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We See Opportunities for New Abbott to Raise Profitability

Sporting a narrow moat, Abbott is set for moderate growth, but the real opportunity for investors is in rising profitability.

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 Abbott Laboratories' (ABT) split, planned for early January, will result in a diversified medical product company, which will keep the Abbott name and ticker, and a research-based pharmaceutical company, AbbVie. We peg new Abbott's intrinsic value at $34 per share. With four mainly unrelated businesses left, we have a clearer picture of new Abbott, and see much potential for margin improvement. We give new Abbott a narrow moat rating, reflecting its competitive advantage in nutritionals, devices, branded generics, and diagnostics. While each of these markets offers modest growth prospects, we are more enthusiastic about the opportunity to partially close the margin gap with key competitors in the four segments. Even though Abbott competes in these markets that offer appealing margins, the firm presently trails key competitors in various segments on profitability, including Boston Scientific, C.R. Bard, Mead Johnson, Dr. Reddy, and Roche's diagnostic division. Even with relatively slow low- to mid-single-digit top-line growth, Abbott has plenty of room to raise margins and returns on invested capital. There may be upside to our valuation if new Abbott can increase profitability beyond our estimates.

New Abbott Faces Task of Whipping a Flabby Company Into Shape
Removing the contributions of AbbVie, we now have a clearer picture of how profitable the remaining segments--nutritionals, devices, diagnostics, and established pharmaceuticals--really are. The picture is not pretty. Even though Abbott competes in businesses that are characterized by attractive margins, it appears to lag key rivals on profitability measures. New Abbott's cost structure reflects a poor combination of its individual segments. For example, new Abbott's consolidated gross margin around 54% is comparable with Roche's diagnostic gross margin--one of the lower-margin businesses in the Abbott's portfolio--despite significant contributions from coronary stents and pediatric nutritionals, where the competitive gross margin is in the 60%-65% range. On the other hand, new Abbott's consolidated operating expenses are on par with those of medical devices and nutritionals, which must typically spend more on sales and marketing than the diagnostic segment.

Debbie Wang does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.