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ABBOTT LABORATORIES

Analyst: LINH HO April, 23, 2013

HOLD

Support by technical analysis

Cash-rich balance and better debt structure

Constant and increasing dividends

Diversified products and markets

Positioning for substantial growth

Pricing Pressure

Uncertainty from healthcare reform

Threat from competitor’s innovation

Concern about nutritional segment

Overvalued by DDM and FCFE

Threat of Competition: High Threat of New Entrants: High Threat of Substitutes: Moderate Power of Suppliers: High Power of Buyers: HIGH

Abbott Laboratories is an American global

pharmaceuticals and health care products company.

It has 90,000 employees and operates in over 130

countries. The company headquarters are in Abbott

Park, North Chicago, Illinois. The company was

founded by Chicago physician, Dr. Wallace Calvin

Abbott in 1888. In 2010, Abbott had over $35 billion

in revenue. Source: Wikipedia

Ticker ABT

Exchange NYSE

Industry Generic

Pharmaceutical Manufacturing

Sector Healthcare

Classification Capital Appreciation

and Income

Market Cap. $58.32B

52 Week Price Range $28.26- $37.55

Recent Price $37.20

Current P/E 11.34 TTM

Projected 2015 P/E 13.6x

Projected 2015 EPS $2.5

Dividend Yield 1.67%

Debt Rating A1 (Moody’s)

Beta 0.52

Pros:

Cons:

Recommendation:

Porter’s Five Forces

Brief Overview

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At present, there are 5 stocks in healthcare industry under management of

the EIF, including ABT (Abbott Laboratories), CELG (Celgene Corp), SYK

(Stryker Corp), AKRX(Akorn Inc), ABBV(ABBVIE). The reason Thermo Fisher

Scientific was sold will be discussion latter. The weight of the sector is 12%,

which is also the target weight of EIF for healthcare industry. Most of EIF holdings

are doing very well and beat the S&P 500 index. Noticeably, ABT and CELG

which are holding total returns of 69% and 49.3% respectively, whereas these

numbers for S&P 500 are only 22% and 14.92%. This phenomenon is showing that

we picked up these stocks at the right time.

In terms of diversification, there is a quite low correlation between stocks in

our portfolio, except for the correlation between Stryker and Thermo Fisher. This

is understandable because both Stryker and Thermo Fisher Scientific are medical

technology companies which produce instruments, equipment and devices for

health care industry. Last year, SYK and TMO (Thermo Fisher Scientific lnc) was

considered to bring exemplary returns for the fund but the very high correlation

between TMO makes the fund become risky and less efficient. Besides some

fundamental issues, in order to improve the diversification of the holdings, EIF

decided to sell TMO to make the portfolio more efficient.

Ticker

Purchase

Date

Number of

Shares

Cost

Per Share

Current

Price

Current

Market Value

Equity Holding Period

Total Return (%)

EIF YTD EARNED

RETURN (%)

S&P 500 Holding

Period Return

Equity

Percentage

Last Dividend

ABT 4/21/2008 415 $24.18 $35.08 $14,558.20 69.04% 35.23% 21.99% 1.42% 0.14

ABBV 12/10/2012 415 $35.00 $37.58 $15,595.70 8.64% 8.64% 7.57% 1.52% 0.40

AKRX 2/8/2013 2,421 $13.00 $12.82 $31,037.22 -2.95% -2.95% 0.20% 3.02% No Dividend

CELG 6/15/2012 321 $66.00 $98.77 $31,705.17 49.29% 49.29% 14.92% 3.09% No Dividend

SYK 4/25/2012 480 $53.76 $63.85 $30,648.00 20.44% 20.44% 11.38% 2.98% 0.27

Company Name Abbott Labs Celgene Corp Stryker Corp Thermo Fisher Akorn Inc Abbvie Inc

Abbott Laboratories 1.00 0.40 0.53 0.53 0.27 -0.28

Celgene Corp 0.40 1.00 0.43 0.51 0.14 -0.09

Stryker Corp 0.53 0.43 1.00 0.69 0.24 0.29

Thermo Fisher Scientific Inc 0.53 0.51 0.69 1.00 0.23 -0.08

Akorn Inc 0.27 0.14 0.24 0.23 1.00 0.22

Abbvie Inc -0.28 -0.09 0.29 -0.08 0.22 1.00

Correlation

Portfolio Considerations

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The spinning off Abbvie seems to be a positive thing for our fund, in terms

of diversification when Abbvie has negative and low correlation with other stocks

in our portfolio. For example, the correlation between Abbot and Abbvie is -0.28.

This is explained by the fact that new Abbott now is a generic pharmaceutical

company whereas Abbvie is branded name pharmaceutical company. In the next

sections in the report, I will show that companies in generic pharmaceutical

industry are rivals and competitors to companies in brand name pharmaceutical

industries to some extent. Furthermore, later in the report, I will explain why

management of Abbott decided to spin-off Abbive. What are the strategic plans

and rationales behind this decision?

Since Abbott was established, research based pharmaceuticals have been

major revenue source and main line of business. However, there has been a change

in the company’s strategy by shifting its focus on from branded pharmaceuticals to

other segments, especially branded generic products. The spin-off of Proprietary

Pharmaceuticals (branded pharmaceuticals) business segment into a new

independent company, named Abbvie, was clear evidence for the company’s

strategic change. Under New Abbott, Branded Generics will account for 31.6%

(largest part and this number will increase in the future) of the new business1;

therefore, I decided to categorize New Abbott into Generic Pharmaceutical

Manufacturing industry.

1. Industry at a Glance

Data from IBIS shows the Generic Pharmaceutical Manufacturing industry

has total revenues of $44.7bn and a net profit margin of 14.8% in 2012. With

average growth 5.7% during 2008-2013 periods, the Generic Pharmaceutical

Industry outpaces the branded pharmaceutical industry which just earned -2.3%

profits for the same period of time. This trend is forecasted to continue due to

several factors such as patent cliff (period in which a lot of patents for brand drugs

1 JPM

I. Industry Analysis

4

will expire), health care reform, shifting from developed countries to emerging

markets. All of this factors as long

as other drivers like technology

change, private insurance and senior

population increase will foster the

growth of generic pharmaceutical

industry. It is estimated that the

industry will grow average 6.4% for

2013-2018 period. The growth

prospect of the industry, in turn,

will attract more and more

businesses, but sustained

consolidation and active M&A

activities will offset that trend. As a

result, IBISWorld project that during 5 years from 2013 to 2018, the number of

companies in the industry only increase average 0.4% per year to 1,141.

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Revenue Growth

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2. Drivers for Industry Growth

a. Patents cliff

In the next five years, many block-bluster brand name drugs like Nexium,

Cymbalta, and Humira, which have sales revenue over 1 billion of dollars will

expire. The expiration of these drugs will create opportunity for generic drugs

which are chemically identical to their branded counterparts, have same or similar

effects on diseases, but are sold for huge discounts. As a natural response,

customers will switch to buying generic drugs, instead of brand name

pharmaceuticals. According to the Congressional Budget Office, generic drugs can

save customers an estimated around from $8b - $10b per year at retail pharmacies.

At hospitals, the money saved is even bigger.

