Abbott Laboratories: A Cheaper Version of Johnson & Johnson?

Johnson & Johnson

I recently wrote about Medtronic PLC (NYSE:MDT) because I’d like to broaden my exposure to medical device firms and diabetes treatment. I suggested that Medtronic is not worth investing in because of its (underperforming) diabetes franchise. Abbott Laboratories (NYSE:ABT) is a more viable portfolio selection in this setting.

Investors have been drawn to the company partly because of its good performance during the COVID-19 pandemic, in which it plays a vital role as a provider of quick testing devices. ABT’s share price reached $140 in December 2021 due to rising investor optimism. However, as global immunity has grown and newer SARS-CoV-2 strains have resulted in less severe outbreaks, demand for quick tests has fallen, as has investor optimism. As a result, the share price has now recovered to more realistic levels. I decided it was time to examine more closely at the company and compare it to industry leader Johnson & Johnson (NYSE:JNJ).

Balance Sheet Quality And Dividend Safety

Standard & Poor’s assessed the company’s long-term debt as A+ as of December 31, 2021, according to its 2021 10-K. According to FAST Graphs, the current credit rating is AA-. These are certainly impressive debt ratings, but they pale compared to JNJ, one of the few corporations with a AAA rating.

Based on statistics as of the end of fiscal 2021, Abbott’s debt-to-equity ratio was 1.1. In the hypothetical (and highly improbable) case that dividends and share buybacks were suspended, the corporation would need only three years to pay off all of its financial debt using free cash flow – hardly an uneasy level of leverage.

Over the next five years, more than half of Abbott’s long-term debt will mature. Thus it appears reasonable to expect the business to spend a bigger share of its operating income on interest expenses. However, Abbott is unconcerned about rising interest rates with a current interest coverage ratio of more than 12 relative to normalized free cash flow before interest and a good credit rating.

Management is particularly shareholder-friendly, increasing dividends at a CAGR of 9% over the last nine years. Growth has surged in recent years (three-year CAGR of nearly 14%). Johnson & Johnson is slightly poorer, but its dividend growth rate remains unusually constant for such a mature company, normally about 6% per year. Given JNJ’s (NYSE:JNJ) present 2.6% starting yield, I would not overestimate ABT’s higher dividend rate. Abbott would need to sustain 9% annualized dividend growth through 2038 for an investor to gain from the same return on cost (6.8%) as a new Johnson & Johnson investment, assuming JNJ maintains its dividend growth rate of 6% through 2038.

Valuation

Abbott stock has dropped more than 20% since its all-time high in December 2021. However, even at $110, I believe the stock is overpriced. Abbott has risen pretty rapidly in earnings per share since the spinoff of AbbVie in 2013 – a CAGR of more than 10% surely warrants a premium price-to-earnings (P/E) ratio. JNJ’s earnings per share increased at a CAGR of 5.5% over the same period.

The market’s “normal” P/E ratio of 23.6 appears a little far-fetched, considering that earnings expectations for the next few years are practically unchanged. It remains uncertain how well Abbott will offset diminishing demand for SARS-CoV-2 diagnostics, for example, through expanding medical device sales.

ABT currently has a composite P/E ratio of 21.5, whereas JNJ trades at 17.5 times earnings. Given the unpredictable nature of the pandemic, I would say that Abbott could surprise the upside, but JNJ remains the safer bet. The market is expecting a favorable surprise connected to the pandemic; otherwise, I’m not sure I understand the premium P/E ratio now allocated to ABT, although acknowledging Libre Freestyle’s robust growth. Considering the uncertainties, an annualized total return of 6% through 2024 appears slightly low.

JNJ is predicted to generate a comparable return, and analysts have been highly accurate in estimating JNJ’s earnings, even over two years. JNJ is simply the industry behemoth, and its management is doing an outstanding job – think of the company as a healthcare mutual fund. I also find the standard P/E ratio of 17 much more appealing. Finally, the higher starting yield of 2.6%, a fairly consistent annual growth rate of 6%, and a low payout ratio make JNJ appear to be an excellent dividend growth company.

Concluding Remarks

To summarize, I believe Abbott is an excellent, shareholder-friendly firm that is well managed and has a very strong financial sheet. The Medical Devices market is fascinating, and the diabetes care business is growing rapidly. It is not comparable to Medtronic, which is still struggling in this field. I see no reason why the company cannot achieve considerable excess returns on capital in the future if management continues to focus on the highest margin businesses. Given the solid balance sheet, I can also see management wanting to make acquisitions to strengthen the portfolio further. The corporation had $8.9 billion in cash and cash equivalents and $350 million in short-term investments at the end of the second quarter of 2022.

As a result, I’m keeping Abbott on my watch list and may reconsider if Mr. Market offers ABT shares for $100 or less. Regarding JNJ, I am reinvesting dividends but am not a buyer at the current pricing.

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About the author: Adewumi is an expert financial writer and crypto enthusiast with more than 2 years' experience in writing crypto news and investment analysis. When not writing or reading about crypto and finance, Adewumi spends his time watching football and visiting museums and art galleries.