company’s second quarter results, global COVID-19 testing sales hit $2.3 billion, helping to boost revenue by 10% and more.

Abbott acquired Alere and St. Jude Medical in 2017, significantly strengthening its diagnostics and medical device businesses. Future acquisitions are likely as Abbott seeks to solidify its market position in lucrative parts of the healthcare space while unlocking new growth opportunities. We caution that such transactions are likely to be financed at least in part by debt.

Our discounted cash flow valuation model assumes that Abbott will maintain strong revenue growth rates in the future while experiencing significant margin expansion, enabled in part by acquisition synergies. If the company were to stumble, our estimate of its intrinsic value would face significant pressure, but that may not materialize. In its second quarter report, Abbott raised its full-year 2022 EPS guidance, now projecting “diluted EPS on a GAAP basis of at least $3.50 and projected adjusted diluted EPS of at least 4, $90”.

Abbott has been in the news lately due to problems with its formula manufacturing operations in the United States. This included a voluntary recall of certain infant products in February 2022. Abbott is working to resolve its issues on this front. This is something investors should watch out for.

Abbott Economic Profit Analysis

The best measure of a company’s ability to create value for its shareholders is expressed by comparing its return on invested capital to its weighted average cost of capital. The gap or difference between ROIC and WACC is called the economic profit gap of the firm. Abbott’s historical 3-year return on invested capital (excluding goodwill) is 25%, which is above its cost of capital estimate of 9.4%.

As such, we give Abbott an EXCELLENT value creation rating. In the chart below, we show the likely trajectory of ROIC in the coming years based on the estimated volatility of the key drivers of the metric. The solid gray line reflects the most likely outcome, in our view, and represents the scenario that results in our estimate of fair value. Abbott is a fantastic generator of economic value.

Abbott's return on invested capital.

Abbott Return on Invested Capital (Abbott)

Analysis of Abbott’s cash flow assessment

Abbott Cash Flow Generation


We think Abbott is worth $109 per share with a fair value range of $87.00 to $131.00. The shares are trading roughly at our estimate of fair value at this time. The margin of safety around our estimate of fair value is determined by the company’s LOW ValueRisk™ rating, which is derived from an assessment of the historical volatility of key valuation factors and a future assessment of these. .

Our near-term operating forecasts, including revenue and earnings, do not differ materially from consensus estimates or management guidance. Our model reflects a compound annual growth rate of 3.5% in revenue over the next five years, a slower pace than the company’s historical compound annual growth rate of 12.1% over 3 years.

Our valuation model reflects a projected 5-year average operating margin of 27.7%, which is above Abbott’s 3-year average. Beyond year 5, we assume that free cash flow will grow at an annual rate of 3.4% for the next 15 years and 3% in perpetuity. For Abbott, we use a weighted average cost of capital of 9.4% to discount future free cash flow.

Abbott's Valuation Assumptions


Abbott valuation breakdown


Abbott’s Margin of Safety Analysis

Abbott Stock Range of Potential Outcomes


Our discounted cash flow process evaluates each company based on the present value of all future free cash flows. Although we estimate the company’s fair value at approximately $109 per share, each company has a range of likely fair values ​​that is created by the uncertainty of key valuation factors (such as future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn’t see much volatility in the markets, as stocks would trade precisely at their known fair values.

This is an important way to view markets as an iterative function of future expectations. As future expectations change, the value of the company and its stock price should also change. Stock prices are not a function of fixed historical data, but rather act to capture future expectations as part of constructing company valuation. It’s a key part of our book Value Trap: Universal Valuation Theory.

Our ValueRisk Rating defines the margin of safety or range of fair value we assign to each stock. In the chart above, we show this likely range of fair values ​​for Abbott. We think the company is attractive below $87 per share (the green line), but quite expensive above $131 per share (the red line). Prices that fall along the yellow line, which includes our estimate of fair value, represent a reasonable valuation for the business, in our view. Abbott shares are roughly priced at the time of this writing, but that’s pretty much the dividend growth game, in our view.

Final Thoughts

It’s hard to criticize a company that has increased its dividend in each of the past 50 years. Although Abbott has net debt, the company’s incredibly resilient cash flow profile, combined with its ample cash, should make managing its dividend obligations and net debt quite feasible in the future. coming. Abbott’s capital allocation priorities should be watched given its acquisition history and share buyback programs competing for capital against its dividend payout. The company’s future dividend obligations have become much more substantial in recent years after several major increases in payouts, although Abbott’s dividend cushion ratio remains high. Although the stock is roughly priced at the time of this writing, we like the company as a solid dividend growth idea.

This article or report and any links it contains are for informational purposes only and should not be considered a solicitation to buy or sell any securities. Valuentum is not responsible for any errors or omissions or results obtained from the use of this article and assumes no responsibility for how readers may choose to use the content. Assumptions, opinions and estimates are based on our judgment as of the date of the article and are subject to change without notice.

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