Furthermore, high pressure from stockholders, high failure risk, increased

research and development costs and government regulation projected to shorten

patent protection period make brand name drugs less attractive for pharmaceutical

firms. As a consequence, firms now are more interested in generic drugs because

these drugs require less R&D, failure risk and more profitable.

b. Healthcare reform

Abbott and other companies in the industry are clearly impacted by

Obamacare, whose purpose is to make healthcare generally less expensive and

increase the coverage for millions of people in the States. For example, the Patient

Protection and Affordable Care Act provide people more access to lower-cost

products by prohibiting brand name pharmaceutical manufacturers from changing

their drug labels to brand-name. Furthermore, to make the healthcare costs more

reasonable for people, the Government is considering shortening the patent

protection time for branded products, making them become generic drugs more

quickly; thereby lowering their prices. Last but not least, Medicare and Medicaid

are receiving more funds from the government to cover people under their

program. Covered by Medicare and Medicaid, many people have chance to access

to drugs and medical products which they could not before. These, in turn, will

help increase customer base for companies like Abbott.

c. Aging people increase

Senior people are the main consumers of drugs and medical therapies

because when they are old, they more likely to contract illnesses and age-related

diseases. More than 90.0% of seniors and 58.0% of all adults rely on a prescription

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medicine on a regular basis, according to the Agency for Healthcare Research and

Quality2. Baby boomers have started reaching ages of 65 or older. This trend will

create an average growth rate of 3.1% per year. As this senior group increases, the

demand for industry products will rise as well.

d. Number of people with private health insurance

Private health insurance coverage helps people be able to afford products

and services in the industry by reducing out-of-pocket costs of pharmaceuticals. In

other words, thanks to private health insurance, the demand for pharmaceuticals in

general and generic pharmaceuticals will increase in the years to come. According

to IBIS, there will have a sharp increase in the number of people with private

health insurance from now to 2007. This trend is due to: First. the recovery of the

economy will get people jobs. These people will be covered under their employers’

healthcare plan. Second, in 2014, a health insurance exchange will start. The intent

of health insurance exchange is to create a better organized and competitive market

for health insurance by increasing regulation on offering and pricing of insurance

products, providing customers with more information and more choice of plans

which they can find more suitable for them, and subsidizing premium for poor

people. All of these favorable characteristics of new health insurance exchange

will enroll more people into private health insurance.

2 IBIS

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E. Demand from Emerging markets

When living standard improved, people will spend more money on health

expenditure. In emerging countries like Brazil, India, Russia, and China, there is a

merge of middle classes who are caring more for their health and spending more

on drugs and medical products. However, in these emerging market, most of the

time, people pay out-of-pockets for their medicines; therefore, they often choose

generic products, instead of expensive brand name drugs. In other words, generic

pharmaceuticals have more advantage in emerging nations. As seen in the charts

below, spending on pharmaceuticals in emerging markets will nearly equal that in

the U.S by 2015. Although, there are a lot of risks for doing business, potential

demand from these developing countries is huge and worth to make a bet.

3. Products and Services

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a. Products

In 2013, pharmaceutical preparations are expected to account for about

75.1% of industry revenue, a slight decline compared to 78.0% in 2008. The

decline is entirely due to the growth of generic biologics. Preparations make up the

largest product segment and include drugs that are ready-made for use, such as

those in the form of ampoules, tablets, capsules, vials, ointments, powders,

solutions and suspensions. Prescription drug manufacturers and over-the-counter

(OTC) pharmaceutical companies make them. Products in this segment are

distributed to two primary lines: professionals in the dental, medical or veterinary

fields and the general public. Although veterinary drugs account for a relatively

small percentage of overall industry revenue, many leading companies are

involved in the animal healthcare industry and some maintain specific animal

health divisions.

Cardiovascular and oncology

In 2013, key therapeutic drugs are oncologics, followed by respiratory

agents and lipid regulators, based on revenue. Antidepressants and lipid regulators

are the most prescribed prescriptions. In addition to the established key therapy

areas, there is a promising pipeline of therapeutics, including products to treat

central nervous system disorders and diabetes, both of which will see increasing

revenue, according to the Agency for Healthcare Research and Quality.

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Medicinal and botanical products supply the preparations

Medicinal and botanical products account for roughly 9.6% of industry

revenue. Companies in this segment furnish the active ingredients used by

pharmaceutical firms to manufacture finished products or pharmaceutical

preparations. Components produced by this segment include endocrine products,

basic vitamins and extracts of unprocessed drugs derived from plant or animal

sources, such as agar.

Biological products are made from living systems or organisms

This category covers the production of bacterial and virus vaccines, serums,

plasmas and other blood derivatives (except for in vitro and in vivo diagnostic

substances). Most biologics cannot be made synthetically; rather, they are

produced using living systems or organisms, which makes the manufacturing

process more difficult.

Global initiatives aimed at eradicating deadly diseases as well as preventing

common illnesses, such as ear infections, have boosted growth of biological

products in recent years. Additionally, manufacturers have increased their

development of more user-friendly vaccines, such as vaccines sans needles, which

can be priced at a premium.

Although demand and revenue of biologics are rising, biologics are costly

and relatively difficult to produce as production ingredients are derived from living

material and they require special facilities with high quality assurance. In addition,

the regulations controlling production are often more extensive than for other

pharmaceutical products. Nonetheless, biologics are attractive to pharmaceutical

companies because they command higher prices, and revenue is growing at a faster

rate than for traditional prescription drugs.

In 2010, the Affordable Care Act implemented legislation on patents for

biologics, paving the way for generic biological products (biosimilars). In 2013,

major biological products, such as Procrit and Humalog are scheduled to lose

patent protection. Both products had over $1.0 billion in global revenue over 2012.

As a result, revenue generated from biosimilars is expected to increase in 2013.

Over the year, biological products are expected to generate 9.5% of industry

revenue.

In vitro and in vivo diagnostic substances are on the move

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In vitro (meaning "in glass," such as in a test tube) and in vivo (meaning "in

the body") diagnostic substances are chemical, biological, or radioactive

substances used in diagnosing or monitoring the state of human or animal health by

identifying and measuring constituents of body fluids or tissues. In vitro

diagnostics, which are used outside of the body, constitute the largest share of this

product category.

The current trend in the segment is to miniaturize in vitro diagnostics

machinery to make it more portable. This point-of-care (POC) testing is expected

to present the greatest growth area in the near future for in vitro diagnostics.

Already, the technology is penetrating hospitals and medical centers and will soon

be available in the home healthcare field. While FDA approval of products, such as

an imaging agent for use with ultrasound technology, is expected to help bolster

the category, current regulations are stringent and an increasing burden.

Therapeutic classes

The most prescribed generic drugs in 2013 are expected to continue to be

related to pain treatment, high cholesterol and high blood pressure. Just over half

of the drugs dispensed for high blood cholesterol in the United States are generics.

Similarly, generic products dominate the large class of cardiovascular

medications.3

b. Market and supply chains

Retail pharmacy chains, mail-order pharmacies, group purchasing

organizations, distributors and wholesalers are direct customers of generic drug

producers. In other words, end-user customers have to get drugs from independent

pharmacies, managed care organizations and hospitals which are redistributed by

distributors, wholesalers and so on.

One of the issues for the industry is that a substantial portion of sales goes to

small number of U.S retail drug chain, wholesalers and group-purchasing

organizations. These buyers have already had a prevailing purchase power. In

addition to that, many these customers have tendency to implement consolidation

and integration to gain even bigger power. This trend will pose a huge risk for the

industry because it is very hard for them to maintain a high profit margin when

customers get large discounts and create an enormous price pressure on products.

3 IBIS

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Although FDA set up quality standards for products, many retailers who

play critical role in determining the sales of producers, want to go beyond these

standards to ensure everything is good at every level of production and

distribution. Because the competition is so high in the market, manufacturers have

no choice to increase the quality standards as required by retailers. To do that,

more investment will be needed and more costs will incur, dragging down profit

margin.

