Pat McKeough recently replied to a member of his Inner Circle looking for an opinion on Johnson & Johnson. Both revenue and earnings continue to grow for this leading maker of prescription drugs and consumer products. But still, there are risks, says Pat.
Q: Pat: Can I have your recommendation on whether or not Johnson & Johnson is a buy? Thank you.
A: JOHNSON & JOHNSON (symbol JNJ on New York; www.jnj.com) operates through three major businesses:
Pharmaceutical (47% of revenue) makes anti-infective, antipsychotic, contraceptive, dermatological and gastrointestinal drugs;
Medical devices and diagnostics (35%) sells equipment for joint reconstruction and managing circulatory diseases;
Consumer (18%) makes over-the-counter products such as Johnson’s baby care items, Band-Aid bandages, Tylenol and Motrin painkillers, Listerine mouthwash and Neutrogena skin cream.
In June 2016, Johnson & Johnson agreed to acquire beauty-products firm Vogue International for $3.3 billion; it represents the company’s biggest acquisition in four years. Vogue’s annual revenue—from hair and personal-care brands such as OGX, Proganix and Maui Moisture—is about $300 million.
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Instead of relying on traditional advertising, Vogue has successfully used colourful packaging to help its products stand out on store shelves and to drive sales. Its product line complements Johnson & Johnson’s personal-care brands such as Clean & Clear and Neutrogena.
Also the company has announced two additional acquisitions: its medical device business, Ethicon, will buy NeuWave Medical Inc. That company makes and sells minimally invasive soft-tissue microwave ablation systems. Physicians use these radiology machines to hit tumours with microwaves and kill cancer cells. Johnson & Johnson will also buy NeoStrata, a maker of skin care products created by dermatologists. The company has yet to disclose purchase prices.
Excluding one-time items, Johnson & Johnson earned $4.7 billion in the three months ended April 3, 2016. That’s up 6.1%, from $4.4 billion a year earlier. Per-share earnings grew 7.7%, to $1.68 from $1.56, on fewer shares outstanding.
Growth stocks: Sales up 3.8%, excluding exchange rates
Revenue in the quarter increased 0.6%, to $17.5 billion from $17.4 billion a year earlier. Overseas markets supply about 47% of Johnson & Johnson’s revenue, and the high U.S. dollar cut the contribution of its foreign sales. Excluding currency exchange rates, sales rose 3.8%.
Most of the revenue growth in the quarter came from the company’s pharmaceutical division, where sales increased 12.3%. That’s mainly because of stronger sales of existing drugs and new product launches. Those new treatments include Imbruvica (chemotherapy), Xarelto, (an oral anticoagulant), Darazalex (treatment of patients with multiple myeloma), and Invokana (treatment of adults with type 2 diabetes). The gains offset lower sales of Olysio/Sovriad, a combination treatment for Hepatitis C.
Meanwhile, revenue at the consumer division rose 1.9% during the quarter. Sales of over-the-counter products such as Tylenol and Motrin, Listerine oral care products and international anti-smoking aids were up. That was offset by weaker sales for other product lines: baby care, wound and skin care, and women’s health. Revenue at the medical devices division increased 3.0%.
The company continues to develop new treatments. In the latest quarter, it spent $2.0 billion (or 11.5% of its total revenue) on research, up 6.0% from $1.90 billion (or 10.9%) a year earlier.
Johnson & Johnson’s balance sheet is strong: its long-term debt of $20.2 billion is just 6% of its market cap. It also holds cash of $39.9 billion, or $14.25 a share. That puts it in a strong position to acquire smaller pharmaceutical firms with promising drug therapies or medical-device makers with products that complement its existing lines.
The company will likely earn $6.65 in 2016, and the stock trades at 18.5 times that estimate. Johnson & Johnson raised its quarterly dividend by 6.7% with the June 2016 payment, to $0.80 a share from $0.75. The new annual rate of $3.20 yields 2.6%. The company has increased its payout annually for the past 54 years.
The long-term outlook for Johnson & Johnson is positive. In the near term, though, the strong U.S. dollar will continue to hold back its revenue. As well, the company gets the majority of its sales from its pharmaceutical division—and that adds risk.
We’ve always felt that many investors underestimate the risk of drug stocks, and overestimate their potential. They overlook the huge costs drugmakers face in creating a new product and gaining regulatory approval for it. They also ignore the limited time that drugmakers have to recoup their investment before the drug’s patent expires or something better comes along.
Inner Circle recommendation: HOLD.
For our advice on making sound decisions on growth stocks, read How to keep hot growth stocks from burning your portfolio.
For our recent report on an ambitious growth stock with a challenging road ahead of it, read Uncertainty ahead for Tesla Motors.
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