SHARE PRICE: $128.02
MARKET CAP: $343B
1. INTRODUCTION
Ever since I started analyzing businesses, I’ve wanted to take a look at Johnson & Johnson. I know a bunch of people working there and they exude the corporate culture like nobody else. They love it and just can’t stop talking about it.
2. BUSINESS OVERVIEW
2.1. BUSINESS DESCRIPTION
Whenever I talk about JnJ (Johnson & Johnson) the first thing that comes to my mind is a happy baby taking a bath. We all remember the commercials for their Baby Shampoo that promised “no more tears”. That slogan was music to millions of desperate parents ears. But JnJ is now much more than just a shampoo company. Let’s find out what else they do. I’m going to take a look at their website.
Founded in 1886, Johnson & Johnson is now the world’s largest pharmaceutical company by revenue. Its name originates from the names of the three brothers that founded it, Robert Wood Johnson, James Wood Johnson and Edward Mead Johnson Sr.
The company specializes in 3 major segments:
Medical Devices: Surgical devices, orthopedic prosthetics, wound closures, used mostly by physicians, hospitals, nurses and clinics.
Pharmaceutical: Drugs for prescription use, divided in Immunology, Infectious diseases, Neuroscience, Oncology, Hypertension and Cardiovascular.
Consumer products: Marketed to the general public, includes a broad range of products like skin care products, shampoos, baby care, oral care and over-the-counter pharmaceuticals. Some of these products are household names like Listerine, Neutrogena or Piz Buin. Have you ever smelled Piz Buin? If you haven’t, next time you go to the beach, try it out. You’re welcome.
2.2. LARGEST SHAREHOLDERS
No surprise here. The largest shareholders are all big funds.
2.3. MANAGEMENT TEAM
After all these years I have come to know Alex Gorsky’s name but I don’t know much about him. Let me do a quick search on him.
Ok, so he worked for JnJ from 1988 to 2004, then he joined Novartis, and finally he came back to JnJ in 2008, becoming CEO in 2012.
3. HISTORICAL CONTEXT
3.1. LONG TERM CHART
The company went public in 1978 and an investor who bought in the IPO and held on to the stocks, would’ve gotten a compound annual growth rate of 11.5% (not including the dividends). The stock price went sideways between 2001 and 2012 and from 2012 onward went up quite nicely. It is now at $128,02.
3.2. MARKET CAP AND SHARES OUTSTANDING
Since 1990 the number of shares outstanding has remained relatively stable and it’s now at the 90’s level of 2,7 Billion shares outstanding. Like the stock price, the Market Cap saw a period of stagnation between 2001 and 2012 but has been rising ever since. The company is valued at $343 Billion right now.
3.3. SALES - OPERATING INCOME - OPERATING MARGIN
Sales are at an all time high. In 2018 sales went up 7% to $82 Billion. Although some results came out just today, operating income wasn’t one of them, so I am relying on analysts projections here. Anyhow, management said that adjusted EBIT went up 9.8% in 2018.
3.4. SALES BY GEOGRAPHY
The USA represents 50% of total sales.
3.5. SALES BY SEGMENT
The Pharmaceutical segment is the main sales driver followed by the medical devices and in last place comes the consumer products segment.
Pharma products have the highest margin of them all at 30%, Medical has margin of 20% and Consumer 18.5%.
3.6. SALES TRENDS BY SEGMENT
I would like to see the evolution throughout the years for these 3 segments so we can have a clearer picture of what is happening. I’m going to search for this info on some of the previous annual reports….
OK, here we have it.
What we see over recent years is a leveling off in Consumer Products sales, a slight increase of Medical Devices sales (+1,6% yoy) and a clear upward trend in Pharmaceutical sales (+5,2% yoy), the segment that has the better margins.
3.7. NET INCOME, NET MARGIN
Profits for 2018 went up to $15,3B and net margin 18,7%. If it were not for special special items, net income would’ve reached $22B!
We can clearly see a big hit in net income in 2011 and a HUGE ONE in 2017.
The sudden fall in profits in 2017 was due to the Tax Cuts and Jobs Act (TCJA). For JnJ to bring home the cash it had outside of the US, it had to pay $13 Billion.
If it wasn’t for this one time tax, net income would’ve reached $14,3 Billion.
3.8. RESEARCH AND DEVELOPMENT
An important figure when analyzing pharmaceutical companies is the R&D figure. Clearly the big money is being spent on the pharma segment, the one with highest margin and potential for growth. I would do exactly the same as Mr. Alex Gorsky.