Changing regulations

As an outcome of healthcare reform and poor economy, regulatory and

competitive environment have been reshaped. The distribution system has become

much more complex. For example, third-party logistics are challenging

conventional wholesale position. An increasing number of orders are direct sales

coming from mail order or online. Moreover, regulators require companies to make

their pricing details more transparent as well as initiate methods to reduce price of

drugs.

Wholesalers

Despite these changes, it may take years to see a considerable effect and

drug wholesalers are still the largest customer category for pharmaceutical and

medicine manufacturers, accounting for an estimated 58.7% of industry revenue in

2013. Why can wholesalers achieve this position in the industry? One of the

answers for this question is: As a key buyer in the market, hospitals often prefer to

delegate inventory management to wholesalers to reduce investments in inventory

and receivables, and manufacturers want to outsource much of the distribution

work to wholesalers to focus on core competencies: research and development

(R&D) and marketing. In this regard, generic drug manufacturers use direct

distribution more often than branded companies, because generics can afford to

devote more resources to distribution and less to research. Under the wholesaler

chain is drug store chain. Drug store chain is the main buyer from wholesalers;

accounting for 27.8% wholesales revenue. Among chain drug stores,

merchandisers and super markets with pharmacies inside like Wal-Mart take a

large part of that.

Third-party logistics providers

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Third-party logistics, like DHL, UPS, FedEx, are increasing their role in the

distribution system. Providers are expected to account for about 15.0%, up slightly

from 2008, because these firms have benefitted from the outsourcing of drug

distribution activities. Most notably is DHL, which landed a lucrative long-term

contract with Pfizer to become the first logistics provider to be given complete

responsibility for the company's worldwide clinical trial materials distribution,

according to In-Pharma Technologist.4

Direct sales

There are a lot of methods that companies can use to sell their products

directly to end-user customers like online sales, but this trend does not really have

a huge impact on the sales in the next several years. According to IBIS, Direct-to-

consumer sales are expected to account for about only 9.0% of pharmaceutical

sales in 2013, about the same as 2008.

4 IBIS

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1. Threat of Competition: High

The competition in the industry increasingly base on price. The continued

price decline is cutting down profit margin of companies. Many of them cannot

endure fierce competition and have to accept merge or to be acquired with other

firms. This can be seen clearly by looking at the forecast for the number of firms in

the years to come. According to IBIS, growth rate for number of companies is only

average 0.4% per year from now to 2017 despite of the fact that many new

companies are entering the markets.

Furthermore, only a small number of retail drug chains and wholesalers

account for a substantial part of U.S generic sales. These retail drug chains and

wholesales are consolidating and gaining more purchase power. Due to

consolidation between customers, pharmaceutical firms are working very hard to

gain contracts with their customers.

Most importantly, generic drugs companies are also facing aggressive

competition from brand name pharmaceutical producers. To some extent, we can

consider generic drug market as derivatives from brand name drug market because

most of generic drugs come from expiration of their branded drugs. If companies

in the brand name industry know how to prevent or delay approval of generic

equivalents, this action will seriously and negatively affect the generic drug

market. Many tactics and techniques are used by brand name companies such as:

filing suits for patents infringements that may delay approval of new generic

products, reducing the demand for the first generic products by bringing out “next-

generation” drugs prior to expiration of market exclusivity for the reference

product and applying to extend patented product protection and etc.

2. Threat of New Entrants: High

Many people may think that new entrant barrier into the generic

pharmaceutical market is low because firms do not have patent protection.

However, a lot of other barriers are created to make new firms find hard to enter

the market. First of all, high front costs such as infrastructure investment, R&D,

and marketing expenditures, give well-established and sizable companies more

advantage over smaller and start-up firms. Furthermore, manufacturing of generic

products is highly controlled by regulators like FDA. FDA often set up a series of

quality standards relating to products and production process. Not every company

II. Porter’s Five Forces

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with less experience has capability to meet these standards at reasonable costs.

Competing within an environment in which saving costs is the key to success;

many companies cannot see an attractive profit margin to enter the market if they

have to meet all of requirements from FDA. Last but not least, reputation plays a

critical role for operators in the market because customers have tendency to choose

products from well-established firms. This trend makes new entrants with less

reputation disadvantageous to popular producers. All of these factors contribute to

failure of many newcomers into the market when many firms go bankrupt or are

acquired by other bigger companies.

3. Threat of Substitutes: Moderate

The increase in R&D and rapid change in technology create opportunity for

potential new products. For example, many firms now are focusing on producing

new compounds or unique biologic products. The new biologic drugs may have

better use and effect than existing generic drugs to cure certain diseases. In many

parts of the world, there are some alternative medical treatments, but not widely

used. In this respect, some non-pharmaceutical substitutes may challenge the

industry to some extent. For example, psychiatry may replace anti-depressants. In

some markets, especially in Asia, herbs, acupuncture, and other traditional

therapies are likely to substitute for prescription drugs.

4. Power of Suppliers: Moderate to High

First of all, we need to know that inputs for producing a drug vary from

stage to stage. During research and development stage, for example, primary inputs

are laboratory and research equipment. These inputs are quite unique because it

supports only certain purpose. As a result, suppliers have quite high power in this

situation. In other stages, like production and manufacturing or packaging and

labeling materials, the inputs are quite homogeneous; therefore, pharmaceutical

producers have more choice of their suppliers. Consequently, these suppliers have

little or low bargaining control on drug manufacturers.

5. Power of Buyers: Moderate High

The major buyers for pharmaceutical products include retail drug store

chain, hospitals, wholesalers and state and federal government. These buyers often

purchase in huge volume; therefore, gain a lot of discount. Furthermore, many

wholesalers and drug store chains are undergoing integration and consolidation.

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This activity will make them become bigger organizations and give them

more purchase power. Moreover, there are a lot of variations of a generic drug

which have the same function and effect. This characteristic obviously provides

customers more choice of which one is suitable for their needs and their ability to

pay. However, customers sometimes do not have much option in situations like the

drugs are prescribed by physicians.

Dr. Wallace C. Abbott founded the company in 1888 when he was a

practicing physician and pharmacy proprietor at his People’s Drug Store in

Chicago. In 1898, Dr. Abbott started making tiny pills called dosimetric granules

using alkaloid to improve his patients’ medication. Very soon after that, the

therapy became very popular among patients and other doctors in the region.

Abbott Laboratories was known as Abbott Alkaloidal Company at that time.

During its first years of operation, the company had very modest revenue which

was approximately $2000. But by 1910, however, the company expanded

exponentially to other regions such as New York, San Francisco, Seattle and

Toronto with more than 700 products. In 1915, Alkaloidal Company officially

changed its name to Abbott Laboratories to target the company’s course of

development into research and synthetic compounds. The company did IPO in

1929, and now Abbott has presence in more than 130 countries worldwide with

91,000 employees and revenue of $39b in 2012.(Wikipedia)

United States 42%

All Other Countries

29%

Japan 6%

The Netherlands 5%

Germany 4%

France 3%

Italy 3%

Canada 3%

Spain 2%

United Kingdom

3%

Sales by Region

III. Company Overview

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Basically, Abbott has two main product groups. The first is diversified

medical products which comprise medical devices, established pharmaceuticals,

nutritional products and diagnostics. The other one is research-based

pharmaceuticals which bring major revenue for Abbott and spurred most of the

firm’s growth. Products from the second group are brand-name; therefore, Abbott

was categorized in brand pharmaceutical industry before 2013.

Since established, research-based pharmaceuticals have been Abbott’s core

line of business for many decades. However, in recent years, the company has been

shifting its focus on to diversified medical product sector. The question is why?

