Tuesday, May 09, 2006

Abbott Laboratories gets a SELL

Abbott Laboratories [ABT] has a special place in my heart. In my earlier life I was a science geek and a fair number of friends found employment at Abbott. When my list of stocks to review turned up Abbott Labs I silently wished it would turn up a buy and I could happily start conversations with those old friends with a comment about how well ABT is doing.

Sadly it was not to be, ABT gets a SELL.

This storied company was founded in 1888, a year with uncanny resemblance to 2000: Democrat Grover Cleveland won the popular vote for the presidency of the United States but Benjamin Harrison (Republican) won the Electoral College vote and therefore became president. Six years after 1888 Abbott Labs was a successful and growing little company, six years after 2000 Abbott Labs has almost 60,000 employees and looks to be seriously stalled.

Starting with the price to cash flow ratio I calculate a 13.7 ratio, which is not all that bad and could be justified if growth is good. Unfortunately the projected 5 year analyst growth rate is only 9.4% which is more than priced into the stock. If I apply my favorite harsh requirement for a stock to have a present value that supports a 15% discount rate on future earnings I get a target price of $38, several dollars below the current pricing of $42. This doesn’t mean the stock will necessarily drop right away, most analysts use an 11% discount value, which would support a target price of $52, but I find that this number is often wishful thinking and leaves little room for anything to go wrong.

Why would I be worried not everything will go right? Well, in the case of a stock this close to the edge we need to look closely at the market and management. One stock pulled into a BUY rating by a fast growing market and a very good position to exploit that market was Nokia [NOK], which got a BUY rating here recently. Meanwhile United Parcel Service [UPS] had ratios and a discount rate on the edge, had a good market and management, but suffered from a lurking problem in pensions which pushed the company into a SELL rating here recently.

Abbott Laboratories has a respectable dividend of 2.8%, but otherwise doesn’t seem to handle its money very well. The company’s return on equity has been below the drug industry average for each of the last five years, as have net profit margins. As a result of these poor returns each dollar of retained earnings the company has held onto over the last ten years has generated $0.83 in market value. This is the equivalent of saying that management's moves were less profitable for the shareholders than if ABT had simply handed out the money and you kept it under your mattress. Meanwhile, poor return has led to heavy borrowing and for the last five years ABT has had a long term debt to equity ratio above the industry average, meaning they were borrowing lots of money and have to recycle earnings into debt payments. For one glorious quarter they came down and actually met the industry average then today, less than a month after reporting first quarter financials, they borrowed another $4 billion to buy Guidant’s coronary stent business in order to help Boston Scientific [BSX] avoid antitrust concerns over their purchase of Guidant. Abbott is also loaning BSX almost a billion dollars to help them buy Guidant. Why wouldn’t BSX simply get the loan from a bank? Hard to tell, but Abbott was an original investor in BSX and the two still have an unusually close relationship and I get nervous when management seems to be running the company for other shareholders. Whatever the reason, ABT has a book value of only about $9 per share and now will have over $10 billion in debt to carry.

I can’t guarantee that ABT stock will go down in price, but you can find better value. If you were considering buying some ABT I encourage you to look as some of the BUY stocks in the column at the right as I consider them all better than ABT and you can click on them and read through every bit of the analysis, exposed for review and criticism. I think in the long run ABT isn’t the bargain we would want it to be.
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