AbbVie (NYSE:) has recently had a sell-off triggered by the FDA's Aug. 31 announcement that the packaging of Rinvoq, the prescription drug for rheumatoid arthritis, requires a warning for very serious side effects. ABBV is relying on Rinvoq to offset the projected drop in sales of Humira, ABBV's current blockbuster drug, which is due to go off patent in 2023. ABBV shares are down 11.5% from a close of $120.75 on Aug. 31 to its current level of $106.87. Analysts do not expect a major impact from the new label and see the price drop as an exaggerated reaction. An additional concern for ABBV and other pharma stocks is that the White House recently approved the federal government's ability 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 just 3.75%, well below the drug manufacturers industry. ABBV has also lagged the sector over the past 3 years, the stock solidly beating the sector's performance over the lagging 5-year period. ABBV spun off from Abbott Labs (NYSE:) in 2013, so there is no 10-year performance data yet.
ABBV Trailing Total Return Vs. Drug-Manufacturing Industry and Overall US Stock Market
Source: Morningstar.com
One of the standout 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, earnings don't require much growth to make the stock look attractive. The 3- and 5-year dividend growth rates are 15.8% and 18.0% on an annualized basis, respectively. ABBV has beaten expectations for 10 consecutive quarters and the latest miss, on January 25, 2019, was just $0.04 on quarterly earnings per share of $1.90 (consensus forecast was $1.94). The company does a good job of generating steadily growing revenues and setting expectations.
To form an opinion on ABBV, I rely on two forms of consensus. The first is the well-known consensus of Wall Street analysts. When there is not too much spread between analysts' price targets, the consensus has predictive value. The second form of consensus outlook that I follow is the market implied outlook, derived from the market prices of options.
The price of an option represents the market's consensus estimate of the probability that the price will fall above (call option) or below (put option) a specified level (the strike price) from today until the expiration date of the option. By analyzing the market prices of calls and puts with a series of strikes, but with a common expiration date, it is possible to calculate the probability of all possible price returns that best match the option prices for the period. For those who are not familiar with this concept, I have written an overview, including links to the relevant financial literature. More generally, it's worth looking at the research on the value of consensus estimates, which are often more accurate than even the best individual estimates that make up the consensus.
I last analyzed ABBV on May 2. , 2021 and I gave the stock a bullish rating until early 2022. Since then, the total return on ABBV has been -4.03%. Alpha
Idiosyncratic surprises are not uncommon with individual stocks and are more common in pharmaceutical stocks. For example, failure or success in a clinical trial typically shocks the stock price. The FDA's recent announcement has led to a substantial short-term decline. I'm updating my analysis to see if the long-term outlook for ABBV has changed. who have published ratings and price targets in the last 90 days. The consensus rating is bullish and the consensus price target for 12 months 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. The street consensus is derived from the opinion of 24 analysts who have published ratings and price targets in the past 90 days. The consensus rating is bullish (outperform) and the consensus price target for 12 months is $125.19, implying a price increase of 17.4%. Wall Street Consensus Rating and 12 Month Price Target
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). An important question, even taking the analyst consensus at face value, is whether the risk associated with ABBV makes this an attractive risk-return proposition. call and put options on a series of strikes for two expiration dates, January 21, 2022 and June 17, 2022, to generate market implied outlook 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 correspond to the market prices up to an average of 0.4% of the market prices of the options.
The standard presentation of the market implicit outlook is a probability distribution of returns, 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 highly symmetrical, 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 consider a version of the market implied outlook with the negative returns side of the distribution rotated on the vertical axis (see chart below).
Source: Author's calculations using option quotes from eTrade. The negative return side of the distribution is rotated about the vertical axis.
The chances of positive and negative returns of the same magnitude are very similar (the red dotted line and the solid blue line are very close). The chance of a negative return is in any case slightly higher. We expect the market-implied outlook to be negatively biased towards dividend-paying stocks, as dividends reduce upside potential versus downside potential. In addition, the 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 for January 21, 2022 is modestly bullish. In my analysis in May, the market-implied outlook for January 21, 2022 had tilted markedly negative and, given the large dividend and tendency for negative bias in this outlook, I interpreted the results as neutral with a slight negative (bearish) tilt. The current market implied outlook for January 21, 2022 is significantly more positive than in May.
Source: Author's calculations using option quotes from eTrade. The negative return side of the distribution is rotated about the vertical axis.
The market-implied outlook for the next 9.1 months (calculated with options expiring on June 17, 2022) shows an increased probability of negative returns (red dotted line significantly 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 sell-off in ABBV presents a buying opportunity. The Wall Street consensus is that the impact of the new FDA labeling requirement for Rinvoq will not be substantial. %. The market implied outlook for January 2022 has improved significantly since my last analysis in May, going from neutral with a bearish tilt to modestly bullish. The expected volatility is 27% (on an annual basis).
As a rule of thumb, I want to see a 12 month expected return of at least half the value of the expected volatility. If the expected return approaches the analyst consensus of 23.8%, ABBV easily exceeds this threshold. . The bearish tilt in the market-implied outlook through June 2022 suggests we need to revisit this analysis in early 2022.