First of all, the research-based pharmaceuticals are extremely risky. The statistics

data follow will help us understand how risky brand name manufacturing industry

is. Only one of every ten thousand discovered compounds will become an

approved drug for sale. Beyond that, it takes companies from 7 to 10 years to get

official approval. And only there out of twenty drugs end up making enough

revenue to cover their costs5. As can be seen in the chart below, the cost of

production of a successful drug is increasing from time to time. Therefore, in order

to be successful in the market, companies need to have a consistent stream of

blockbuster (which have billions of dollar of sales revenue) coming out every

certain years.

Secondly, patent expiration is creating huge pressure on brand name

companies. When patents expire, other companies in the market can produce

generic drugs which are as effective as branded drugs, but cheaper. This makes 5 http:// www.phrma.org/about/biopharmaceuticals

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Drug Development cost (Millions of $)

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brand name pharmaceutical firms find hard for their premium prices. In some

cases, after a drug loses its patent protection, its price plunges 80%. Moreover,

generic drug companies do not have to spend much money on R&D and enjoy

reputation established by their brand name counterparts. In recent years, under

Obamacare, government is implementing a series of actions to make prescription

drugs more affordable such as shortening patent protection periods and carrying

out rebate programs. All of these factors make branded drugs less attractive and

less profitable and leaning toward to generic products is a new trend. Abbott is go

ahead to take advantage of this trend.

The culmination of this shift is the spinning off its proprietary

pharmaceutical company, named AbbVie. There are several strategic rationales

and actions behind this spinning off. First of all, according to managers of Abbott,

the investment identity and the operating model of each separate enterprise is very

different from the other. The management thinks that keeping generic and brand

name segments together will not a wise choice when investors as well as market

will not fully realize the fundamentals of the company and believe that the value of

Abbott will be better revaluated with this spin-off. Second, Humira – current brand

name blockbuster and other patented drugs which will belong to AbbVie after

spin-off are going to lose their patent protection in the next five years. As

mentioned above, after losing protection, these products will be sold at huge

discount and no longer are main money-making money machines for the company.

In addition to that, R&D expenses are enormous and prohibitive for product

discovery and development. These R&D expenses from research-base segment

will badly affect the profit margin of generic sector which have much lower R&D

costs if we let both of them stay together. Last but not least, old Abbott will

transfer nearly 70% of its debt to Abbvie, leaving the new Abbott with more free

cash flow to implement its strategy to focus on generic drug development. JP

Morgan estimates that sales growth for new Abbott will be from 5% to 5.5%

annually in the next five years whereas this number for brand name segment is

1.5%.

Divisions and products

Proprietary Pharmaceuticals

As the name implied, this segment includes all of the products which are

made internally by Abbott. These segments have some blockbuster drugs such as

Humira - or the treatment of rheumatoid arthritis, Kaletra - for the treatment of

HIV infection; Lupron - or the palliative treatment of advanced prostate cancer and

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Synagis - for the prevention of respiratory syncytial virus. These prodcts account

for 79% revenue of this segment in which Humira makes 47% total revenue.

Wholesalers, Government Agencies, healthcare facilities, and independent retailers

are main buyers of these drugs. Competition with Proprietary Pharmaceuticals

comes from other healthcare and pharmaceutical companies. The introduction of

new products by competitors or changes in medical therapy may severely affect

Proprietary pharmaceuticals by making existing products obsolete. Because of high

risk associated with patent loss, sluggish growth and fierce competition from

generic companies, Abbott’s managers decided to spin-off this segment, beginning

in 2013.

Established Pharmaceuticals

This is the division which management sees most growth and is spending a

lot of investment into. These products include a broad line of branded generic

pharmaceuticals manufactured worldwide and marketed and sold outside the

United States, and are generally sold directly to wholesalers, distributors,

government agencies, health care facilities, specialty pharmacies, and independent

retailers from Abbott-owned distribution centers and public warehouses, depending

on the market served. Some principle products for this division are: Creon® - for

the treatment of pancreatic exocrine insufficiency associated with several

underlying conditions, Influvac®, an influenza vaccine available during flu season;

Brufen®, for the treatment of pain, fever and inflammation and so on. This

segment is supported by healthcare reform which wants to help people to access

medical products and service at more reasonable prices.

Vascular products

These products include a broad line of coronary, endovascular, vessel

closure, and structural heart devices for the treatment of vascular disease

manufactured, marketed and sold worldwide. The main buyers for these products

are hospitals. Sales are implemented through Abbott-owned distribution centers or

public warehouses. Some main products for this segments are: Absorb®, a drug-

eluting coronary bioresorbable vascular scaffold, Xience Xpedition®, Xience

Prime®, Xience nano™, and Xience V®, drug-eluting coronary stent systems

developed on the Multi-Link Vision® platform; and MitraClip®, a percutaneous

valve repair system. Technological innovation, price, convenience of use, and long

term contracts may make the market very competitive. Just take long term contract

as an example. There are a small amount of hospitals which often buy products

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under million or even billion dollar contracts. Every company understands that

gaining the contract with these hospitals will ensure the revenue stream in the long

run. That explains why companies compete so aggressively to earn these contracts.

Diagnostics

These products include a broad line of diagnostic systems and tests

manufactured, marketed, and sold worldwide to blood banks, hospitals,

commercial laboratories, clinics, physicians' offices, government agencies,

alternate-care testing sites, and plasma protein therapeutic companies. In recent

years, Abbott has made more bet into this segment through a series of acquisitions

of companies already in their respective markets. Some key products in this

segment are: the Vysis® product line of genomic-based tests, the m2000™, an

instrument that automates the extraction, purification, and preparation of DNA and

RNA from patient sample, Immunoassay and clinical chemistry systems, including

ARCHITECT® and ABBOTT PRISM®. Many products are facing risk of being

obsolete when other companies introduce new products into the market.

Nutritionals

This division has been split into adult and pediatric nutritionals. This

segment has been gaining its position in the emerging market. Currently, Abbott is

the largest nutrition firm in the world. On the one hand, some chief pediatric

nutritional products are: Similac®Advance®, Similac® Advance® with

EarlyShield®, Similac®. One the other hand, we have adult nutritional products

like Ensure®, Ensure Plus®, Ensure® Muscle Health, Ensure®. Primary

marketing efforts for nutritional products are directed toward securing the

recommendation of Abbott's brand of products by physicians or other health care

professionals. Competition for these nutritional products comes from other

diversified consumers and healthcare manufacturers basing on competitive factors

like consumer advertising, formulation, scientific innovation and intellectual

property.

20

45%

13%

16%

11%

8%

4% 3%

Sales by segments of old Abbott

Proprietary Pharmaceutical

Established Pharmaceutical

Nutritionals

Diagnostics

Vascular

Diabetes Care & Other

Medical Optics

21

Noticeable M&A

When Competition in the industry is increasingly aggressive and the market

becomes saturated, big companies like Abbott often activate M&A activities to

take of advantage of economies of scales as well as create new segment and

achieve stable source of revenue.

In 1964, Abbott purchased Ross Laboratories and turned it into wholly

owned subsidiary of Abbott. Abbott renamed Ross Laboratories into Nutrition in

2007. This transaction is one of the most successful M&A deals of the company

because as you know Abbott now is the largest firm in the world for nutritional

products.

