AbbVie: Q122 Results Dampen Enthusiasm & Test Management's Growth Plans

Investment Thesis

Yesterday after market close, AbbVie Inc. (NYSE:ABBV) - currently the U.S.' third-largest pharmaceutical company by market cap, behind only Johnson & Johnson (JNJ) and Pfizer (PFE), announced its Q122 results.

As much as the headline figures are important - quarterly net revenue of $13.54bn, up 4.1% year-on-year on a reported basis, GAAP earnings per share ("EPS") of $2.51, up 26% year-on-year, and adjusted EPS of $3.16, up 9% year-on-year, on a positive note, and downgraded FY22 EPS expectation of $13.92 - $14.12 on the negative side - close followers of AbbVie will know that the looming patent expiration of flagship auto-immune asset Humira - a $20.7bn selling asset in 2021 - dominates management's thinking and is likely to dictate how the share price performs over the next 3-5 years.

Humira - an inhibitor of Tumor Necrosis Factor ("TNF"), an inflammation-causing protein - dominates market share in markets including Rheumatoid Arthritis ("RA"), Psoriatic Arthritis ("PsA"), Crohn's Disease ("CD"), and Ulcerative Colitis ("UC") - all multi-billion dollar markets at home and abroad.

AbbVie management - led by CEO Rick Gonzalez - successfully protected Humira's market exclusivity via the issuance of new patents, altering, e.g., certain elements of Chemistry, Manufacturing and Controls ("CMC") for years longer than expected, frustrating rivals and generic drug manufacturers. However, Humira has now lost its exclusivity in Europe and also will experience loss of exclusivity ("LOE") next year in the U.S.

In reality, Humira has been losing market share in the U.S. for some time, but AbbVie's price hikes have ensured the drug's revenues have kept growing. That will all change next year, and although AbbVie is a diversified company - partly due to its mega-money acquisition of Allergan, bought out for $63bn in May 2020, and partly due to a strong oncology portfolio led by blood cancer drug Imbruvica - Humira will continue to dominate the agenda.

I have discussed in previous articles how AbbVie management has been planning for Humira's LOE, and believes it can still drive high single-digit percentage top line growth until the end of the decade, despite an anticipated drop in revenues in 2023, and a ~15% annual drop in US Humira revenues. By my calculation, that suggests the Big Pharma expects to deliver revenues of ~$69bn by 2026, and close to $85bn by 2030.

That equates to a forward price to sales ratio of ~3.8x for 2026, and ~3x by 2030, based on AbbVie's current market cap of $259bn. If debt is successfully paid down - the Pharma is highly leveraged thanks to its Allergan buyout - and profit margins increased slightly, also as a result of operational efficiencies, then my target EPS for 2026 would be ~$17. This implies a forward PE of ~9x, which is nearly half the current average amongst the "Big 8" US pharmaceuticals, which stands at ~23x.

Management's lofty ambitions and determination to achieve them has helped to drive AbbVie's share price from $110 at the end of April last year, to a peak of $175 in early April this year. This is a gain of 59%, making AbbVie the second best performing Big Pharma in this category, behind only Eli Lilly (LLY).

But yesterday's results triggered a sharp selloff in AbbVie stock, which implies that the market believes management may not be hitting their targets, and that the path to top and bottom line growth even in the midst of Humira's LOE is not quite as smooth as originally believed.

I revised my long term share price target for AbbVie upward from ~$135, to $168 in my last note on the company in February, after a stellar 2021 - a target the company easily exceeded in super-quick time - but it seems as though the issues expected to test the company in 2023 may be arriving earlier than expected.

In the rest of this post, I'll take a deeper dive look at Q122 results, and try to highlight where the cracks may be emerging, what management's takes on the issues are, and, as a result, where the share price may be headed in the remainder of 2022 and into 2023 - certainly the most pivotal year in the company's short history to date, since the company was spun out of Abbott Laboratories back in 2012.

