Governments have currently implemented draconian measures to stop the coronavirus, leading to a wide global sell-off on the stock exchanges. Market drops are often a good thing if you have cash or if the companies have the liquidity to buy back shares and wither the storm.
The FED is printing almost insane amounts of money every day and EU states are going into debt to limit the number of deaths (on mostly unreliable data – only later will we be able to measure what was smart or not). Clearly, Western governments are completely unprepared for this pandemic.
Johnson & Johnson (JNJ) should be one of the safest performers in this environment. Below you find some notes I made this morning:
Business/segments:
- Consumer (17% of revenue): Personal healthcare in beauty, baby care, oral care etc. This includes OTC medicines like Zyrtec (allergy), Ibuprofen products, etc.
- Pharmaceutical (51% of revenue): Immunology, infectious diseases, neuroscience, oncology, cardiovascular/metabolism and pulmonary hypertension. These medicines are prescribed and distributed to retailers, wholesalers, hospitals, etc.
- Medical Devices (32 of revenue): Orthopaedic, surgery, interventional solutions and eye health. These are mainly ordered by professionals (nurses, hospitals, etc.)
JNJ sells to all corners of the world. The same goes for their production. 42.1% of sales is in the US, 18.5% in Europe, 15.6% in Asia, and 5.9% in the rest of the Western world.
Over the last two years, JNJ has invested about 15 billion in R&D to develop new drugs. Management focuses on markets it can hold a dominant position, among the three best, and divesting assets that don’t hold such positions.
Inside ownership or skin in the game:
All directors and officers own about 1.25 million shares, and even with compensation-controlled options, the ownership is below 1%. Alex Gorsky, the CEO, owns about 4 million shares, worth around 40 million.
Historical numbers:
| 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | |
| Sales | 63,747 | 61,897 | 61,587 | 65,030 | 67,224 | 71,312 | 74,331 | 70,074 | 71,890 | 76,450 | 81,581 | 82,059 |
| Net earnings | 12,949 | 12,266 | 13,334 | 9,672 | 10,853 | 13,831 | 16,323 | 15,409 | 16,540 | 1,300 | 15,297 | 15,119 |
| EPS | 4.57 | 4.40 | 4.78 | 3.49 | 3.86 | 4.81 | 5.70 | 5.48 | 5.93 | 0.47 | 5.61 | 5.63 |
| Operating cash flow | 14,972 | 16,571 | 16,385 | 14,298 | 15,396 | 17,414 | 18,471 | 19,279 | 18,767 | 21,056 | 22,202 | 23,416 |
| Free cashflow per share | 5.02 | 4.3 | 4.43 | 4.65 | 5.08 | 5.3 | 4.79 | 6.71 | 6.76 | 7.31 | ||
| Equity per share | 18.37 | 20.66 | 20.95 | 23.33 | 26.25 | 25.06 | 25.82 | 26.02 | 22.43 | 22.44 | 22.59 | |
| LT debt | 8,120 | 8,223 | 9,156 | 12,969 | 11,489 | 13,328 | 15,122 | 12,857 | 22,442 | 30,675 | 27,684 | 26,494 |
| Dividend per share | 1.93 | 2.11 | 2.25 | 2.40 | 2.59 | 2.76 | 2.95 | 3.15 | 3.32 | 3.54 | 3.75 | |
| Interest expense | 451 | 455 | 571 | 532 | 482 | 533 | 552 | 726 | 934 | 1005 | 318 | |
| ROE % | 30.460 | 24.247 | 23.567 | 16.945 | 16.742 | 18.677 | 23.401 | 21.657 | 23.488 | 2.161 | 25.5 | 25.400 |
| ROIC % (Morningstar) | 19.65 | 13.39 | 14.22 | 16.39 | 18.47 | 17.55 | 17.86 | 1.69 | 16.9 | 17.01 |
Revenue has grown 2.32% annually since 2008 (11 years) while operating cash flow has grown 4%.
The dividend:
Many own JNJ because of the dividend (which has been raised for over 30 years in a row). That is understandable, but most investors should know there are other ways to create “income”, like selling shares for example. The current yield as of writing is 3.2%, the highest yield since 2012. The payout ratio is about 50% of the free cash flow, and I would say the dividend is pretty safe.
Valuation:
I expect JNJ to be much less impacted by the coronavirus than most other companies. Since the outbreak, the stock has dropped from 150 to 120 (20%), and currently trading at 16 times last year’s free cash flow. The financial crisis little impacted JNJ in 2008/09, but it remains to be seen how the coronavirus affects earnings. I expect a drop, but I assume much of it is already discounted.
Moat:
To develop a new drug is immensely costly, mainly due to very tight regulations. Thus, developing a new drug requires a lot of capital, sometimes billions of USD. Regulation limits competition and I assume big pharma, which clearly JNJ is, has an advantage over much smaller and less capitalized drug companies. The diverse drug portfolio developed by JNJ means no drug has more than 13% of the segment’s sales, and obviously less on company-wide revenue.
Risk:
Most of the acquisitions have been small, in a category that can be labelled “bolt-on”, only occasionally every 5-6 years do they make a bigger acquisition. The biggest over the last ten years was Actelion for 30 billion back in 2017. M&A is difficult, but based on history it seems JNJ has managed this pretty good.
The pharma segment obviously is dependant on patents, and sales drop as soon a drug is no longer patented. The segment is the most profitable and it’s thus important that R&D allocates enough funds for the extreme costs of developing new drugs. Furthermore, many new drugs fail approval from the FDA (after spending billions in development), and this gives way to the “necessity” for some M&A.
Lawsuits are (unfortunately?) pretty common in the US, and JNJ is no exception and has ongoing lawsuits at all times, for example the talcum powder lawsuits.
Balance sheet:
Cash and liquid assets at 31.12.2019 were 12% of the assets, 20 billion. Long-term debt is at 26 billion (debt/equity is 0.5) and rated AAA, the highest rating together with Microsoft. The company has a rock-solid balance sheet and is unlikely to have any problems servicing the debt.
Conclusion:
JNJ is highly likely a boring but stable performer. During stressed times like today, it provides a safe haven and is unlikely to be hugely affected by the pandemic, except perhaps being forced to close some factories due to infection. However, this will pass.
What rate of return can you expect in JNJ over the next decade? I like to keep things simple and use late John Bogle’s very simple formula of calculating future returns over the next decade (or longer):
Dividend yield + earnings growth + multiple expansion = annual growth.
If we expect the same growth as over the last two decades, which is about 4%, and the same valuation in ten years’ time, we can expect 7.2% (3.2 + 4). Clearly, it will not set the world on fire.
I currently have no position in JNJ.
Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.
FAQ:
– What is Johnson & Johnson’s approach to research and development (R&D)?
Over the last two years, Johnson & Johnson invested approximately 15 billion USD in R&D to develop new drugs. The company focuses on markets where it can establish a dominant position and divests assets that do not hold such positions.
– Why is Johnson & Johnson often considered a reliable dividend stock?
Johnson & Johnson is known for consistently raising its dividend for over 30 years. The current dividend yield, payout ratio, and free cash flow support the safety of the dividend.
– What risks does Johnson & Johnson face in its business operations?
The risks Johnson & Johnson faces include dependence on pharmaceutical patents, high costs of developing new drugs, FDA approval challenges, lawsuits (e.g., talcum powder lawsuits), and the need for occasional mergers and acquisitions (M&A).