In order to maintain position as a leader in global, broad-based health care

and an innovator in new medicines, technologies and health management, since

2001, Abbott made a series of strategic acquisitions and surprisingly all of these

purchases are quite successful so far. We can name some of them such as Knoll a

the pharmaceutical division of BASF, TheraSense – a diabetes care company, the

vascular device division of Guidant and Advanced Medical Optics, giving Abbott a

Vision Eye care division in 2009. As you can see in the financial statements of

Abbott, all of these segments earn them their own space in these statements,

proving their significant position with the company.

For example, in 2001, Abbott took over BASF AG’s Knoll Pharmaceuticals

unit in 2001 for $6.9 billion dollars. The purpose of this deal is to expand Abbott’s

drug research business and provide it access to several experimental medicines.

The acquisition of Knoll proves to be a phenomenal success for Abbott when Knoll

created and owned the drug Humira, a blockbuster, which treats rheumatoid

arthritis. Humira is estimated to bring to Abbott more than $10 billion in sales until

its patent is expired.

In February 2010, Abbott purchased Solvay’s pharmaceutical business

(Solvay Pharmaceuticals) for nearly $6.1b, in cash, plus additional payments of up

to EUR 100m per year if sales milestones are met in 2011, 2012, and 2013. The

acquisition of Solve is to provide Abbott with a large and complementary portfolio

of pharmaceutical products and expand operation of the firm into global emerging

markets where lucrative opportunities emerge.

In March 2010, Abbott took over STARLIMS Technologies for

approximately $100 in cash, providing Abbott with leading products and expertise

22

to build its position in laboratory informatics. The acquisition enhanced Abbott’s

early-and-mid stage pharmaceutical pipeline, including a biologic for multiple

sclerosis and compounds that complement Abbott’s oncology program.

On September 8, 2010, Abbott purchased Piramal Healthcare Limited’s

Healthcare Solutions business, a leader in the Indian branded generics market, for

$2.2b, in cash and additional payments of $400m annually in 2011, 2012, 2013,

2014. Abbott recorded a $1.6b liability for the present value of the additional

payments at the acquisition date. This amount of money surely will affect cash

position of the firm to some extent. But looking at cash position of the firm on its

balance, I do not see a problem for Abbott to service these payments.

Main risk factors

As a company working in the field relating to people health, Abbott has to

comply with a lot of government regulations. It may be very costly to meet all of

the requirements set by regulators like FDA. The process of getting a product

approval is very tedious and time-consuming. Normally, it takes the company from

7-12 years to complete the process. Any delay in this approval process may affect

expectation of the company revenue in the future and on Abbott’s stock price.

Even after achieving approval from FDA, there is no assurance that Abbott will

remain compliance with applicable FDA and other regulatory requirements. A lot

of issues relating to producing, labeling, and packaging may create defected

products or quality problems. Any of these events may not only disrupt the

business (such as, recall, shut down of production, seizure, and refunds,), but also

bring company to law suits. Product liability claims and lawsuits and safety alerts

or product recalls, regardless of their validity or ultimate outcome, may have a

material adverse effect on Abbott's business and reputation and on Abbott's ability

to attract and retain customers. Consequences may also include additional costs, a

decrease in market share for the products, lower income or exposure to other

claims. All of these costly expenses will materially affect Abbott’s financial

position.

In addition to that, investors should expect risks relating to Changes in the

health care regulatory environment. Obamacare program with the Patient

Protection and Affordable Care Act and the Health Care and Education

Reconciliation Act of 2010 is trying to make access to health care products and

services easier for people by creating new fees for the pharmaceutical and medical

device industries. Furthermore, other programs are also implemented like increase

in rebate rate, or requiring additional reporting and disclosure to protect customers.

23

It is very hard for Abbott to predict and estimate this risk factor which is totally out

of their control

Abbott's research and development efforts may not succeed in developing

commercially successful products and technologies, which may cause Abbott's

revenue and profitability to decline. To remain competitive, Abbott must continue

to launch new products and technologies. To accomplish this, Abbott commits

substantial efforts, funds, and other resources to research and development. A high

rate of failure is inherent in the research and development of new products and

technologies. Abbott must make ongoing substantial expenditures without any

assurance that its efforts will be commercially successful. Failure can occur at any

point in the process, including after significant funds have been invested. By

spinning off Abbvie, Abbott gets rid of significant amount of this type of this.

The international nature of Abbott's business subjects it to additional

business risks that may cause its revenue and profitability to decline and unstable.

Following the separation of AbbVie, sales outside of the United States are

expected to make up approximately 70 percent of Abbott's net sales. The risks

associated with Abbott's operations outside the United States include: First, the

company has to comply with governmental legislation which regulates

manufacturing and marketing of its products. Because the law systems and

requirements in each country are very different, it may be costly to meet all of the

requirements as well as to gain approval for Abbott’s products. Furthermore, one

of the target markets Abbott wants to expand is the emerging markets, like China

and India; however, in these countries, copyright violation and patent infringement

are rampant and hard to control. If Abbott does not control its intellectual property

well, the company may lose its competitive advantage to domestic rivals who can

copy its products and sell with much cheaper price. Last but not least, currency risk

could negatively affect the operation of Abbott. Moreover, performance results of

foreign facilities will be translated into U.S dollar for consolidated financial

statements. Unfavorable move of foreign currency against the U.S dollar will cause

the financial statements to look unattractive to outside stakeholders. As you can see

in the table below how significantly a change in Foreign exchange may impact on

a change in sales of Abbott. In 2012, a disadvantage movement of foreign

exchange took away 2.9% revenue growth of Abbott. In the future, if Abbott finds

out effective hedge method, the firm may make their sales performance look more

stable and predictable.

Total

% Change Price Volume Forex

Total Net Sales

2012 2.6 1.7 3.8 (2.9)

2011 10.53 1.20 6.50 2.80

2010 14.3 (0.10) 13.20 1.20

2009 4.2 (0.10) 8.30 (4.00)

Components of Change

24

Looking at the chart, we can easily realize that, during October to the first

half of November, Abbott stock was trading at very high price and very high

volume. This is the time there were rumor on Abbvie spin-off. After Abbott

officially announced the spin-off, many investors think that the effect of rumor had

been full reflected on the price, then decided to sell their shares to protect their

return, making Abbott price plunge. From December to now, the stock consistently

recover and increase due to positive perspective investors have on the spin-off.

Some rationale investors think this spin-off is better for Abbott as follow: New

Abbott gives away the risk it may get from patent protection loss for many of its

products to Abbvie. Second, 70% of its debt was transferred to Abbvie, leaving

Abbott with better free cash flow to focus on its strategies for generic drugs.

Lastly, revenue is expected to higher from 5%-5.5% annually.