I would still set a long-term price target for AbbVie's Stock of >$200, but it may be some time before the Pharma's shares hit that mark - 3 - 5 years at least, barring unexpected developments. In the meantime, the opportunity to cash in has passed. My advice to investors would be to keep holding the stock, benefiting from a generous dividend yielding nearly 4%.

Skyrizi & Rinvoq Continue To Impress, But Have High Hurdles To Overcome

These 2 drugs are the cornerstones of AbbVie's post-Humira LOE strategy. Between them, Skyrizi - which inhibits the cytokine / protein IL23 similarly to how Humira inhibits TNF - and Rinvoq, which belongs to a class of drug known as Janus Kinase inhibitors ("JAKi's") - are expected to add $15bn to AbbVie's top line revenue by 2025, and eventually exceed Humira's >$20bn peak revenues.

Both target markets in which Humira currently dominates. Rinvoq is approved in rheumatoid arthritis, psoriatic arthritis, ankylosing spondylitis, and ulcerative colitis, and will challenge for approval in Crohn's Disease and Atopic Dermatitis also, whilst Skyrizi is approved for plaque psoriasis and psoriatic arthritis, with late stage trials in psoriasis, Crohn's disease, ulcerative colitis and psoriatic arthritis ongoing.

Both made huge year-on-year revenue gains in Q122, with Rinvoq earnings $465m, up 54%, and Skyrizi $940, up 64%. As impressive as this is, however, the expectations placed upon both are enormous - each is expected to contribute $7.5bn of sales by 2026. By my calculations, although Skyrizi - apparently on track for $3.8bn revenues in FY22 - is keeping pace with its long-term target, Rinvoq - on track for $1.87bn in FY22 - is falling slightly behind.

The issue here is that AbbVie is by no means the only Big Pharma attempting to develop drugs that can dominate in auto-immune the way that Humira has done for so many years. In fact, the list is a long one. Eli Lilly's (LLY) Mirikizumab, Novartis (NVS) Cosentyx, Johnson & Johnson's (JNJ) Tremfya, Amgen's (AMGN) Otezla, Bristol Myers Squibb's (BMY) deucravacitinib (not yet approved, but posting strong data), and Zeposia, Pfizer's (PFE) Etrasimod - to name a few.

Although Skyrizi and Rinvoq's head-to-head comparisons against many of these drugs is impressive, and there is likely >$40bn of market share up for grabs across auto-immune indications, Rinvoq in particular is threatened by safety concerns associated with the JAK inhibitor class of drugs. For my money, the S1P modulators Etrasimod and Zeposia constitute real threats to AbbVie's prospects of transferring the dominance of Humira onto its 2 new autoimmune drugs.

Mega-Blockbuster Imbruvica Struggles

Since Imbruvica was jointly developed and is marketed and sold by both AbbVie and Johnson & Johnson, investors were already aware that the drug would underperform for AbbVie based on JNJ's earnings published earlier in the week.

Imbruvica earned revenues of $5.4bn in 2021, but earnings in Q122 were down year-on-year, to $1.2bn, a fall of 7.4%. AbbVie management blamed both higher levels of competition - from, e.g., AstraZeneca's (AZN) Calquence - and COVID suppression on new patient starts in Chronic Lymphocytic Leukemia ("CLL"), as well as competition from its own asset, Venclexta, which earned revenues of $473m for the quarter, up 17% year-on-year.

Although the Venclexta news is encouraging, it is the only other major drug in AbbVie's oncology portfolio - a division that is a key element of the post-Humira growth strategy. Management will be disappointed to see Imbruvica lose market share to Calquence, though AbbVie's late-stage pipeline seems to suggest that there are value-enhancing oncology drugs close to approval.

Navitoclax in Myelofibrosis, the PARP inhibitor Veliparib in breast and ovarian cancer, and antibody-drug conjugate ("ADC") Teliso-V, targeting non-small cell lung cancer ("NSCLC"), are late stage candidates with blockbuster (>$1bn per annum) sales potential, although, as ever, these markets are relatively unknown to AbbVie and the challenge from other Big Pharma's is immense.

