Johnson & Johnson: Boring, Slow Growing And Stable (Recession Proof)

Johnson&Johnson logo.

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 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 a 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 cashflow 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. Current yield as of writing is 3.2%, the highest yield since 2012. The payout ratio is about 50% of the free cashflow, and I would say the dividend is pretty safe.

Valuation:

I expect JNJ to be much less impacted by the corunavirus than most other companies. Since the outbreak the stock has dropped from 150 to 120 (20%), and currently trading at 16 times last years free cash flow. JNJ was little impacted by the financial crisis 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, it requires a lot of capital to develop a new drug, 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 the 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 for 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.

(This article was published 23rd of March 2020.)

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.  

 

 

 

 

 

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