AbbVie: Too Darn Hot?

Introduction

To my surprise, AbbVie (ABBV) has turned into a growth stock. As noted next, I began seeing this when the stock was much lower than it is now, and not much has changed.

This article addresses matters from the standpoint of an investor wondering about buying ABBV now that it has doubled in the past year. Secondarily, it addresses and rejects the idea that a satisfied investor such as myself should sell, unless of course the stock has become so overweighted in a portfolio as to be an issue simply for that reason.

ABBV soars, looks fully valued now

ABBV gained $15 on Friday, up 14%. That’s a $24 B gain in market cap in one day, and in this brief analysis, I want to show that it appears to be undeserved. A little background on one stock I have gotten right:

I have been a value buyer of ABBV, initially one year ago as an undervalued income play with a relatively low GAAP P/E and a dividend yield around 4.2%; the stock was around $60 then. That was discussed in a Jan. 31, 2017, article in which the introductory, summary bullet points said:

• ABBV mildly disappointed the Street in Q4, and the stock sold down to $60.
• I make little of a “miss” that was foreshadowed by JNJ‘s Imbruvica sales results and expected severe weakness in HCV sales in the US.
• More important to me is whether ABBV is simply now undervalued on a P/E basis.
• This article goes through several key considerations in valuing ABBV and finds it interesting as a potentially undervalued stock with a seemingly secure dividend above 4%.

It’s important to note not only the key, final bullet point, but also how bearish traders were on ABBV, knocking the stock down over 1% for minor reasons, when it was already a fairly cheap stock. Right now, the reaction Friday may bookend that mindset, but in the opposite direction.

As 2017 wore on, ABBV began to show more potential as a growth stock. In July, I thought that the stock was going to be important enough that I gave it the DoctoRx seal of approval with a 2-part series. First up on July 31 was AbbVie Drops; Getting Bullish: Part 1 – Focus On Q2 And Humira. I was bullish because the stock was at $69.61, but I liked the prospects more than before. That evolving new view of ABBV as not just “another Gilead (GILD)” doomed to a profit decline sooner rather than later was crystallized before the third quarter ended, with AbbVie Transitions To Growth Stock From Income Play. ABBV was up to about $87 on the open the day that was published. But I think I nailed it; the stock is $123.21 now. Here’s why this stock may finally have incorporated the known positives, and possibly gotten ahead of itself.

First, the balance sheet is weak. As of Q3, tangible net worth was -$37 B (The Q4 press release did not provide the updated balance sheet, and the 10-K is not out yet). On top of that, investors can either add the next tax liability of $4.5 B to that, or, more realistically in my view, subtract from GAAP EPS the amount of tax actually paid each year from 2018 to 2025. Just using the -$37 B and adding it to stated market cap of $197 B ($123 X 1.6 B diluted shares) gives a more realistic “true” market cap of $234 B. This exceeds the similarly-calculated market cap of Roche (OTCQX:RHHBY), which is much larger, and is near that of Pfizer (NYSE:PFE), which is larger than RHHBY in pharma sales.

NOTE: This number may be up to a few billion higher or lower based on the recent tax bill. I will wait for ABBV to submit the 10-K for 2017, but the general point will not change. There is a ton of long-term debt on the balance sheet $34 B, and only $3 B of long-term investments plus “other long-term assets.” So, even if one wants to look not at net worth minus intangibles and goodwill, looking at net long-term debt gets one to a similar implied valuation. One way or another, I give credit to companies such as Apple (NASDAQ:AAPL) and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) that have large amounts of excess cash on the balance sheet, and I similarly adjust in the other direction for companies that have large amounts of “negative excess cash” on the balance sheet, which I call net debt.

With ABBV looking to generate sales of $32 B this year, it is trading at 7X adjusted sales per share or more. Here’s why that is too high to attract me to buy more for my own account or for family accounts I manage.

