The most profitable healthcare stocks are stuck in a sideways trend

A university in the United States conducted an investment study, which showed that if you invested 1 dollar in Abbott (ABT.US) in 1937 and lived until 2023, you would receive a return of 78,083 dollars. In other words, from 1937 to 2023, Abbott's stock had a cumulative compound return rate of up to 7,803,730%.

Families with children are no strangers to Abbott, a well-known infant formula brand in China. However, investors who have been deeply educated by Chinese Feihe would never believe that a company selling milk powder could achieve such a return rate.

In fact, Abbott has long stopped selling milk powder in China. Selling milk powder in China is a challenging issue; not only are state-owned enterprises mired in valuation dilemmas, but many overseas giants have also gradually retreated.

Abbott's true identity is that of a global healthcare leader, not just a simple milk powder seller. Its diversified multinational operations have made the group one of the highest-returning healthcare stocks globally.

However, even such a high-performing stock that outperforms its peers and has annualized returns that surpass state-owned enterprises has seen its stock price enter a sideways fluctuation for nearly three years. Looking back at the latest performance and considering the forward price-to-earnings ratio, now is not the time to buy Abbott.

1. Weak Old Business

Abbott is a global healthcare company and a well-known player in the pharmaceutical sector, operating four major businesses: nutrition, mature pharmaceuticals, medical devices, and diagnostics.

In the Chinese infant formula market, it was once on par with foreign brands like Wyeth, Mead Johnson, and Friso, becoming a household name for many Chinese families. According to Euromonitor data, in 2017, Abbott's market share in China was 5.4%, ranking fifth.

However, during the fierce competition among milk powder giants over the past few years, Abbott's market strategy has remained conservative, failing to maintain its position in the high-end market, and its downward strategy has not been entirely successful. Frequent safety incidents, such as the vanilla incident in 2021 and the bacterial contamination incident in 2022, have further affected Abbott's reputation in the Chinese market.

From 2019 to 2022, Abbott's market share in China dropped from 4.9% to 3.1%, gradually falling out of the top ten. In the dynamic and challenging Chinese market, the imbalance between investment and output has led the group to decide to withdraw with tears.

After exiting the Chinese market, the profit margin of Abbott's nutrition department, which includes children's milk powder, plummeted from a peak of 25% to 16% in 2023.

However, even without exiting the Chinese market, nutritional products have long been a low-growth old business. Many of the group's current businesses have already lost strong growth potential in the fiercely competitive red ocean, making it difficult to drive overall performance growth.

Similar to the situation with infant formula, mature pharmaceuticals are also facing challenges. In the mature pharmaceutical sector, the group mainly sells branded generics to developing countries. Branded generics have a stronger consumer base and lower R&D costs compared to unbranded products, making them a source of considerable and stable income.

However, generics are essentially a form of outdated capacity, existing in a low-growth market with an annual growth rate of only about 4%. In the competitive landscape, generics that have lost patent protection rely heavily on cost control as their key competitive advantage. In comparison, Teva, which holds the largest global market share and has a gross margin close to 50%, has a profit margin of only 23.8% in Abbott's mature pharmaceutical sector as of 2023, indicating insufficient competitiveness.

Over the past three years, the combined revenue growth of nutritional products and mature pharmaceuticals, which account for more than 30% of the business, has been nearly 0.

The overly weak development prospects make it difficult to expect these old businesses to drive market capitalization growth. For Abbott at present, the urgent task is to find sufficiently large incremental businesses.

II. New Businesses in Their Infancy

The United States is one of the developed countries with the highest obesity rates, and poorer individuals tend to be more obese. This demographic is more sensitive to price, which means that products offered in this market must be both high-quality and affordable.

Dexcom has long been a leader in Continuous Glucose Monitoring (CGM), but for a long time, it has not addressed the issue of high prices. It has also incurred significant sales expenses due to its deep engagement with endocrinologists (equivalent to domestic hospital channels, buying off attending physicians), resulting in a 14-year period without profitability.

If one does not strive, they will be challenged by new entrants. Compared to Dexcom, Abbott has advantages in price and distribution in the CGM market.

After experiencing a series of negative impacts, including exiting the Chinese infant formula market, Abbott has now resumed growth, with success in CGM contributing to this recovery.

