Abbott Laboratories

Abbott reported second-quarter performance that included organic revenue growth of 5%, and adjusted EPS up 4% year over year. Shares were up roughly 10% at time of writing.

Why it matters: While the first full quarter of contributions from the Exact Sciences acquisition gave a major boost to reported growth, we think comparable growth from underlying businesses shouldn't be overlooked, including strong contributions from rhythm management, electrophysiology, and diabetes. Importantly, newly-won WIC contracts have begun to offset the losses in US pediatric nutrition, and we expect a return to growth in the third and fourth quarters. The firm's efforts to moderate price in adult nutrition also seems to be aiding resumption of volume growth. While shares have seen substantial shifts since April when management first lowered EPS guidance and then raised it in second quarter as the dilutive impact of Exact has become clearer, we remain focused on competitive dynamics in Abbott's markets.

The bottom line: We're slightly lowering our fair value estimate to $107 per share, down from $115, after incorporating our new methodology for calculating weighted average cost of capital. Abbott's considerable exposure to international markets raised WACC by 30 basis points to 7.6%. We remain confident in Abbott's narrow economic moat, and the intangible assets and switching costs that support it. We expect upcoming launches of TactiFlex Duo (pulsed field ablation, PFA), Libre Duo, and commercialization of Volt (PFA) to reinforce that moat.

Coming up: We're largely optimistic about Libre Duo, which will monitor both blood glucose and ketones. Buildup of ketones can be dangerous diabetes patients, and most type 1 patients do not regularly test for ketones. Libre Duo offers a convenient way to keep tabs on blood glucose and ketones, with little intrusion on the patient. We're eager to see the uptake of this device in Europe, and expect US regulatory approval by end of year.

We're slightly lowering our fair value estimate to $107 per share, from $115, incorporating our new methodology for estimating the weighted average cost of capital. Abbott's considerable exposure to international markets raised WACC by 30 basis points to 7.6%.

We continue to hold muted projections for nutrition through 2026, and long-term estimates for the Libre franchise in the low double digits now that the business has reached $8 billion in sales. We also think that procedure volume is likely to soften in 2026-27, as subsidies to the exchanges and lower Medicaid spending take hold. We expect the established pharmaceuticals business to stabilize with mid-to-high single-digit growth. Additionally, we assume that Abbott's recent new-product launches, such as the Amplatzer Amulet for left atrial appendage closure, will experience moderate adoption. Over the longer time frame, we anticipate top-line strength from innovations in electrophysiology and heart failure, rhythm management, and the addition of Exact's cancer screening portfolio through 2030. Neuromodulation has been a recent area of weakness as competitors have introduced new products, and we expect this softness to persist in the near term.

We anticipate incremental margin improvement, with operating margin peaking with new products and mix. On a consolidated basis, Abbott has significantly narrowed the gap between its operating margin and those of its key competitors in various business segments. We see this as evidence that Abbott's investments in streamlined distribution channels, new products, and new facilities in lower-cost locations are paying off.

Abbott garners a Morningstar Economic Moat Rating of narrow. We think the addition of St. Jude's portfolio of cardiac devices pushed Abbott toward the wider side of a narrow moat, but we're not convinced that it has tipped into the wide moat category. The firm has not been able to nurture the kind of ongoing (and occasionally revolutionary) innovation that is necessary to secure reimbursement gains over the longer term, in our view.

In most cases, Abbott is one of three or four competitors that dominate the market, including nutrition, cardiac rhythm management devices, surgical heart valves, continuous glucose monitors, coronary stents, venous closure, and immunoassays. In these markets, Abbott enjoys the benefits of intangible assets that give rise to economic profits.

We think the nutritional business is one of the moatiest parts of Abbott, where it wields a leadership position in this highly consolidated market that is estimated to be $35 billion worldwide. The firm has developed intangible assets in the form of brand trust with new parents as well as pediatricians. We think Abbott has also developed other intangible assets through its various proprietary formulations of specialty infant formulas for babies with allergies and metabolic challenges. Concerns about potential formula contamination and the ensuing shutdown of a primary US manufacturing plant hit the pediatric nutrition business in 2022. However, this episode also underscored the strength of Abbott's moat in this market, as the firm has already regained significant levels of the market share lost.

These building blocks and experience with nutritionals are also highly relevant when applied to Abbott's established pharmaceutical product segment, which is sold outside the US. This business, frequently called branded generics, operates more like a consumer business than traditional branded drugs. For example, Abbott's branded generics will mainly be sold in less-developed markets that often lack well-developed distribution infrastructure. Instead, Abbott must sell its products directly to pharmacy chains and physicians. As a result, brand recognition and reputation are key factors that Abbott can leverage. Selling to a fragmented market also translates into less pricing pressure for Abbott. This could change over the longer term once more emerging markets turn to the tender system that characterizes developed nations. However, we have yet to see much impact from this dynamic. Further, Abbott has recently begun producing biosimilars for this business. Considering the manufacturing complexities involved with these large-molecule therapies, we anticipate limited competition, which should stave off price competition.

We think Abbott benefits considerably from legacy St. Jude's impressive expertise in cardiac rhythm management, structural heart, and heart failure. Intangible assets in this segment include specialized engineering knowledge, expertise in navigating the regulatory pathway, and, importantly, strong sales representative relationships with practitioners.

Moreover, some , spinal cord stimulators, and cardiac resynchronization devices. For these types of products, the initial implantation of an Abbott device means subsequent replacement parts will most likely also come from Abbott.

The diagnostics segment differs slightly from the other divisions in its primary moat source. Rather than intangibles, we think Abbott's diagnostics business exhibits switching costs common in the life sciences market. Once the durable testing platform is installed and technicians are trained on it, Abbott generates an ongoing stream of revenue from higher-margin consumables, supplies, and reagents.

Outside of intangible assets and switching costs, Abbott also relies on intellectual property to ward off competitors in the device and diagnostic segments and protect some level of differentiation in its products. However, we do not consider patents to be bulletproof in the medical technology arena, particularly because competitors can engineer a different way to a similar solution. Nonetheless, developing products that tiptoe around competitive intellectual property seem to foster product differentiation that can add to a firm's intangible assets.

Though we see signs of moatiness throughout Abbott's businesses, we're less confident in Abbott's ability to nurture and renew innovation over the long haul, which is the key factor that leads to pricing power in the long term. For example, we think Abbott has done a credible job of commercializing what was already in St. Jude's pipeline, just as it had done with earlier acquisitions of Guidant's stent assets, Advanced Medical Optics, and Perclose. However, we have rarely seen Abbott generate greater leaps of innovation, building on these acquired technology platforms. Abbott is more likely to follow Medtronic and Boston Scientific to market than to pioneer the path, from our perspective.

Abbott has been investing in structural heart products, including the left atrial appendage closure and transcatheter mitral valve markets.

Despite being late to pulsed field ablation, Abbott has benefited from robust electrophysiolgy growth thanks to its established ablation devices and aims to catch up with new PFA catheters.

Abbott's sale of its established pharma business in developed markets to Mylan and its acquisition of CFR and Veropharm have put the branded generics business in a strong position to benefit from growing demand in emerging markets.

Edwards Lifesciences' Pascal device and its emerging portfolio of transcatheter mitral technologies are likely to put pressure on Abbott's MitraClip franchise over the longer term.

Abbott remains a peripheral presence in the crowded field of molecular diagnostics, where it must go head-to-head against market leader Roche, along with energetic competitors like Qiagen and Hologic.

Falling global birthrates in the wake of the pandemic would offer challenging conditions to Abbott's nutritionals segment. This could saddle nutritionals with an unfavorable secular trend.