Last analysis of VF Corporation showed that although share price performance over the last week was poor fundamental valuation didn’t change so much and I see no special opportunity to buy. Today we will have a look on Abbott Labs, which performed very weak over the last month. What’s happened?
When I was looking at company in January it seemed like a highly diversified business and I wrote, that at $33 it might be a good opportunity to buy shares. Now shares are traded at around $37 so I should have a closer look on what’s going on.
Results for Q1 were presented on 20 April and were broadly in line with expectations – small decline on reported net sales due to currency (strength of USD). Operating earnings were a little bit lower than in 2015.
On the other hand full year guidance was raised to EPS around $2.14 to $2.24 vs $2.10 to $2.20 before, which is definitely a positive sign. Share price reaction on financial results was slightly positive, but then…
Abbott announced a transaction with St. Jude Medical. From business point of view it seems that St. Jude Medical is a very suitable business.
Abbott will increase scale and will be able to enter new segments with strong brands. Cardiovascular segment will be dominated by combination of Abbott and St. Jude Medical products. Moreover Abbott is quite successful both in M&As and disinvestments. Moreover management is very good and know medical devices business much better than most of investors. So why are investors so worried?
The only problem is the size of the deal.
Transaction is huge. First transaction will increase number of shares outstanding in Abbott, but secondly (which is more important for me) a huge debt will be taken to pay a cash portion of deal. Adjusted debt-to-EBITDA ratio should increase to 4.5 and 3.8 in 2017 and 2018 respectively. It is a lot!
Moreover company will reduce share repurchase activity and moderate the pace of growth of its dividends. I see it as follows. Company will have a huge debt and if business go wrong (which might happens, global recession might come one day) there is a big probability that in some year company will decide to pay smaller dividend and lose Dividend Aristocrat status. Riskiness of company should increase after a deal and many long term investors (especially those looking for dividend growth) might have decided to sell Abbott and buy some more stable player, e.g. JNJ. I don’t say that it is bad to leverage (especially if cost of borrowing is low) and make a good deal. I only state it definitely change a risk profile for more risky and might be inappropriate for some investors.
Summing up, in the short term announcement of transaction was value decretive for investors. No one knows what will happen in the future. First of all there is a possibility that transaction will not be completed. Secondly there is a risk that synergies will not be as high as estimated. Also riskiness of company will significantly increase due to a high leverage. I will look closely on company and as previously assumed at $33 I will consider buying some shares. In long term current weakness might be a good opportunity for long term investors (but growth should come mainly from share price appreciation than dividends paid) and leverage (if used correctly) can positively influence profits.
Disclaimer ABT – no position