3.9. SEASONALITY
There is no significant seasonality to JnJ sales, but there is a high seasonality of operating income due to increased spending in advertising in the 4th quarter.
3.10. DIVIDENDS
I’m not a fan of dividends, I prefer to invest in companies that can still invest earnings back into the business, but since these big caps all increase dividends like clockwork, I might as well post it here. With the stock trading at $128 right now, the dividend yield is 2,8%.
3.11. PROFITABILITY RATIOS
After the sudden drop in 2017, we are seeing ROIC coming back to 16% and ROA to 12%, which is more less in line with previous years.
3.12. FINANCIAL RATIOS
Current ratio above 1,5 and Debt to Equity ratio bellow 0,5 are just perfect. JnJ has a really strong balance sheet. In fact, alongside Microsoft, JnJ is one of only two companies to be given AAA rating, which allows it to borrow money at lower rates than everybody else. Definitely a plus, should the opportunity for a big acquisition arise.
3.13. PRICE TO EARNINGS RATIO
Taking into account the analysts estimates for 2019, the PE ratio is at 17 and the average historical PE ratio for JnJ is…..
…… 21, which might indicate a slight undervaluation related to its own history.
It is obvious that such a great company is hard to find trading at an attractive multiple like back in 2008 and 2010 when it was selling at a PE of 13.
Just so we get a feeling for where competitors are, Roche trades at a PE of 20, Novartis at 15 and Pfizer at 11. I always like to make this comparisons but lets not forget that none of these other companies can be directly compared to JnJ because JnJ is the only one that incorporates 3 segments together and I am not aware of the particularities of each of these other companies.
Note: For the year 2017 I have not taken into account the on time tax on overseas money.
3.14. RISKS AND COMPETITION
Like most pharmaceutical companies, a big risk is the ability to continue to launch patented products while losing the patents for older ones. JnJ has been able to do with some degree of success and it has reached a point where it can just buy smaller companies in order to continue delivering innovative products.
Another risk is the ability to find other companies to acquire at reasonable prices. We can look at Teva, the generics giant, and its expensive acquisitions has a way of messing up a perfectly good company.
In the consumer products world, there is a lot of competition these days. From other big companies to small, more natural oriented companies, there is a wide range of options for skincare, hair treatment or baby lotions.
3.15. TYPE OF PLAY
I consider Johnson & Johnson a slow growth and a dividend play.
5. OVERVIEW AND CONCLUSION
5.1. OVERVIEW
Johnson & Johnson is one of the best companies I have ever seen, there is no doubt about that. I can easily remember the days when one would immediately associate it with baby care shampoos and powders. That image is still present in our minds, but JnJ is far from being just a shampoo company these days.
With an ageing population showing no signs of slowing down, I can easily see the Pharmaceutical segment growing for the foreseeable future, the medical devices segment growing as well, but at a slower rate, and the consumer products continuing to lag behind, due to the competitive environment from smaller, more “natural” brands.
Since the trends are so well defined, lets extrapolate them into the next 10 years and do a back-of-the-napkin estimate:
Pharmaceutical: although this segment has grown at a 5% rate for the last 10 years, I will use the last 5 years growth rate of 7,6%. It will reach $85 Billion in sales in 2028.
Medical Devices: let me give it the benefit of the doubt and say this segment will grow at 3% annually until 2018 reaching $36 Billion in sales in 2028.
Consumer Products: like in the previous segment, let’s be optimists and say it will grow at a rate of 1% for the next 10 years, reaching sales of $15 Billion. All of these stack up to $136 Billion in sales for 2028. Apply a net margin of 25% to that number and we get net income of $34 Billion.
At a historical PE of 21, this will amount to a Market Cap of $715 Billion.
This represents an annual compound rate of return of 7.6%. If we throw in a 2.5% dividend yield, we get a 10% rate of return.
For the number crunching lovers among the readers, I’ve set up a simple model. Coincidentally, it leads more less to the same back-of-the-napkin results I’ve reached before. I’ve assumed the following:
- revenue growth of 6% yoy
- EBIT margin of 26%
- a rather conservative share buyback rate of 2% a year
- payout of 50% of profits in dividends every year
- debt will be pay down as they go along.
This isn’t supposed to be a highly accurate mathematical prediction, just a simple approach to what I consider to be the most likely scenario. Take it with a grain of salt.
5.2. CONCLUSION
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