COVID testing has become the bread and butter for this company, and reopening plans only help its strategy
Today’s company has made a massive business out of coronavirus testing.
Many investors are wondering how sustainable the robust returns of this company are. Can it even expand current levels like the market is pricing it to do?
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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As current testing results indicate, the United States is making major strides towards containing the coronavirus.
With vaccinations rolling out strongly in most of the developed world, Europe has announced over the past two weeks that it is going to reopen this summer. However, there’s one caveat—it’s only for those who have been fully vaccinated.
Additionally, a core part of any strategy when opening society back up is to continue to have strong testing programs in place for the coronavirus.
Hopefully, this will ensure people’s safety as the world reopens.
Testing has been a crucial aspect in getting life back on track prior to the vaccine, and it will continue to play a prevalent role in our future society.
One company that has been at the front lines of coronavirus testing and will continue to be is Abbott Laboratories (ABT).
Abbott has been one of the leading suppliers of testing programs and kits. It has also created essential equipment for treatment as well as drug development for diagnosing, treating, and beating the coronavirus.
Prior to the pandemic, the company has been creating drugs to treat many other diseases.
This has led Abbott to successfully generate robust returns, as many investors might have already expected given the tailwinds in their space recently.
However, the as-reported metrics indicate otherwise. They paint a different story than commonly believed.
We have identified an even larger issue with this story though.
To gain a greater understanding about what the market is pricing in, we can use our Embedded Expectations Framework.
Most investors determine stock valuations using a discounted cash flow (“DCF”) model, which takes assumptions about the future and produces the “intrinsic value” of the stock.
However, here at Valens we know models with garbage-in assumptions only come out as garbage. Therefore, we’ve turned the DCF model on its head with our Embedded Expectations Framework. Here, we use the current stock price to determine what returns the market expects.
In the chart below, the dark blue bars represent Abbott’s historical corporate performance levels in terms of ROA. The light blue bars are Wall Street analysts’ expectations for the next two years. Finally, the white bars are the market’s expectations for how the company’s ROA will shift in the next five years.
Wall Street analysts are expecting Abbott’s Uniform ROA to expand to 34% levels by 2022.
With this forecasted growth, the market is pricing in Uniform ROA to remain at 34% levels by 2025.
These expectations may be overly optimistic given the strong surge in demand may be temporary during the pandemic.
The market is pricing in ROA levels to remain at these highs forever.
While Abbott should see all-time high ROA levels in 2021 thanks to the continued strong demand for its equipment and supplies, the market is expecting even more.
This may be challenging for the firm to meet.
As a result, anyone buying Abbott at the moment may be paying for the pandemic to remain in place forever, and that is a bet we are sure no one wants to make.
SUMMARY and Abbott Laboratories Tearsheet
As the Uniform Accounting tearsheet for Abbott Laboratories (ABT:USA) highlights, the Uniform P/E trades at 22.7x, which is around the global corporate average of 23.7x and its own historical average of 22.4x.
Moderate P/Es require moderate EPS growth to sustain them. In the case of Abbott, the company has recently shown a 13% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Abbott’s Wall Street analyst-driven forecast is a 39% and 5% EPS growth in 2021 and 2022, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Abbott’s $119 stock price. These are often referred to as market embedded expectations.
The company needs to have Uniform earnings grow by 9% per year over the next three years in order to justify current stock prices. What Wall Street analysts expect for Abbott’s earnings growth is above what the current stock market valuation requires in 2021, but near that requirement in 2022.
Furthermore, the company’s earning power is 5x the long-run corporate average. Also, cash flows and cash on hand are more than 3x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk.
To conclude, Abbott’s Uniform earnings growth is above its peer averages but the company is trading well below average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research