Humira may be about to peak fairly soon after 2018, and then decline a lot

Every champion gets old. ABBV generated $7.7 B in sales in Q4, just under $5 B of that from the US. Humira generated $4.9 B, $3.3 B or 2/3 of that from the US. ABBV is Humira plus a lot of other stuff.

In the EU, ABBV is guiding to expect biosimilar competition beginning in Q4 this year. Precisely how that will work out country by country, and how intense this competition is expected to be within the first 12 months (say), is an important question that I cannot answer. In the Q&A, ABBV guided that its strategy will be to compete on price to maintain volume:

We’ve also said that we will compete for volume within certain parameters to try to maintain the volume and ultimately maximize profitability of the brand. So we will be taking proactive actions in countries where that is feasible to do. That’s primarily in Southern Europe, so places like Spain, Italy, Portugal. Those markets are controlled primarily by hospitals and so it is our intent to negotiate with those hospitals to be able to put us in a position to be able to maintain our position effectively.

Going forward, we’ve done some of that when indirect biosimilars entered the marketplace and we were successful in doing that and we have already started that action now in those European markets. So you will see some impact on price, it should be offset in most cases by volume, and that’s what we have described as a proactive actions that we will take. [CEO Gonzalez in response to a question from Chris Schott]

I am skeptical that it is possible to cut prices in the face of biosim competition and maintain sales, and it is even less likely to maintain profits that way. I simply do not believe ABBV here, just as I did not believe it back in October 2014 when it projected that its first entrant for hepatitis C would annualize sales at $3 B by the end of 2015. I expect that international Humira sales and even more importantly profits will be tailing off noticeably by 2020, possibly late 2019. Then we have a real conundrum for ABBV and its investors, as the next sections show.

Looking ahead to slowing and possible negative growth for ABBV

Imagine it is 2021, say March, so that we have had a chance to digest the 2020 10-K. What have we learned? My base case is that in 2020, Humira will be seeing negative growth of some significance in the 1/3 of its sales base (ex-US) that may fully offset much slower growth (by then) in the US than Humira will have in 2018. Then, there is Mavyret for hep C. ABBV guides to $2.5 B in sales this year. Fine. If Mavyret splits the global market with GILD’s portfolio of HCV drugs, and if the global average price is $20,000 per treatment (note these are just guesses to make a point), then 250,000 patients will have been treated and very likely cured annually. This means that there is no upside for unit sales in existing market. Re China, I’m very cautious about this opportunity for US companies, based on GILD’s cautious comments and the level of competition I expect there in this particular market. Meanwhile, the amazing Imbruvica, a major engine of growth for ABBV, will finally be seeing slowing growth by 2020-1 as its markets get fully penetrated.

So, if Mavyret does $2.5 B and Humira grows as expected this year, together they will comprise 74% of ABBV’s revenues this year and perhaps next year. If by 2020-1 their sales are flattish, then even if the other 1/4 of the company grows 20% per year, then we are only looking at 6% sales growth.

That’s not too impressive, and that’s my base case for the 2020-1 time period.

But it gets worse. Look ahead to 2023. In January, Amgen (AMGN) can market its authorized biosim (Amjevita) to Humira in the US. I have to assume that others will follow, either then or fairly soon after. So, without trying to time the precise decline of Humira, and understanding that ABBV has negotiated an undetermined royalty rate from AMGN on its Amjevita sales, I am simply going to assume that the Street will project Humira sales declining for years to come. Shall we say from a peak of $22 B down to $10 B (including royalties) within five years, say by 2028? And will the mega-blockbuster Imbruvica go generic around 2028?

In other words, investors are taking a projected $10 B in profits this year (under GAAP) per ABBV and valuing the company, including debt, at around 23X EPS. But my analysis shows that the substantial majority of ABBV’s sales are likely to peak by about 2020, and then decline, perhaps sharply. Then, the remaining very large known growth driver, Imbruvica, is going to see sales fall from very high levels quickly to nearly zero. Yikes!

