Following the split from Abbott, AbbVie will carry approximately $16 billion in debt and $7 billion in cash. With cash flows from operations close to $6 billion annually, AbbVie shouldn’t have any problem servicing its interest expenses. However, we also don’t expect AbbVie will pay down debt rapidly, as it needs to bulk up its pipeline through acquisitions and partnerships. In addition, we expect AbbVie will probably pay out close to $2.5 billion annually in dividends
And a product, Humira, which is a megablockbuster:
We expect Humira will remain a leading drug in immunology disease over the next five years, and we project it will have an 11% five-year compound annual growth rate (slightly above consensus expectations because of our high conviction in the drug’s strong efficacy and safety). However, patent losses on several less prominent drugs reduce our five-year total sales CAGR to 5%. We believe earnings should outpace total sales growth thanks to the increasing contribution from Humira, which carries higher margins than the company average. Longer term, the company needs to build a better pipeline to prepare for increased Humira competition after 2016.
Armed with best-in-class Humira, AbbVie is well positioned to drive strong cash flows to support its next generation of pipeline drugs. With AbbVie’s next generation of drugs not likely to reach the market until 2015 and several midsize drugs losing patent protection, Humira’s cash flows are particularly important. The company also holds a portfolio of hard-to-make drugs that will help supplement Humira’s growth.
At more than 50% of total sales and a higher portion of earnings (due to higher-margin revenue), Humira is set to drive the majority of AbbVie’s performance over the next five years. With approvals in rheumatoid arthritis, psoriasis, and Crohn’s disease, Humira is well positioned for growth in these markets, as penetration rates are below 20% on average. Despite the low penetration, these markets already represent multi-billion-dollar opportunities. Furthermore, with leading efficacy and a favorable side effect profile, Humira should continue to post double-digit growth over the next couple of years, in our view.
Despite a strong near-term outlook for Humira, uncertainty around encroaching competition is likely to weigh on investor sentiment toward the company. In particular, Pfizer’s new RA drug Xeljanz represents a key new competitor, as it offers patients efficacy potentially as good as Humira in an oral form (in contrast to the twice-monthly Humira injections). However, Xeljanz’s side effect profile is still not fully clear and represents some risks, which may delay physician acceptance unless patients fail an anti-TNF-alpha drug like Humira. Additionally, many Phase III RA drugs are likely to reach the market over the next three years.
As an aside here, we have to wonder what possessed Pfizer to name their drug Xeljanz. Are drug names now judged based on their Scrabble scores?
Humira is wildly successful, accounting for more that 50% of AbbVie sales and 70% of profits. That’s a lot of power in a little syringe. The drug has an excellent safety profile, but AbbVie’s oversized reliance on it is anything but safe. The drug faces new challengers, has only a few years left of patent protection, and the company’s pipeline is anemic.
AbbVie’s pipeline is weighted heavily toward 2015 launches, with its hepatitis C drugs the crown jewel in the pipeline. While AbbVie holds other pipeline drugs, its next-generation hepatitis C drugs offer the potential to replace Humira sales if successful in Phase III development. Additionally, we expect AbbVie will redeploy capital through bolt-on acquisitions to strengthen its internal pipeline.
Ultimately, Morningstar values the company at $38 per share but sees a wide range of possible outcomes:
We believe Humira’s sales trajectory following the drug patent losses in 2017-18 represents the biggest unknown facing AbbVie. In our base case, we estimate approximately 20% annual Humira declines due to increasing generic competition and new branded competition emerging and gaining traction.
In our bear case, we assume 50% annual Humira declines starting in 2018, based on strong generic and branded competition. In this scenario, our fair value estimate drops to $16 as Humira’s high margins have an amplified impact on the bottom line. Conversely, in our best case, we assume generic and branded competition fail to materially take market share from Humira. Under this case, we project 2% annual Humira growth in 2018, which results in a $49 fair value estimate.
AbbVie finished when-issued trading at $34.16. Based on Morningstar’s fair value of $38, and the huge uncertainty in that number, there are undoubtedly better places to invest.
Disclosure: The author holds no position in any stock mentioned
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