Published August 20th, 2015
Abbott Laboratories (ABT) spun-off biopharmaceutical business AbbVie (ABBV) in 2013.
Baxter International (BAX) must have been paying attention. The company spun-off its own biopharmaceutical business this year. The new business is called Baxalta (BXLT).
Baxalta has a market cap of $27 billion, while AbbVie has a market cap of $114 billion.
Baxter and Abbott both have very long dividend histories. Their new spin-offs intend to pay ever-increasing dividends as well.
The question is, what company makes the better long-term investment?
I recently wrote that AbbVie is the riskiest Dividend Aristocrat…
The company generates 65% of its revenue from 1 drug – Humira. As Humira goes, so goes AbbVie. Humira is used to treat rheumatoid arthritis, plaque psoriasis, Crohn’s disease, ulcerative colitis, and other similar ailments.
Unfortunately for AbbVie, Humira will begin losing patent protection at the end of 2016. This will impact Humira sales as cheaper generic versions of Humira hit the market. No one knows exactly how much sales will decline. Some analysts are projecting declines of 15% a year starting in 2017.
I want to be clear – AbbVie is not going out of business, but it could very well face declining sales as a business over the next several years.
Despite being recently created, Baxalta has the better diversified revenue stream of the two companies. Baxalta generates about 60% of its revenue from its Hematology segment, and 40% from its Immunology segment. Revenues are further diversified by specific drugs/treatments in each segment.
Baxalta is more diversified than AbbVie. It is the safer business today because it does not suffer from the ‘patent cliff nightmare’ that AbbVie must tackle in the coming 2 years.
Acquisitions & Recent Performance
Take a look at the performance of AbbVie and Baxalta stock over the last two months:
- AbbVie stock down 2.7%
- Baxalta stock up 23.3%
AbbVie stock has declined, while Baxalta shares have surged. For comparison, the S&P 500 fell 1.3% in the same time period.
Acquisition activity was the cause of Baxalta’s rise, and contributed to AbbVie’s weak performance as well.
I recommended Baxalta as a buy in the July 2015 Sure Dividend newsletter – I believed it to be deeply undervalued at the time. A few weeks later, I wrote about how undervalued Baxalta was on Sure Dividend.
I wasn’t the only one who thought so… Shire PLC apparently also thinks Baxalta is a bargain. Shire offered to acquire Baxalta for over $45 a share on August 4th. The stock was trading around $32.00 at the time.
Baxalta’s management rejected the offer, but the company’s stock climbed anyway. The announcement helps to show that Baxalta is more valuable than its market price indicates.
Interestingly, Shire has also been involved with AbbVie – but in a reverse role. AbbVie planned to acquire Shire, but the deal fell through in October of 2014 because the U.S. Treasury Department disallowed AbbVie to gain from lower taxes that would have resulted from the acquisition.
AbbVie’s management appears hell bent on making acquisitions to diversify itself, not matter the cost. The company announced in May it would acquire Pharmalytics for $20.2 billion. AbbVie will acquire Pharmalytics for a price-to-sales ratio of around 20.
Paying this much is almost never a good idea. For comparison, there are only 20 stocks in the S&P 500 with price-to-sales ratios 10 or higher. Only one stock in the S&P 500 has a price-to-sales ratio higher than 20 – Vertex Pharmaceuticals (VRTX). Facebook (FB) is the 2nd highest with a price-to-sales ratio of 18.3.
I believe that stagnation in AbbVie stock over the last few months has much to do with the company’s management’s questionable acquisition of Pharmalytics.
Compare this to Baxalta’s management. The company is acquiring cancer treatment Onscapar from Italian drug-maker Sigma-Tau. The deal will cost Baxalta $900. Onscapar currently generates $100 million in sales for a price-to-sales ratio of 9. Onscapar has significant upside (which is the same justification for the Pharmalytics acquisition). The difference is, Baxalta’s management paid less than half the valuation multiple that AbbVie did.
Dividend & Valuation Comparison
Both company’s dividend yields are shown below:
- AbbVie has a dividend yield of 3.0%
- Baxalta has a dividend yield of 0.7%
Obviously, AbbVie’s dividend yield is much more appealing than Baxalta’s. On the other hand, Baxalta has a much lower payout ratio.
- AbbVie has a payout ratio of 53.7%
- Baxalta has a payout ratio of 13.0%
Baxalta’s lower payout ratio gives it more room to grow dividend payments going forward. It also gives the company more financial flexibility to engage in share repurchases – which are highly accretive to shareholder wealth when a stock is undervalued. The company recently approved a $1 billion share repurchase plan.
Both Baxalta and AbbVie are now trading at similar price-to-earnings ratios (using adjusted earnings):
- AbbVie has a price-to-earnings ratio of 18.0
- Baxalta has a price-to-earnings ratio of 18.4
AbbVie is slightly cheaper than Baxalta at current prices, due to the recent run-up in price of Baxalta shares. Still, both companies are cheaper than the overall market. The S&P 500 is currently trading at a price-to-earnings ratio of 21.0.
The long-term growth of both Baxalta and AbbVie will come from the research and development of new treatments. One can think of research and development spending as an investment today that will pay out in the future in the form of higher sales, earnings, and higher real dividends.
To determine the amount of research and development you are getting for your investment, the ‘price-to-R&D’ multiples of each company are shown below:
- AbbVie has a price-to-R&D multiple of 34.5
- Baxalta has a price-to-R&D multiple of 45.0
AbbVie looks cheaper than Baxalta based on its research and development spending compared to its share price. The efficiency with which research and development is done for both companies is important going forward as well.
AbbVie shares are slightly cheaper than Baxalta shares using the price-to-earnings ratio. Baxalta appears to be the better buy at current prices, however. Baxalta is still trading for less than Shire’s original acquisition cost. Baxalta is better diversified than AbbVie, meaning it has less risk of declining earnings over the next few years.
Baxalta outranks AbbVie using The 8 Rules of Dividend Investing, but it’s fairly close. Qualitatively, Baxalta is the more appealing investment due to its lower risk and solid growth opportunities – and the possibility of an acquisition in the future by Shire or another large pharmaceutical company; perhaps even AbbVie itself.