AbbVie Inc (NYSE:ABBV) is an interesting business – it has the highest qualitative risk of any Dividend Aristocrat.

Risk and Dividend Aristocrats typically do not go together. Dividend Aristocrats must have at least 25 consecutive years of dividend increases. They are typically the ‘bluest of the blue chips’, with names like Wal-Mart, Coca-Cola, and Johnson & Johnson on the list. Click here to see all 52 Dividend Aristocrats.

AbbVie ‘snuck in’ to the Dividend Aristocrats list when it was spun-off from Abbott Laboratories in 2013. Since that time, AbbVie has continued to raise its dividend payments every year like clockwork.

AbbVie has 5 ‘leading brands’ according to its management: Humira, Duodopa, Creon, Synagis, & Synthroid. I argue that the company really only has 1 ‘leading brand’; Humira, which makes up a whopping 65% of the company’s sales.

The unusual characteristics of Abbvie have attracted several high profile investors including Larry Robbins of Glenview Capital and Steven Cohen of SAC Capital.

The over-reliance on Humira is what makes Abbott Laboratories riskier than other Dividend Aristocrats. The potential risks associated with Humira are analyzed below.

Humira Analysis

Humira is a highly successful drug used to treat rheumatoid arthritis, plaque psoriasis, Crohn’s disease, ulcerative colitis, and other similar ailments.

AbbVie’s Humira profits are protected through patents. Unfortunately, the company’s patents for the drug begin expiring at the end of 2016.

There is much debate as to the severity and timing of falling Humira sales. The bearish side estimates that Humira sales could decline by 15% annuallystarting in 2017. AbbVie’s global Humira patent portfolio could offer partial protection until 2022, according to AbbVie management.

Despite all the talk about patents, Johnson & Johnson’s biosimilar competitor for Humira called Remicade is already in the market.

Fortunately for AbbVie shareholders, Remicade has not significantly damaged Humira’s market position. Here’s what AbbVie’s management had to say on the matter in the company’s most recent earnings call:

“HUMIRA’s momentum has not been adversely impacted by the biosimilar. For the full year 2015 we continue to expect global HUMIRA sales growth in the mid-teens on an operational basis.

But the bottom line when we’ve done is I would tell you that we have seen no impact from Remicade biosimilar on HUMIRA in the international market…

So let’s talk specifically around what we’re seeing with biosimilars and I’ll give you a little bit of facts maybe to support it. So the biosimilar Remicade has been approved now in 46 countries. It is actually launched in about 36 of those countries. They participated in five national tenders and they participated in about 11 regional hospital tenders. If you look at markets that they have been in for more than a year to be able to measure what their market share is, their total market share is 2.8%.

So they haven’t any meaningful impact. We measured every one of those markets that they are in, we’ve been doing it from the very beginning and in those markets HUMIRA continues to grow as we would have expected it. We don’t see any impact from nor did we expect any impact from Remicade biosimilars within those markets.”

The bottom line is that Humira will likely continue to generate massive sales and profits for AbbVie for many more years – even as generic products enter the market. The company will likely see some sales declines in Humira over the next several years, but more modest than the bear case suggests.

Management’s Attempt to Diversify

AbbVie’s other 4 ‘leading brands’ are Duodopa, Creon, Synagis, and Synthroid. The percentage of total sales generates for AbbVie by each of these 3 brands is shown below:

  • Synthroid: 3.4% of sales
  • Creon: 2.9% of sales
  • Duodopa: 1.0% of sales
  • Synagis: 0.8% of sales

The company’s two largest drugs by sales (after Humira) are Viekira and Imbruvica. Viekira was responsible for 7.0% of sales in AbbVie’s most recent quarter. Imbruvica would have generated 4.3% of total sales for AbbVie had it been acquired at the beginning of the quarter instead of the end.

Imbruvica was the primary drug acquired in the company’s recent acquisition of Pharmalytics for $20.2 billion. At its current rate of sales, Imbruvica should generate close to $1 billion over a full fiscal year. AbbVie is expecting rapid growth from Imbruvica. The company is targeting $7 billion in annual sales for Imbruvica when it reaches its peak.

The Imbruvica acquisition was for a price-to-sales ratio of around 20… This is not advisable. Imbruvica must realize extreme growth to justify the high price tag AbbVie paid for the company.

It is very understandable why AbbVie did this acquisition – it needs to diversify its sales. Unfortunately, the company’s management got into a bidding war with Johnson & Johnson and one other unnamed ‘large’ pharmaceutical company and drastically overpaid for Imbruvica. I believe the Pharmalytics acquisition destroyed share holder value due to the extremely high valuation multiple of the deal.

In addition to acquisitions, AbbVie also spends a great deal on research and development. The company spent $3.3 billion on research and development in fiscal 2014. The company’s Viekira drug is a recent success story resulting from research and development expenditures. Viekira is a Hepatitis C cure that is already AbbVie’s 2nd largest drug by sales.

Final Thoughts

I have no doubt that AbbVie can successfully grow organically though its research and development department over the long run.

The company appears to be desperate to diversify at this time. The Pharmalytics acquisition shows poor capital allocation skills from AbbVie’s management. The company should be spending cash flows from Humira wisely – not in desperation to grow at any cost.

AbbVie currently has a 2.9% dividend yield and an adjusted price-to-earnings ratio of 18.3. The company has the potential to grow earnings-per-share at a solid pace over the long-run if management stops overpaying in its acquisitions.

At current prices, I can see the appeal of an investment in AbbVie, but I can’t trust AbbVie’s management’s capital allocation skills after the Pharmalytics acquisition. Investors looking into the health care sector may want to consider AbbVie’s parent company (prior to spin-off) Abbott Laboratories at this time instead of AbbVie.

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