IV. Recent SYK Performance

25

Altman Z-score: 4.1

Profitability: Abbott is doing really well in maintaining and improving their gross

profit margin from time to time. The improvement in gross profit margin is

explained by better margins in the established pharmaceutical, diagnostics,

diabetes, and nutritional businesses. Although Abbott’s gross profit margin is far

behind its competitors, the net profit margin of the company is nearly par with J&J

and industry average. The reason for this trend is Abbott’s tax advantage position

when its effective tax for 2012 was only 5%. This number for J&J and industry

average is 23.7% and 23% respectively. Furthermore, R&D expenses which

FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 Pfizer J&J Industry Avg

Return on Common Equity 12% 20% 28% 25% 20% 19% 23% 17.8% 17.8% 26.0%

Return on Assets 5% 9% 12% 11% 8% 8% 9% 7.8% 9.2% 10.7%

Gross Margin 57% 56% 58% 58% 58% 60% 62% 81.4% 67.8% 71.2%

EBITDA Margin 26% 25% 28% 30% 26% 24% 27,98% 46.2% 30.8% 33.3%

Operating Margin 19% 18% 21% 22% 18% 17% 21% 33.3% 25.3% 25.5%

Pretax Margin 10% 17% 20% 23% 16% 13% 16% 20.5% 20.5% 20.9%

Net Income Margin 8% 14% 17% 19% 13% 12% 15% 24.7% 16.1% 16.8%

Quick Ratio 0.47 0.85 0.91 1.26 0.73 1.02 1.72 1.58 1.34 1.17

Current Ratio 0.94 1.54 1.47 1.79 1.29 1.54 2.36 2.15 1.9 1.72

Debt to Equity 1.57 1.23 1.43 1.29 1.66 1.46 1.51 1.29 0.87 1.88

Financial Leverage 2.57 2.23 2.43 2.29 2.66 2.46 2.49 2.29 1.93 2.52

Asset Turnover 0.62 0.65 0.70 0.59 0.58 0.64 0.63 0.3 0.6 0.6

Inventory Turnover 3.43 3.87 4.42 3.94 4.60 4.73 4.27 1.61 3.14 2.66

P/E 17.90 19.20 18.30 13.00 12.20 11.00 12.92 11.5x 13.6x 16.1x

Price/Book 5.30 4.87 4.72 3.65 3.25 3.57 3.86 2.3 3.0 5.1

Price/Sales 3.32 3.34 2.79 2.71 2.11 2.25 2.59 3.16 2.85 2.79

Price/Cash Flow 15.21 18.75 12.82 12.43 9.08 10.40 11.08 10.94 12.43 11.76

Net Profit Margin 8% 14% 17% 19% 13% 12% 15% 25% 16% 17%

Asset Turnover 0.62 0.65 0.70 0.59 0.58 0.64 0.63 0.32 0.57 0.61

Financial Leverage 2.57 2.23 2.43 2.29 2.66 2.46 2.49 2.29 1.93 2.52

Return on Equity 12% 20% 28% 25% 20% 19% 23% 18% 18% 26%

Additional

Effective Tax Rate 25% 19% 19% 20% 19% 9% 5% 21.2% 23.7% 23.0%

Dvd Payout Ratio 103% 54% 44% 42% 57% 62% 44% 68.9 61% 66%

Sustainable Growth Rate -0.4% 9.3% 15.5% 14.6% 8.6% 7.3% 13.0% 5.55 7% 13%

Returns

Margins

Liquidity Ratios:

Debt Utilization:

Asset Utilization:

Valuation Ratios:

DuPont Analysis:

V. Financial Analysis

jdlasKF;DAS

26

represent a substantial portion of pharmaceutical firms like Abbot, actually account

for smaller percentage of Abbot’s earnings than its competitors like J&J and Pfizer.

From data table above, we can say that Abbott is one the right track to improve its

profitability and are catching up with its competitors. However, rebate programs

under Medicare and Medicaid may create challenge for the company to enhance its

profit margin in the years to come. According to Abbott’s managers, one-

percentage point increase in the percentage of rebates to related gross sales would

decrease net sales by approximately $269m in 2012. Rebates and charge backs

charged against gross sales in 2012 were $6.2b, equivalent with 22.9% of gross

sales subject to rebate.

Operating: These ratios show Abbott’s excellence in controlling its assets. First of

all, receivable turnover, inventory turnover and asset turnover are better than its

competitors and industry. Furthermore, as a result of acquisitions, inventory will

increase. If the company does not manage their new inventory well, these assets

may turn obsolete and have to be written-off. The inventory turnover ratio has

remained nearly unchanged from 2010 – 2012. This clearly tells us that the

company does not face any difficulty to sell new products compared to its existing

products. This conclusion is once again shored up when we look at asset turnover

ratio. The maintenance of ratio from 2007-2012 proves that sales increase well

enough to offset the increase of assets, which is a positive trend.

Liquidity: In the last report, analyst Bobby raised concern on the liquidity of the

company because ratios of Abbott like current rations and quick ratios were deeply

below those of its competitors and industry average. However, looking at the

numbers for 2012, we can see that the situation has changed dramatically. This is

understandable because Abbott was using a lot of their cash for acquisition

activities, restructuring expenses and making early principal payments for their

debts, leading liquidity ratios plunge. In 2012, when the companies spent less for

mentioned activities, their cash position has improve a lot, so their liquidity ratios

which are higher than those of Abbott’s competitors and industry average.

Debt Utilization: Although debt-to-equity and leverage ratios are higher than

those of J&J and Pfizer to some extent, this does not cause much worry for

company future. First of all, the company has enough cash reserve to service its

debt interest. Second, I do not see any significant principle debt to be mature in the

near future, which may have consideration on financial position of the firms.

Lastly, after spinning off Abbvie, Abbott will transfer 70% of its debt to Abbvie;

therefore, we can see Abbott’s debt structure will improve a lot in 2013.

27

DuPont:

Return on Equity figure measures Abbott’s profitability by revealing how

much profit the company has generated with the money shareholders have put into.

Dupont analysis will help us explain and understand in which way the company

can improve ROE. According to data table above, ROE for Abbott in 2012 is 23%,

which beats its competitors J&J and Pfizer. Dupont analysis tells us there are 3

ways the company may make an impact on its bottom-line number. First, the

company may increase its net profit margin. However, this does not explain why

ROE of Abbott’s is better than those of its competitors because Abbott’s net profit

margin is far behind J&J and Pfizer. In order to do this, the company has to either

increase its price or reduce cost. It is hard for Abbott to increase price of their

products when competition is high and rebate program may seriously affect their

profit margin. Therefore, cost cutting may be a better solution for the company.

Second, the company may want to increase its asset turnover. This is what the

company is doing with a series of acquisitions. Through acquisitions, Abbott may

want to access infrastructure and technology to help the company streamline its

production and optimize its asset utilization which is the second component of

Dupont function. Lastly, Abbott may want to borrow more debt to finance its

operation and increase its leverage ratio. This action may pose a risky situation in

which growth rate of the company is not higher than cost of debt, putting the

company in trouble. However, after spinning off Abbvie, we will observe a

decrease in leverage ratio when 70% debt of old Abbott will be transferred to

Abbvie. Decline in leverage ratio will negative affect on ROE of Abbott next year,

assuming other things will not change.

OpinionCurrent

Month

Last

Month

Two

Months

Ago

Three

Months

Ago

Strong Buy 4 3 3 2

Buy 4 4 4 4

Hold 13 13 15 14

Underperform 0 0 0 0

Sell 1 1 1 1

VI. Recommendation: HOLD

28

Cash-rich balance sheet and Better debt structure

As analyzed above, a strong cash status can help the company meet all its

liability and unexpected challenges, stabilize its operation, and embrace investment

opportunities such as target acquisitions. With a huge pile of cash, the company

can also have flexibility in dividend payout or repurchase schedule. This flexibility

may mitigate the volatility of the stock price in the market. Furthermore, buy

transferring 70% of its debt to Abbvie, capital structure of the company will

become better in the eyes of investors. With less debt obligation, the company does

not need to service interest and principle; therefore, the firm has more disposal

money for their strategic plan.

Diversified products and markets and Positioning for substantial growth:

Under new Abbott, there are 6 major diversified medical products, including

Vascular, Medical Optics, Nutritionals, Established pharma, Diabetes care, and

Diagnostics with the presence in more than 130 countries. Six segments with

different characteristics and markets will ensure a diversified revenue source for

the company and hedge risks if one of the segments has a problem. Furthermore,

emerging market with the sharp increase of middle class who are caring more

about their health will promise a handsome return for health care companies. One

of noticeable information about the middle class in emerging markets like China

and India is that these middle-class people pay very close attention to reputation or

brand of health-care companies because in these countries, customer protection is

not highly regulated; therefore, people always afraid of buying low-quality

products. Abbott with huge investment in building out its emerging-market

infrastructure and establishing reputation (such as buying Piramal – the biggest

health care company in India) there will give the firm a huge advantage over their

competitors in the market.

