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Abbott Labs' Weakness in Devices Hurts Long-Term Growth Potential

NEW YORK (TheStreet) -- By conventional valuation methods, shares of Abbott Laboratories (ABT - Get Report) aren't expensive. In fact, it's easy to argue that Abbott is one of the best bargains in medical technology.

At around $43 per share, up nearly 12% for the year to date, the stock is trading at a price-to-earnings ratio of 27, one point below the industry average P/E of 28, according to Yahoo! Finance. On a forward-looking basis, these shares are trading under three times 2015 revenue estimates of $23.6 billion. Likewise, that's below the industry average price-to-sales ratio of 3.51.

That, however, is part of the problem. Abbott's growth projections are too low. With the stock trading just 1.19% away from its 52-week high, these shares just might have reached their ceiling for the next couple of quarters.

All told, Abbott, as cheap as the stock may appear, doesn't offer the sort value one would expect from a large medtech player -- unless management figures out a way to revive the company's stagnant devices business.

Like Stryker (SYK) , Abbott should consider a deal to secure long-term growth and remain relevant in the fast-pace world of medical device technology. Management can't sit idle and expect to keep up with Covidien (COV) and Medtronic (MDT) .

That's easier said than done, especially with the company lacking in exceptional free cash flow margins. The company's recent deal with Mylan (MYL) , which gives its Established Pharmaceuticals business much-needed exposure in emerging markets, is a step in the right direction. But it's not enough. Not when Abbott's nutrition business, its largest segment, is growing at just 3% annually.

While management has turned its focus on growing its drug business to offset the underperformance seen in other areas, the devices segment remains the Achilles heel, growing just 1% in the most recent quarter. The company recently invested in a solid peripheral stent platform, likely in response to Medtronic's acquisition of Covidien.

Nevertheless, while that deal does strengthen Abbott's capabilities in vascular treatment, it fails position Abbott in such a way that it helps the company better compete against neither Johnson & Johnson (JNJ) or a stronger Medtronic/Covidien. The latter, upon their merger, will be able to bundle products together like vascular and cardiology to pressure Abbott's recent investments in that area.

Abbott has to do a deal to protect itself. More importantly, it needs a way to grow its top line. Otherwise, the bottom line, which declined 2% in the recent quarter, will have Wall Street second-guessing whether the P/E of 27 -- albeit low -- is deserved.

By contrast, Johnson & Johnson just posted a 13% jump in profits. Johsnon & Johnson trades at a P/E that is eight points lower and is producing four times the revenue growth.

Abbott has now reached a point where management should start thinking about a strategic acquisition or two. The devices business is where the focus should be placed. It's the only way for Abbott to catch up to Johnson & Johnson and Boston Scientific (BSX) . Until then, at best, these shares are a hold. There's no compelling reason to buy above $40.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates ABBOTT LABORATORIES as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate ABBOTT LABORATORIES (ABT) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, good cash flow from operations, expanding profit margins and solid stock price performance. We feel these strengths outweigh the fact that the company has had sub par growth in net income." You can view the full analysis from the report here: ABT Ratings Report

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