AbbVie (NYSE:ABBV) has recently suffered a sell-off, triggered by the Aug. 31 FDA announcement that the packaging of Rinvoq, its prescription drug for rheumatoid arthritis, will require a warning about very serious side effects. ABBV is relying on Rinvoq to offset the anticipated decline in sales of Humira, ABBV’s current blockbuster drug, that comes off patent in 2023.
ABBV shares have fallen 11.5%, from a close of $120.75 on Aug. 31 to the current level, $106.87. Analysts don’t expect the new label to have a major impact and see the share price decline as an over-reaction. An additional concern for ABBV and other pharma stocks is that the White House has recently endorsed allowing the federal government to negotiate drug costs.
Over longer time horizons, ABBV’s total returns are a mixed bag. With the recent declines, ABBV has a YTD total return of only 3.75%, far below the Drug Manufacturer industry. ABBV has also lagged the industry over the past 3 years, the stock has solidly beaten the industry return over the trailing 5-year period. ABBV was spun off from Abbott Labs (NYSE:ABT) in 2013, so there is not yet 10 years of performance data.
Source: Morningstar.com
One of the notable features of ABBV is its modest valuation. The forward dividend yield is 4.85% and the forward P/E is 7.74. At these levels, the earnings don’t require much growth to make the shares look attractive. The 3- and 5-year dividend growth rates are 15.8% and 18.0% annualized, respectively.
The combination of the current yield and the dividend growth rate makes an attractive value proposition. ABBV has beaten EPS expectations for 10 consecutive quarters and the last miss, on Jan. 25, 2019, was only $0.04 on quarterly EPS of $1.90 (consensus expectation was $1.94). The company is doing a good job of steadily growing earnings and setting expectations.
To form an opinion of ABBV, I rely on two forms of consensus outlooks. The first is the well-known Wall Street analyst consensus. When there is not too much dispersion among the analyst price targets, the consensus has predictive value. The second form of consensus outlook that I track is the market-implied outlook, derived from the market prices of options.
The price of an option represents the market’s consensus estimate for the probability that the price will rise above (call option) or fall below (put option) a specific level (the strike price) from today until the option expiration date. Analyzing the market prices of calls and puts at a range of strikes, but a common expiration date, it is possible to calculate the probabilities of all possible price returns that best reconcile the options prices for the period.
For those who are unfamiliar with this concept, I have written an overview, including links to the relevant financial literature. More generally, it is worth having a look at the research on the value of consensus estimates, which are often more accurate than even the best individual estimates that are part of the consensus.
I last analyzed ABBV on May 2, 2021 and I gave the stock a bullish rating to early 2022. Since then, the total return on ABBV is -4.03%.
Source: Seeking Alpha
Idiosyncratic surprises are not uncommon with individual stocks and occur with greater frequency among pharma stocks. Failure or success on a clinical trial, for example, typically shocks the share price. The recent FDA announcement has triggered a substantial short-term decline. I am updating my analysis to see whether the longer-term outlook for ABBV has changed.
Wall Street Analyst Consensus Outlook for ABBV
eTrade’s calculation of Wall Street consensus combines the views of 13 ranked analysts who have published ratings and price targets within the past 90 days. The consensus rating is bullish and the consensus 12-month price target is 20.6% above the current price. Even the lowest price target is 5% above the current price. The consensus price target was $127.50 when I analyzed ABBV in May.
Source: eTrade
Investing.com’s calculation of Wall Street consensus is derived from the views of 24 analysts who have published ratings and price targets over the past 90 days. The consensus rating is bullish (outperform) and the consensus 12-month price target is $125.19, implying a 17.4% price appreciation.
Source: Investing.com
Today, as in May, the prevailing outlook for ABBV from the analysts is bullish. Combining the dividend and the consensus price outlook, the expected 12-month total return is 23.8% (taking the average of the two consensus price targets). A key question, even taking the analyst consensus at face value, is whether the risk associated with ABBV makes this an attractive risk-return proposition.
Market-Implied Outlook for ABBV
I have analyzed call and put options at a range of strikes for two expiration dates, Jan. 21, 2022 and June 17, 2022, to generate market-implied outlooks for the next 4.3 months and the next 9.1 months. When I calculate the theoretical prices of the options using the market-implied outlook, the theoretical prices match the market prices to within an average of 0.4% of the market prices of the options.
The standard presentation of the market-implied outlook is a probability distribution of return, with probability on the vertical axis and price return on the horizontal.
Source: Author’s calculations using options quotes from eTrade
The market-implied outlook for the next 4.3-months is very symmetric, with similar probabilities of positive and negative returns of the same magnitude. There is a very slight positive tilt, with the peak probability corresponding to a price return of +1%, but this is not large enough to be considered meaningful. The annualized volatility derived from this distribution is 27%.
To make it easier to directly compare the probabilities of positive and negative returns, I look at a version of the market-implied outlook with the negative return side of the distribution rotated about the vertical axis (see chart below).
Source: Author’s calculations using options quotes from eTrade. The negative return side of the distribution has been rotated about the vertical axis.
The probabilities of positive and negative returns of the same magnitude are very similar (the red dashed line and the solid blue line are very close). If anything, there are very slightly higher probabilities of negative returns.
We expect the market-implied outlook to have a negative bias for dividend-paying stocks because the dividends reduce the upside potential relative to the downside. In addition, theory suggests that there should be a negative bias because investors tend to be risk averse, and therefore willing to pay more than fair value for put options. In light of these two considerations, and especially because ABBV pays such a large dividend, this market-implied outlook to Jan. 21, 2022 is modestly bullish.
In my analysis in May, the market-implied outlook to Jan. 21, 2022 was notably negatively tilted and, considering the large dividend and the tendency for a negative bias in these outlooks, I interpreted the results as neutral with a slight negative (bearish) tilt. The current market-implied outlook to Jan. 21, 2022 is substantially more bullish than back in May.
Source: author’s calculations using options quotes from eTrade. The negative return side of the distribution has been rotated about the vertical axis.
The market-implied outlook for the next 9.1 months (calculated using options expiring on June 17, 2022) shows an elevated probability of negative returns (red dashed line meaningfully above the solid blue line). I interpret this as neutral with a slight bearish tilt. The annualized volatility derived from this distribution is 27%.
Summary
The recent selloff in ABBV presents a buying opportunity. The Wall Street consensus is that the impact of the new FDA labeling requirement for Rinvoq is not going to be substantial.
The consensus 12-month price targets imply almost 20% in price appreciation, for expected total return of 23.8%. The market-implied outlook to January 2022 has improved substantially since my last analysis in May, going from neutral with a bearish tilt to modestly bullish. The expected volatility is 27% (annualized).
As a rule of thumb, I want to see an expected 12-month return of at least half the value of the expected volatility. If the expected return is anywhere close to the analyst consensus of 23.8%, ABBV easily surpasses this threshold.
Given the slightly bullish market-implied outlook to early 2022 and the Wall Street outlook, I am bullish overall for ABBV. The bearish tilt in the market-implied outlook to June 2022 suggests revisiting this analysis in early 2022.