For example, Merck’s (MRK) Tepmetko was approved by the FDA last year for treating both naïve and previously treated METex14 positive NSCLC patients, and so was Novartis’ Tabrecta (capmatinib).

Key Allergan Assets Thriving

In Neuroscience, where AbbVie is mainly developing and marketing assets acquired as part of the Allergan deal, revenues were up 23% year-on-year, to $1.5bn, with Botox and recently approved bi-polar therapy Vraylar and migraine treatment Ubrelvy leading the way, which is encouraging news.

Meanwhile, in Aesthetics, again led by Botox, revenues were up by 16%, to $1.37bn. Eyecare was down ~6%, to $771m, but overall, the Allergan acquisition looks to have been good business. It is capable of delivering the ~$20bn or so of revenues required for management to meet its long term growth target in the mid single digits between now and 2030, even as Humira sales plunge.

As Carrie Strom, President, Global Allergan Aesthetics noted on the Q4 earnings call:

People think about aesthetics more like health and wellness. It's been much more destigmatized, and we see factors like social media and word of mouth continuing to drive aesthetics in the future.

I would broadly agree with this statement, and overall AbbVie appears to have done an excellent job of transforming products that underperformed under Allergan's stewardship into profitable and growing assets. However, as I noted in February:

There was a price to pay for Allergan, and it was not cheap - AbbVie's current debt to equity ratio is nearly 5x - but management does have plans to pay this down, to the tune of $12 billion of debt in 2022, estimating a net leverage ratio of 1.8 times by the end of the year.

A company with $66bn of debt to pay off post-Allergan buyout is clearly going to have trouble driving uninterrupted value for shareholders. That's why, in my view, AbbVie's downgrading its FY EPS expectations from $14.00 - $14.20 to $13.92 - $14.12 is no reason to panic, rather it shows that management can be transparent about the issues that lie ahead.

At times, AbbVie's incredible success has felt too good to be true, and underpinned by controversial tactics such as hiking the price of Humira and waging patent wars. There is no harm in management indulging in some realism and setting investor expectations in the short term, even if it does affect the share price in the short term.

Conclusion - An Underperforming Quarter Highlights Challenges Ahead & Some Share Price Correction Is Not A Bad Thing - I'm Holding, Not Selling

To summarize AbbVie's Q122 results, a missed revenue target (based on Street expectations) will almost always cause a Big Pharma's stock to fall. But, frankly, AbbVie's share price could not continue climbing in perpetuity.

There is still a generous dividend paying $1.41 per quarter, and currently offering a yield of nearly 4%. AbbVie's bottom line continues to be highly attractive, despite the heavy ongoing debt repayments - net interest expense was $539m for the quarter.

As I discussed earlier, based on P/S and P/E ratios, and looking ahead, following management's guidance, AbbVie's share price could almost double in value, and its forward PE rise from ~9x, to ~18x, before it would be in line with the current industry average. That is highly encouraging news.

The battle for auto-immune market share that is going to be up for grabs after Humira's LOE is perhaps more intense than AbbVie's management hoped it would be, however, and the underperformance of Imbruvica is disappointing, since this is an asset that is expected to grow. The oncology pipeline needs to deliver, and there are some question marks here.

The opportunity for investors to cash in on AbbVie's incredible bull run and sell at, e.g., the March high of $175 has probably now been and gone. It may take several more positive earnings quarters before the price challenges $175 again, but I believe we can be confident it will do so again, even if it drops in 2023 as Humira exits stage left.

To my mind, then, AbbVie remains a straightforward long-term hold, that becomes further deleveraged with each passing quarter, even as the Humira LOE looms larger.

AbbVie can weather that storm, in my view, and become a more diversified Pharma with more LOE risk mitigation - a key focus of all Big Pharma companies - but it is going to be a bumpy ride. Investors ought to expect some short to medium term price volatility.

My advice would be to keep collecting the dividend and wait for the post-2023 revenue growth to kick in. But keep a close eye on the battle for autoimmune market share, and the late stage oncology assets.

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