Here’s the next addition to our investment portfolio:
We first got involved in ABBV with a long call spread trade in mid-November. In that initial New Trade post, I outlined the significance of ABBV’s extensive pipeline, as well as its reasonable valuation vs. peers:
In addition to the existing stable of drugs, the company has more than 20 compounds in Phase II or Phase III development. This is a well diversified pharmaceutical company at an interesting valuation.
The stock is actually up 42% in 2013, a stellar performance for a large cap pharma name (only BMY has done better). Interestingly, even after such a strong run, the stock looks relatively cheap compared to both its sector peers and the overall market.
- ABBV – 16x trailing P/E, 8% expected earnings growth over next 2 years
- PFE – 14.5x trailing P/E, 5% expected earnings growth
- MRK – 13.5x trailing P/E, 4% expected earnings growth
- GSK LN – 14x trailing P/E, 8.5% expected earnings growth
ABBV is better than almost all its U.S. peers on simple valuation vs. growth comparisons, and slightly expensive to its European peers (as are most U.S. stocks).
Shortly after we posted this trade, Goldman Sachs actually added the stock to its conviction Buy List on December 2nd, also pointing out the breadth of Abbvie’s pipeline, a rarity among large-cap pharma these days:
We are adding ABBV to the Conviction List and raising our 12-month target price to $60. With an $18 bn revenue base, ABBV has more pipeline leverage than most other mid-sized biopharma peers and is entering a long period of robust clinical trial read-outs beginning 4Q13. ABBV shares have outperformed its peer group YTD (up 42% vs. large cap pharma peers 27%), but the stock is still perceived as a one-product story. In our view, ABBV is a pharma converging with biotech, with one of the least vetted pipelines in the sector. We believe that with data read outs over the next 6-12 months, there will be greater recognition of ABBV’s pipeline, leading to a re-rate of the stock.
GS research acknowledges that the data read outs also pose the risk of trial failures that could hurt in the stock in the coming months. That’s why we chose the options structure detailed below for the investment portfolio rather than simply buying the stock.
As for our prior ABBV trade, we exited that trade (way too early) for a gain as the stock ran into some initial resistance around $50. Since then, ABBV has released a number of positive data points. Moreover, the bar for 2014 has been set rather low (only 1% earnings growth expected on 2% sales growth expected vs. 2013), since analysts have modeled the more significant growth in 2015 and 2016. The company will report earnings in late January, only its 4th earnings report since its spinoff from Abbott. ABBV has been higher following each of the 3 prior reports.
Technically, the stock has pulled back to the $50 level, which we identified as resistance in the fall:[caption id="attachment_34466" align="alignnone" width="600"] ABBV daily, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
That also coincides with the rising 50 day moving average. If this important level holds, we like the prospects for ABBV to break out to new all-time highs in the coming months. If it breaks, we view $45 as more important long-term support, coinciding with the rising 200 day moving average. With that in mind, here’s the structure we settled on for the investment portfolio:
New Investment: Sell the ABBV ($50.60) August 45 Put, Buy the August 52.5/60 Call Spread for 0.10 credit
-Sold 1 Aug 45 Put at 2.05
-Bought 1 Aug 52.5 call for 2.80
-Sold 1 Aug 60 Call at .85
Break-Even on August Expiration:
Profits: Profits up to 7.60 between $52.50 and $60, max gain of 7.60 at $60 or above. Small profit of $0.10 between 45 and 52.50.
Losses: 1 for 1 with the stock below $44.90
The reason why we preferred this structure rather than buying the stock outright is that we do see potential risk down to $45 if the $50 level does not hold in the coming weeks. Rather than take that outright risk today, we’d rather give up some upside through the options structure, and give ourselves downside room down to $45 before we take losses. Finally, as we note on many occasions, for those executing this trade, your sizing should take into account the possibility that you will own the stock at $45 or lower.