Worried about the patent cliff for Humira, the world’s best-selling drug, investors have fled AbbVie.
AbbVie shares are down 13% year to date, and now carry the lowest valuation in Big Pharma. That’s a buying opportunity.
At 13 times projected 2015 earnings, AbbVie (ticker: ABBV) trades at a 24% discount to the Standard & Poor’s 500 index. Big Pharma, including U.S. giants like Pfizer (PFE), Merck (MRK), and Bristol-Myers Squibb (BMY), sells for a median premium of 17% to the S&P 500. AbbVie’s discount would be warranted if the company had no means of replacing profits from its blockbuster arthritis medicine Humira, which goes generic in the U.S. next year, and in 2018 in Europe. In fact, AbbVie has an excellent pipeline of new medicines and strong free cash flow—and a brighter growth forecast for the next three years than some companies with much pricier shares (see table).
A company building in Redwood City, Calif. AbbVie’s huge free cash flow can fund share buybacks, dividend hikes, and acquisitions. Photo: Sipa via AP Images
Look for the stock to trade up to a more suitable 15 times forward earnings, which in a year would put it at $75 versus a recent $58, a gain of nearly 30%. Add to that a plump dividend yield of 3.4%. And payments are likely to grow.
AbbVie’s top money maker is also investors’ top concern—Humira, an anti-inflammatory drug for rheumatoid arthritis, Crohn’s disease, psoriasis, and other diseases. It has tacked on more than $1 billion in sales each year since 2008. Last year, it brought in $12.5 billion. That makes it the best-selling drug in the world.
Trouble is, it contributes more than 60% of AbbVie’s revenue, and new competition is looming. AbbVie’s spinoff from Abbott Laboratories (ABT) two years ago looked something like a quarantine, designed to shield Abbott’s medical-devices, test-products, and infant-formula businesses from the Humira discount. Abbott traded recently at 21.2 times projected 2015 earnings.
AbbVie’s attempted purchase last year of Ireland’s Shire (SHPG) would have added new medicines and slashed taxes. But a U.S. crackdown on such “tax inversions” caused AbbVie to walk away—$1.6 billion poorer, after a breakup fee. In December, AbbVie received Food and Drug Administration approval for Viekira Pak for the treatment of some hepatitis C cases. Viekira has potential to be the company’s first big hit since Humira. The drugs it competes against, Sovaldi, and its successor, Harvoni, both from Gilead Sciences (GILD), are known for remarkable effectiveness and sky-high prices—more than $1,000 a day for some patients. Gilead’s treatment is widely preferred by doctors because it requires fewer pills per day and has a potentially shorter treatment period, but both are effective, and AbbVie can take share by discounting. This past week, Gilead announced deeper-than-expected discounts for its hep-C medicines.
THAT LEAVES ABBVIE facing both a price war for Viekira and a patent cliff for Humira. Investors should nonetheless buy the shares because the long-term outlook is better than the headlines suggest.
Start with Humira. It’s still growing, modestly in the U.S. and faster overseas, on a combination of volume gains and price increases. Wall Street expects sales to peak in 2018 at $16.5 billion, up $4 billion from last year’s level, and to begin declining, starting with a drop to $16.1 billion in 2019. Deutsche Bank likes AbbVie but is considerably more bearish on Humira sales than the consensus; it sees sales peaking at $15.1 billion next year and falling to $11.4 billion by the early 2020s, when sales level off. That leaves an eventual $3.7 billion revenue gap between peak and trough Humira sales. AbbVie is expected to earn $7 billion, or $4.39 a share, on revenue of $22.8 billion in the fiscal year ending in December.
Viekira will help fill that gap before it appears. Its sales are estimated to total $2.6 billion this year versus next to nothing last year, and to peak at $3.4 billion next year before sliding back to $2.6 billion by 2019. Those are obviously estimates subject to change, but the big picture is promising. JPMorgan in a Thursday note wrote that despite Gilead’s discounting, it’s confident that AbbVie has a multibillion dollar hep-C business.
Then there’s the pipeline. AbbVie is currently testing treatments for celiac disease, leukemia, and endometriosis, a painful uterus condition that affects millions. It’s also testing a next-generation treatment for rheumatoid arthritis. Within eight years, today’s pipeline will contribute at least $7 billion in annual revenue, double what’s needed to offset Humira declines, according to Deutsche Bank.
Two more things. First, AbbVie pays royalties to Humira’s developers. When the patent goes away, so do the payments. That means revenue declines will be offset in part by higher gross profit margins. Second, AbbVie is expected to generate $7.1 billion in free cash flow this year, almost 8% of its stock market value—and even more in each of the next three years. That can pay for share repurchases and bigger dividends—or an acquisition. A deal could help diversify AbbVie’s revenue and, so long as the price isn’t extravagent, close the stock’s Humira discount.
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