Unrecognized Potential at Abbott Labs

Shareholders of Abbott Laboratories have been getting the Chinese water-torture treatment lately, having to contend with a thin but steady trickle of sour news about the big health care company. But Abbott's shares have held up remarkably well, suggesting that the slow drip isn't distracting the Street from the company's bright long-term prospects.

Investors felt the first drop when Abbott reported earnings on July 16. Sales of $7.3 billion in the second quarter of 2008 represented a 15% increase from the year-earlier period, and profits of 84 cents a share beat the 2007 figure by 22%. Time to break out the champagne, right? But when management raised full-year 2008 profit guidance by only 3 to 4 cents a share, rather than the full 5 cents per share by which second-quarter results beat analyst estimates, flighty investors caused the stock (symbol ABT) to drop 1.5% for the day.

The trickle continued on July 21, when the stock sagged on news of a competitor's failed cholesterol-drug trial. On July 25, news broke that Abbott had been subpoenaed the month before as part of an inquiry into medical-device sales practices; on July 29, the Food and Drug Administration approved a generic version of Abbott's successful anti-seizure drug, Depakote; and on July 31 the company settled a lawsuit on price hikes of its anti-retroviral meds, agreeing to shell out as much as $28 million.

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Talk about missing the forest. Granted, as part drug maker and part medical-devices company, Abbott can lend itself to misinterpretation. But the company's pharmaceutical business is humming, without a trace of the paralysis besetting many other Big Pharma names.

Second-quarter sales of its cash cow, Humira, clocked in 48% higher than in 2007. The FDA recently approved a sixth use for the drug, which doctors can now prescribe for ailments from rheumatoid arthritis to psoriasis. Abbott gained Humira, which earns nearly 15% of the company's total revenues, in its 2001 acquisition of Knoll Pharmaceuticals.

The wonder drug is already popular abroad, but its potential is far from maxed out. Foreign sales of Humira, at $1 billion in the first half of 2008, accounted for 53% of the drug's total sales and were up 70% from the year before (or 52% if excluding exchange-rate benefits). "Penetration levels of Humira within each of its six approved uses are still very low," says Phil Nalbone, an analyst with RBC Capital Markets. He thinks Humira will churn out 30% annual sales growth for the foreseeable future.

Abbott's also a heavyweight in the booming market for cholesterol meds. Niaspan is a drug that raises good cholesterol, while TriCor regulates fat levels in the blood. Those two brought in $923 million in sales in the first half of 2008. Simcor, one of eight new FDA approvals Abbott gained in the first half of the year, lowers bad cholesterol and raises good cholesterol at once. And TriLipix, which is expected to gain FDA approval this year, is a drug that patients take in collaboration with other cholesterol meds to make the whole package work better.

But those drugs won't likely be the ones hitting the gas on the stock price anytime soon. Nalbone says the driver will be Abbott's enviously successful new drug-eluting stent. Stents are cylindrical scaffolds inserted into clogged arteries to prop them open, lowering the risk of heart attacks. They're nothing new, but Abbott's new Xience stent is, like a few others in the market, coated with drugs that improve how the body reacts to it.

What excites Abbott bulls is that Xience has performed hands-down better in head-to-head trials against the present leader in this category, Boston Scientific's Taxus stent. There's already a $4-billion global market for drug-coated stents, and many doctors who use stents without a drug coating may be amenable to switching to Xience or other drug-coated products.

Nalbone says medical-technology investors watch the stent market closely. "Abbot, coming from nowhere, now has the opportunity to be the dominant player in that market," he says. He says that this recognition among investors will push up the stock.

Abbott has been a consistent performer, generating annualized profit growth of 8% over the past three years and sales growth of 10% (profits and sales clocked in at $4.4 billion and $26 billion, respectively, in 2007). Nalbone says the company's broad product mix makes the stock an attractive long-term play. "You're getting the benefit of significant diversification across product areas on a global scale," he says.

The stock, which closed at $58.71 on August 5, sells at 18 times analysts' average 2008 earnings estimate of $3.27 per share and yields 2.6%. Nalbone calls Abbott a "top pick" and gives it a 12-month price target of $66.