VII. Pros to Recommendation

29

Constant and high dividend

Dividends have been increasing at a rate of 10% annually for the past 5

years, and no mention of dividend cutbacks have been made. As discussed in

detail, the combination of New Abbott and AbbVie will result in a 4.6% (to keep

AbbVie valuations high) dividend yield which is higher than what it is now.

Source: The company website

Pricing pressure:

As operating in generic market where competition is so high, pricing

pressure is inevitable. This pricing pressure is not only coming from buyers with

huge purchase power, but also stemming from government programs like

Obamacare. Furthermore, crisis in Europe also put Abbott into pricing problem

when people here who do not have a job and do not get insurance, cannot afford

expensive drugs. Moveover, like U.S government, European governments are

VIII. Cons to Recommendation

30

taking many steps to force medical and health care companies to reduce their price

for people.

Healthcare reform:

As one of the risk factors mentioned above, there is a lot of legislation

regulating the industry. Law makers are amending and creating a ton of new

regulations such as Medicare and Medicaid program with intent to make the

market better and bring harmonized benefits for all market participants. However,

the effects of these changes are controversial and uncertain.

Threat from competitors’ innovation

Like any company operating in medical industry, Abbott faces a great

challenge from threat of revolutionary innovation from competitors. Whenever

competitors discover a new drug or new method to cure a certain disease, it will

make Abbott’s existing product become obsolete.

Concern about Nutritional segment

Abbott is the largest Nutritional Company in the world and Nutritional

segment also accounts for significant part of new Abbott revenue. However,

according to Morning Star investment research center, Abbott’s nutritional

segment is unlikely to see much growth from developed market.

Approach to the model: Abbott creates an interesting situation when the company

officially spin-offed its proprietary research-based segment as an independent

company named Abbvie on 1/2/2013. After spin-off, the company still filed its 10-

K for financial year 2012 as a consolidated company (which means including

Abbvie). After separating from Old Abbott, Abbvie also filed its 10-K for its

financial year 2012. The issue here is that we need to valuate New Abbott which

does not Abbvie and has not filed its financial statements for its self. We cannot

take numbers from financial statements of 10-K of Old Abbott minus numbers

from financial statements of 10-K of Abbvie to get numbers for New Abbott

because value of assets of Abbvie, for example, will have different value under

independent position as compared with that under as a dependent segment under

IX. Assumption

31

Old Abbott after being revaluated. Furthermore, tax position, capital structure and

so on also change when Abbvie has become an independent organization.

My approach for the issue is: I assume the Old Abbott had still existed and project

IS/BS/CF to 2015. Then with DDM and FCFE, I get the stock price for Old

Abbott. After having the modeled stock price for Old Abbott, I compare this price

with the price which is the sum of current market Abbott price and Abbvie price.

This method is reasonable because our fund currently stil holds both of these

stocks. Furthermore, if the model shows that the stock price is overvalued, we

should expect that the degree should be expected to be less than what the model

shows. Why? The spin-off will help the company specialize and utilize their assets

better. By this way, the assets under two independent companies are understood to

be higher value as compared with being under the whole Old Abbott. As a result,

the hypothetical stock price by adding New Abbott and Abbvie will be higher than

Old Abbott to some extent.

I understand that this approach is not totally quite accurate but it will help us

capture the idea of whether the stock of price is over or undervalue to some extent.

Revenue: I estimated revenue based on management’s discussion and guidance for

2013 on Stryker’s website (4.6-5.5%).

Gross Profit Margin: From 2010-2012, the Gross Profit Margin was very stable

with a range of 60%-62%. Because there were no guidance on the issue, I took the

average profit margins of the most current years (2010-2012), and then applied the

average number for the years from 2013-2015.

Effective Tax rate:Management thinks that the tax bracket of the firm ranges from

12-15% from 2013-2015.

Basic and diluted weighted average shares growth: I noticed a constant increase

in diluted average weighted average shares. Without any information from 10-K

about this trend, I believe that this trend will continue and I add 5 million shares

each year to the average weighted average shares of the previous year beginning

from 2013.

Research and Development Cost: According to conference call which took place

on 4/17/2013, management believes that R&D accounts for 6%-7% revenue.

32

Capital Expenditure: I calculated Capital Expenditure as percent of Net Fixed

Asset for each year. Then I took average Capex as percent of Net Fixed Assset for

most 3 current years, then apply these numbers, starting from 2013.

P/E ratio:I took average numbers from forecasted numbers of financial

intelligence unit.

Risk Free Rate: I used currently quoted 30 year T-bond of approximately 2.89%

on 4/21/2013

Market Risk Premium: 5.7% premium of stock market over the 30 year T-bond

rate since 1926 was employed for my model

Beta: I ran regression for Stryker stock return and premium to get beta of 0.52. I

believe that this number is reasonable reflection of market risk of Abbott stock.

Recent Prices: I picked the stock prices of $42.39 and $37.2 per share for Abbvie

and New Abbott respectively on 4/21/2013.

YAHOO! FINANCE

CNBC

STRYKER WEBSITE

IBISWorld

BLOOMBERG

HOOVERS

MORNINGSTAR

FIRST CALL WEB

THOMSON ONE

LEXIS NEXIS ACADEMIC

VALUE LINE RESEARCH CENTER

X. Sources

33

How Will Q1 Results Impact Abbott Laboratories' Stock?

Since spinning off AbbVie (NYSE: ABBV ) at the beginning of the year, Abbott

Laboratories' (NYSE: ABT ) stock has done pretty well, rising over 13%. The

company announced first-quarter financial results on Wednesday. How will these

results impact Abbott's nice stock run?

Results

The numbers looked pretty good. Adjusted earnings for the first quarter came in at

$0.42 per diluted share. That amount was near the high end of Abbott Laboratories'

previous guidance and narrowly beat the average analyst estimates of $0.41 per

share.

Abbott reported total sales for the first quarter of $5.38 billion, up 1.8% compared

to the same quarter last year. Analysts, though, were expecting higher revenue of

$5.41 billion.

The company confirmed its prior full-year 2013 adjusted earnings guidance of

$1.98 to $2.04 per share. GAAP earnings projections for the full year are $1.39 to

$1.45 per share. Abbott also estimated that second-quarter adjusted earnings would

be in the $0.43 to $0.45 per share range, with GAAP earnings for second quarter of

$0.27 to $0.29 per share.

Reasons

These results marked the first quarter for Abbott Labs without Humira. AbbVie

now has the blockbuster arthritis drug -- along with its growth power. The days of

impressive double-digit growth for Abbott are in the past.

With the brand pharmaceuticals business spun off to AbbVie, Abbott's remaining

divisions are Nutrition, Diagnostics, Established Pharmaceuticals, and Medical

Devices. Two of those divisions are doing relatively well, but two lag behind.

XI. Recent News

34

Nutrition stands out as the shining star for Abbott Laboratories and perhaps the

primary reason for continued interest in the stock. First quarter sales for the

division were $1.7 billion, up 8.7% versus the same quarter of 2012. Emerging

markets, in particular, saw strong operational growth of 20%.

Diagnostics sales increased 4.4% year-over-year to nearly $1.1 billion. Core

laboratory diagnostics, the largest revenue-generator for the business segment,

grew sales by 3.6%. Point-of-care diagnostics is the fastest-growing area, with $99

million in sales for the quarter representing a 17.3% jump over the prior year.

