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Johnson & Johnson: Is it Too Late?

Posted on: October 15, 2008 - Email Article - Printable Version

Ryan Savitz

About the Author:

The markets cannot seem to catch a breather, find a glimpse of hope, or even come close to ending the day flat. Even Healthcare has been getting beaten up recently. Recessionary proof? I do not feel anything is recessionary proof in this current environment. The Healthcare Select Sector SPDR, [XLV: 26.96, 0.00 (0.00%)], is down 22.54% year to date, not quite near the Financials SPDR, XLF down 47.18% (performance as of 10/08/2008), but still more than ever expected in a bear market. So, where does that leave an investor like you trying to find that bottom, time it right, and catch huge on the upside? Well, I won’t necessarily provide you with that information because I think we still have quite a long way to go before we can recover. However, I will provide you a staple holding to your portfolio. No, not something like a Wal-Mart [WMT: 56.52, 0.00 (0.00%)], Proctor and Gamble [PG: 62.35, 0.00 (0.00%)], or a CVS Pharmacies [CVS: 29.80, 0.00 (0.00%)], that is actually a staples company. I am referring to Johnson & Johnson. You might think that JNJ is a very unoriginal thought and possibly a no-brainer to anyone who is diversifying a portfolio; but, many people have strayed away from it because of its Pharmaceutical exposure. Investors forget it’s nice dividend (2.9% yield), but not as high yielding compared to its competitors like Pfizer [PFE: 18.16, 0.00 (0.00%)] (7.3% yield), Bristol Meyers Squibb [BMY: 23.23, 0.00 (0.00%)] (6.6% yield), Sanofi-Aventis [SNY: 31.11, 0.00 (0.00%)] (5.3% yield), and Merck [MRK: 30.53, 0.00 (0.00%)] (5% yield) just to name a few.

So why JNJ?

Why not is the real question? Personally, I wish I had invested in July. I know I wouldn’t have seen any appreciation but being flat right now that’s really all you can ask for as an equity investor. JNJ operates in three major segments: Pharmaceuticals, Medical Devices and Diagnostics, and Consumer. I wrote an article in the past entitled the Big Pharma Effect, outlining the negatives of the pharma industry, and outlining how the CRO market would benefit from the large patent expirations. JNJ has about 40.7% of revenues coming from the Pharmaceuticals segment which may spring up an immediate red flag; however, let me touch upon a couple key points and explain why it is not a negative:

JNJ has a very diverse revenue stream in Pharmaceuticals. Prescription products for Central Nervous System disorders, Infectious Disease, Immune System Diseases, Pain, Reproductive Health/Urology, Cancer and Blood Diseases, Metabolic Disease, and Cardiovascular Disease. As you can see the branded drugs are heavily intensive in biotech, which has a higher growth potential and historically higher margins
JNJ also has a good pipeline with many drugs awaiting FDA approval. When looking just in the therapeutic area of Central Nervous System, JNJ has three drugs in Phase III, four that have been filed, and one that has been approved in the United States This goes along with five drugs in Phase III in the European Union. Also in the pipeline is Stelera, a psoriasis treatment drug in Phase III which has recently been shown to be superior to Amgen’s Enbrel

The Medical Device and Diagnostic division is one that I am most excited about, and the sub-sector that I am very bullish on (two of my favorites are Stryker [SYK: 40.78, 0.00 (0.00%)] and Becton Dickinson, and Company [BDX: 69.11, 0.00 (0.00%)]). The wide variety of products that JNJ offers in this segment is astounding. Their Medical Devices and Diagnostics segment is their second largest segment with about 35.6% of revenues. The areas in which JNJ has diagnostic products is too large to list, but it covers all of the major parts of the sub-industry.

The Consumer division, which contains 23.7% of revenues, came from JNJ’s strategic and timely acquisition of Pfizer Consumer Healthcare in December of 2006 for $16.6 billion. This was an all cash transaction. This acquisition was great for JNJ as it brought a steady flow of revenues, and left Pfizer solely relying on their pipeline and current branded drugs. And as you may know, Pfizer has been struggling as of late.

Effective Management

I could go on for pages concerning how good the management is at JNJ, but let me just point out a few key facts:

46 consecutive years of dividend increases
75 consecutive years of sales increases
$13 billion in cash
9.1% shareholder returns on a 10 year basis, beating the S&P 500 (5.9% return) and S&P Pharmaceutical (3.7% return)
Strategic acquisitions- most notably Pfizer Consumer Healthcare

JNJ’s management knows what it takes to be a top competitor within Healthcare, and they know how to diversify both geographically and by segment. A flight to quality is gained by investing in JNJ and should be heavily considered when looking to stabilize your portfolio during this rough storm.

Large Capitalization-172.90 Billion
Low Beta- 0.51
ROA - 13.96%
ROE - 28.99%
ROIC-WACC Spread - 22.17%
Credit Rating- AAA
Top Line revenues in 2007 of $61,095 Billion and 2008 estimated $64,810.4 Billion

Risks

Generic competition is an obvious risk to any company engaged in Pharmaceuticals. The two branded drugs that investors are weary about are Risperdal and Duragesic. However, due to their expansive pipeline I feel that this is not a large concern, as management has proved year over year that they can effectively beat earnings and provide a return to their shareholders. Another risk is the weakness in the Cypher stents, due to ongoing concerns over the safe use of DES (Drug-Eluting Stent). This concern is for all players within stents, including Abbott Laboratories [ABT: 52.64, 0.00 (0.00%)].

Conclusion

JNJ is seen as a “flight to safety”. This market and your portfolio are screaming for large-cap, diversified, and effectively managed companies. This is exactly what Johnson & Johnson will bring to the table.

-Ryan Savitz

Disclosure: The mutual fund that the author manages is long JNJ.

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