In a partial offset, ABBV has a robust pipeline. These include two follow-ons to Humira, “upa” and “risa.” The latter is an antibody in-licensed from Boehringer Ingelheim, the productive privately-held German company. So there will be payments to BI along the way. There is also the promising Venclexta, which is partnered with RHHBY. Also in-licensed, I believe on favorable terms, is elagolix for certain female reproductive tract diseases, which can be a nice profit driver, but I do not expect it to save the day. There’s more, but a discussion of Rova-T and what actually is a very large pipeline can wait for another day.

Conclusions

ABBV could be following an arc similar to the one that GILD followed from 2012 to 2015. GILD was a low P/E laggard in 2012, viewed as facing a patent cliff on its HIV products with not much else going on. Then it made the deal that energized its hep C products, and the rest is history. Then the market got over-exuberant, and the rest of that is history as well. I was lucky to make a very large bet on GILD in 2014, so that what I gave back later was small compared to those gains. I have done the same thing with ABBV in terms of my risk exposure, and if the stock drops much from here, it will not matter. Very nice profits have been booked, and as implied, I do not find ABBV attractive above $100 and perhaps not above $95 here. There is just too much downside risk in the years ahead for the 3/4 of sales expected to come from Humira and Mavyret in 2018.

The value stock that ABBV appeared to be one year ago when it was half the current price was not a crazily low valuation. One year ago, Mavyret was already understood to be a pipeline product awaiting FDA and EU approval with very strong data to allow projections that it would succeed. Even GILD acknowledged that. So, have the incremental data on upa and risa, and on Venclexta, offset by negative data on ABBV’s important PARP inhibitor (veliparib), really been enough to give the stock and extra $100 B in market value?

No, I doubt it.

Even adding the increased probability that there will be no biosim competitor to Humira before January 2023 (which is not a certainty) cannot possibly be enough to justify this run, nor can a small “beat” on Humira sales.

Humira is getting long in the tooth, and Mavyret may have no growth after this year.

Thus, as usual, my view is that Wall Street wants investors to believe that ABBV is cheaper than it truly is, largely by ignoring its $34 B in long-term debt and ignoring all the risks inherent in research and development. Just as one example of a known quantity that is driving profits, Imbruvica cost a cool $20 B to acquire, and focusing only on its profit stream and ignoring most of the cost of the acquisition in valuing ABBV ultimately benefits no retail investor.

Taking the very big picture, given the very high valuations including debt and profit margin considerations of the S&P 500 (SPY), ABBV looks to me like a very well-run company that deserves a premium P/E but only on normalized earnings; and with Humira almost certain to decline within several years, I do not believe 2018 EPS is normalized.

ABBV has run up from about $37 when it was spun off from Abbott (NYSE:ABT) five years ago to $123, and it has paid generous dividends as well. That comes to about a 30% CAGR. That extreme number supports my guess that the stock is fully priced and not one I would buy at this price. But, as is the case for one fine company after another, very long-term buy-and-hold investors may be happy holding this name indefinitely even if it churns and settles back for a while. Having cut back my holdings, I am one such person.

Thus, as I was implying but at much lower share prices last year, ABBV is the large pharma/biotech company that has impressed me the most relative to my prior expectations. Congratulations to management are in order. Now the valuation air is much thinner, and this story will be very interesting to watch for years to come.

Final comment re ABBV: All the above valuation concerns, and even my skepticism about profits ex-US beginning in 2019, should in my opinion be tempered by Warren Buffett’s point that it’s better to own stocks of great companies at seemingly high valuations than mediocre companies that appear to be bargains. That’s why I want to be a long-term owner of ABBV even here and then, if Mr. Market gives me the opportunity, a value buyer again. Roche, with the RHHBY symbol for the ADR in the United States, has a lower “real” P/E than ABBV and in my view has been, and remains, the single greatest force in biotechnology and has better long-term reward:risk characteristics than ABBV at current stock prices.

Thanks for reading and sharing any comments you wish to contribute.

Disclosure: I am/we are long ABBV, RHHBY, GILD, AAPL, GOOGL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.