Established pharmaceuticals sales dropped by 1.9% compared to first quarter 2012

to $1.2 billion. The bright spot for this segment is in emerging markets like China,

India, and Russia. Emerging market sales increased by 4.4%.

Medical devices remain the weakest segment for Abbott Laboratories. Sales

dropped by 4.6% year-over-year to $1.3 billion. Vascular, in particular,

underperformed with 7.7% lower sales than in the same period of 2012. This drop

stems partially from expiration of Abbott's contract in mid-2012 to supply the

Promus stent to Boston Scientific.

Ramifications

What do these results really mean for Abbott Laboratories' stock? Judging by the

initial market reaction, the results could help. Shares jumped over 2% higher than

the prior close in early trading.

Probably the most encouraging news was Abbott's continued strength in emerging

markets. The Nutritionals business segment appears to have the potential to power

reasonable levels of growth, largely from these markets.

My chief disappointment with the company is its relatively puny dividend. Abbott

declared its 357th quarterly dividend of $0.14 per share. However, the dividend

yield only stands at 1.5%. Meanwhile, AbbVie's yield is 3.7% -- much more in line

with Abbott's historical levels. Abbott won't be a high-growth stock, so a better

dividend would make shareholders happier.

Overall, the results for Abbott Laboratories were solid. The stock should continue

to do well, especially if current weakness in developed markets improves. In my

35

view, Abbott still looks like a decent, if not spectacular, stock pick as part of a

broader portfolio.

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Foreign Business Risk

Russia rejects Abbott Laboratories' plan to buy Petrovax

MOSCOW (Reuters) - Russia's government commission on foreign investment has

rejected U.S. Abbott Laboratories' plan to buy Russian pharmaceutical producer

Petrovax, the head of the Russian antitrust regulator said on Friday.

"The commission has reviewed the question about the sale to U.S. company Abbott

of Petrovax Pharm. As a result of very lengthy discussion the U.S. company was

denied to make this deal," Igor Artemyev, head of the Federal Anti-Monopoly

Service (FAS), told reporters.

Abbott Laboratories filed for permission to buy the Russian vaccine developer and

producer last year.

Abbott Laboratories spokeswoman Irina Gushchina said the company had not

received any official information regarding the state of its application.

Nutritionals Growth Abroad Fuels Abbott's Results

Abbott Laboratories (ABT) announced on April 17 that its total sales for the first

quarter of 2013 were almost $5.4 billion, up 1.8% from the same period last year.

As mentioned in our pre-earnings analysis, the primary driver for this growth was

the company’s nutritional division, which benefited from an over 14% revenue

growth in the emerging markets - especially China. The company’s diagnostics

division’s revenue also grew by 4.4% y-o-y on the back of sales growth in Core

Laboratory and Point of Care Diagnostics products. The only area of concern for

the company was its medical devices division, where revenues declined y-o-y by

4.6%.

36

The earnings result of the company is generally in line with our expectations, and

going forward we expect the nutritional business to continue growing on the back

of increasing demand in emerging markets. Another reason why the sale of

nutritional products is also going to be strong in the future is that the company

continues to leverage its strong brands and launch new products.

Abbott’s stock currently trades at around $37 per share. We will soon release an

updated model for the company on our website and revise our price estimate for

the same.

Nutritionals Continue To Drive Sales

As mentioned in our pre-earnings article, the nutritionals division accounts for

nearly 30% of the value in Abbott’s stock and its revenue has been growing at a

healthy pace of 7-8% over the last couple of years. The current quarter’s revenue

growth of 8.7% is actually higher than that average and is hence positive for the

company.

Driving this growth are Abbott’s pediatric nutritional products such as Similac and

PediaSure. These products account for 58% of Abbott’s total 1Q13 nutritional

sales of around $1.7 billion and the worldwide sales of these products increased

over 13% y-o-y in this quarter - primarily due to a strong demand pull from

emerging markets. The company continues to expand geographically in these

markets and is also benefiting from an uptake in newly launched products.

At the same time, the company’s adult nutritionals business witnessed around 3%

of y-o-y revenue growth in this quarter and is benefiting from a “continued

expansion of the adult nutrition market where Abbott is the global leader.” [1]

Diagnostics Division Also Growing Well

Abbott’s diagnostics division reported a 4.4% y-o-y increase in its worldwide sales

and the major highlights for this division were (1) Point of Care Diagnostics,

which grew around 27% in the U.S. due to continued uptake of new assays and

continued market penetration, and (2) core laboratory diagnostics products, which

grew by 5.9% on an operational basis on the back of a strong performance in key

emerging markets, such as China, Russia and Brazil.

Going forward, we expect the sales in this division to continue growing as new

products from the company hit the markets. Abbott is currently “developing six

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new platforms across Core Laboratory, Molecular and Point of Care that are

designed to improve service to customers, enhance laboratory productivity,

improve efficiency and reduce costs.

However, Medical Devices Are Declining

Abbott’s worldwide medical devices sales decreased by 3% on an operational basis

as the largest segment within this division, Vascular products, was “impacted by

pricing pressure and a decline in procedures due to market conditions," according

to the company’s press release. An expected decline of certain royalty revenues

further affected these revenues.

However, there were signs of hope within this segment as the company’s new

product introductions like the XIENCE Xpedition (which is a drug-eluting stent)

and Absorb (claimed to be the world’s first and only coronary bioresorbable

vascular scaffold) are seeing strong demand in emerging markets.

While we expect pricing pressures and market conditions to continue pushing

profits for this segment downwards in the near term, there is a likelihood that once

market conditions improve a lot of pent up demand for surgical procedures will be

released and Abbott’s vascular products sales in the U.S. will improve.

Product recall risks

Abbott Labs Recalls Glucose Meter

Abbott Laboratories (ABT) recently announced that the company is initiating a

voluntary recall of its FreeStyle InsuLinx Blood Glucose Meters in the US.

Abbott Labs decided to recall the its FreeStyle InsuLinx Blood Glucose Meters as

it found that the device displayed and stored wrong test results in patients with

extremely high blood glucose levels.

Abbott Labs estimates that there are approximately 50,000 active FreeStyle

InsuLinx Meter users in the US and asked them to take appropriate measures.

Following the identification of the deficiency, the company has started the process

of informing the concerned persons about the same.

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Abbott Labs has also notified the US Food and Drug Administration (:FDA) and

all relevant healthcare authorities in the other countries about the defect.

We note that Abbott Labs obtained U.S. regulatory approval for its FreeStyle

InsuLinx Meter in the first quarter of 2013. Earlier in 2011, the company obtained

CE mark and Health Canada approval for ts FreeStyle InsuLinx Blood Glucose

Meters. The CE mark is a mandatory confirmation for products placed in the

European markets.

We remind investors that in Jan 2013, Abbott Labs separated its research-based

pharmaceuticals business by creating a new company – AbbVie (ABBV). The

decision to spin off the business was taken in Oct 2011 when Abbott decided to

separate its business into two publicly traded companies – one in diversified

medical products and the other in research-based pharmaceuticals.

Following the move, Abbott Labs became a diversified medical products company

including branded generic pharmaceutical, devices, diagnostic and nutritional

businesses.

Abbott intends to increase its presence in emerging markets, which provide a

substantial opportunity for growth, given the rise in middle-class income and aging

population. The diversification should enable Abbott to penetrate these markets

and capture market share.

In particular, the nutrition and diagnostics business should maintain momentum

and boost the bottom line due to an improvement in operating margins.

.

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