For most Americans with commercial health insurance, they can purchase Abbott's FreeStyle Libre system sensors for less than $40 a month, while Dexcom's G7 costs $89 a month. Without discounts or insurance, the annual cost of FreeStyle Libre is about $2,000, while Dexcom's G7 is around $7,000.

The significant price advantage makes consumers more inclined to purchase Abbott's products.

In the third quarter of this year, the group's CGM sales exceeded $1.6 billion, a year-on-year increase of 19.1%. This drove the affiliated medical device sector to achieve double-digit growth (organic growth of 13.3%, reported growth of 11.7%).

Both Dexcom and Abbott have recently launched over-the-counter CGM devices, targeting primarily type 2 diabetes patients and expanding to healthy individuals with high physical fitness requirements.

From the perspective of sales channels, after years of focusing on a smaller but more authoritative group of endocrinologists, Dexcom has a larger market share among type 1 diabetes patients in the U.S.

However, as of 2021, there were 2 million people with type 1 diabetes and 36.2 million with type 2 diabetes in the U.S. Abbott holds a leading share among type 2 diabetes patients, and its channel advantages will be more pronounced when promoting the new over-the-counter devices.

Dexcom's high prices and sales strategy concentrated in the prescription drug market are at odds with market trends, which is why Abbott poses a significant threat to it.

For the upcoming over-the-counter CGM devices, Abbott believes that these new devices can collectively generate at least $1 billion in annual sales in the initial phase.

However, a mere $1 billion is insignificant in front of a pharmaceutical giant with a market value exceeding $200 billion.

Taking the group's total sales for the first three quarters of this year as an example, $1 billion accounts for only 3.2% of that total, and only 7.1% of the medical device sector. For Dexcom, which focuses solely on the CGM market, $1 billion represents 27.6% of its total revenue in 2023.

This is the gap; the same sales expectations have completely different impacts on two companies with a market value difference of seven times. Relying solely on the still-nascent revenue scale of the medical device business is insufficient for Abbott to end its sideways trend and achieve a breakthrough. The diversified business development of the group is key to making it the most profitable healthcare stock globally, as when one business unit faces headwinds, the tailwinds from other units help offset the decline. However, the current issue is that there are simply too many headwinds.

III. The Dark Side of Growth

During the global pandemic, Abbott became one of the beneficiaries due to its simultaneous sales of testing kits and other products. With the growing demand for COVID-19 testing products, the diagnostics division once became the largest revenue-generating and highest operating margin segment within the group.

However, after the pandemic, the demand for related products plummeted, and this largest and most profitable business became the biggest drag. Since 2021, the group's revenue and profits have shown no significant growth.

More critically, these negative factors have not completely dissipated. As of the third quarter of 2024, revenue related to COVID-19 testing still amounts to $265 million. Even if new devices could bring in $1 billion in certain revenue, this uncertain portion is expected to shrink by 30% first.

Mature pharmaceuticals and nutritional products are both experiencing low growth, and the diagnostics products still have considerable negative impacts. Although medical devices are achieving double-digit high growth, ultimately, two fists cannot fight against four hands. From a quarter-on-quarter perspective, the rising businesses have not outnumbered the declining ones.

Therefore, even if growth has resumed, the remaining dark side of growth makes the market adopt a wait-and-see attitude towards the group's future development, and it is quite normal for the stock price to continue to fluctuate sideways.

Conclusion

As a century-old enterprise that sold anesthetics in World War I, penicillin in World War II, testing kits during COVID-19, and now OTC blood glucose meters, Abbott has almost keenly captured all emerging demands in its market. Unfortunately, compared to the all-in approach of biotech, Abbott, due to its massive scale, has only slightly committed to each track.

The benefit of this approach is that it avoids total loss, but it also slightly lacks the imagination for excess returns.

Regarding the revenue expectations for the full year of 2024, management has regained confidence and raised the full-year earnings per share forecast to $4.64-$4.70. However, currently, all growth potential can only help the company move out of the previous negative growth impact towards normalization, which means that the forward price-to-earnings ratio of 25 times, close to the five-year average level, has fully priced in these growth potentials For investors, Abbott Laboratories, which currently has little expectation of a significant difference, is not worth buying