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By: Ahmed Ishtiaq

Johnson & Johnson (NYSE:JNJ) is the world's biggest and most diverse healthcare company. It has three divisions: Pharmaceuticals, consumer and medical devices and diagnostics. At the moment, the company ranks eighth worldwide in the Pharmaceutical segment and fifth in biologics segment. In addition, JNJ is ranked top in the medical devices and diagnostics segment. About 38% of revenues for the company come from the Pharmaceuticals segment. However, due to the patent losses, the contribution from the segment is likely to decline. On the other hand, medical devices and diagnostics segment is growing rapidly and accounts for 40% of JNJ revenues.

JNJ stock has risen steadily over the past year. At the moment, the stock trades around $69. In addition to the healthy capital gains, JNJ offers attractive dividends. Let's look at the dividends, payout ratio, cash flows, earnings and debt of the company. It should help us gauge the ability of JNJ to maintain or increase its dividends.

Dividend Profile:

Johnson & Johnson has an impressive dividend profile. The company has a rich history of dividends and has increased dividend payment every year since 1997. At the moment, the company pays $2.40 in annual dividends, which represents a yield of 3.46%. JNJ has a relatively high payout ratio of 77% based on its earnings.

Earnings:

Over the past three years, JNJ earnings have been impressive. The company has recorded impressive growth in its revenues. At the end of 2009, JNJ reported revenues of $61.8 billion, which grew to over $65 billion by the end of 2011. However, net income and EPS for the company declined during the previous three years. JNJ reported EPS of $4.40 at the end of 2009, which came down to $3.49 by the end of 2011. However, for the most recent quarter, the company reported impressive earnings results. JNJ beat the market expectations by $0.04 in the third quarter and reported EPS of $1.25. Further, the market expected the company to report revenue close to $16.4 billion for the quarter. However, the company reported revenue of over $17 billion.

A deeper look at the earnings statement reveals that the company recorded a marginal increase in sales from its international operations. There was an increase of 1.4% in international sales from the same quarter last year. At the moment, most of the Pharmaceutical companies are suffering in their international operations. However, JNJ did not lose sales from its international operations although, the growth was marginal. In addition, a strong US dollar also contributed to the weak growth in international sales. However, strong growth in medical devices segment and aggressive acquisitions will help the company grow. A fall in sales from the pharmaceuticals segment will be covered with an increase from medical devices segment.

Cash Flows:

JNJ has extremely impressive cash flows. The company has generated over $10 billion in free cash flows in each of the past three years. At the end of 2009, JNJ generated $16.5 billion in cash flows from operations. Although, operating cash flows have shown a decline over the past three years; free cash flows remain strong. Capital expenditures have been relatively stable for the company. In the past three years, JNJ have spent over $2.3 billion in capital expenditures each year. For the first nine months of 2012, the company has generated $12.02 billion in cash flows from operations.

Free cash flows after adjustments for acquisitions and additions to property, plant and equipment (PP&E) stood at $5.81 billion. JNJ has paid $4.92 billion in cash dividends to its shareholders this year. Based on the free cash flows, the payout ratio is almost 85% for the current year. However, due to an increase in capital spending, the free cash flows for the firm have come down. Nonetheless, JNJ dividends are adequately covered with the free cash flows.

Debt:

In its most recent earnings announcement, the company reported long term debt of $11.4 billion. There are only two debt issues above $1 billion on the books of the company. JNJ does not have any debt offering maturing in the current or the next year. The earliest maturity date for any debt offering by JNJ will fall in 2014. A 1.20%, 999 million notes will mature in 2014. Almost all of the debt issues carry favorable rates. A long term note due in 2029 carries the highest interest rate at 6.95%. However, weighted average effective rate for JNJ debt is much lower at 4.34%.

Competition:

JNJ competitors include Novartis AG ADR (NYSE:NVS), Merck & Co Inc (NYSE:MRK) and Pfizer Inc PFE. The table below presents a comparison based on important metrics.

JNJ

NVS

MRK

PFE

P/E

22.80

16.90

19.50

20.40

P/B

3.00

2.20

2.40

2.20

P/S

2.90

2.50

2.80

2.80

EPS Growth

-8.60%

2.00%

-17.80%

-2.30%

Operating Margin

23.80%

18.00%

18.60%

25.60%

Net Margin

12.90%

15.00%

14.20%

15.80%

ROE TTM

13.60%

13.00%

12.20%

12.20%

Debt to Equity

0.20

0.20

0.30

0.40

Source: Morningstar.com

At the moment, JNJ is expensive compared to its peers. However, a diverse revenue base, strong research pipeline and exceptional cash-flow generation create a wide economic moat. As a result, investors are happy to pay a premium for the stock. Furthermore, the company has the strongest operating margin among its peers. EPS growth figures of the industry show that the participants are struggling to grow EPS at the moment. However, operating and net margins remain strong in the industry. Moreover, all of the companies mentioned have a manageable debt to equity ratios.

Summary:

At the moment, Johnson & Johnson is the industry leader in medical devices segment. Over the years, the company has improved its position in the global market through investment in research and development. In addition, the company is making acquisitions to increase its foothold in the global pharmaceutical industry. In addition, the company has a healthy pipeline and impressive R&D department. Furthermore, the stock offers impressive dividends, which are backed by healthy free cash flows. JNJ can prove to be an astute long term investment. Strong free cash flows and attractive growth prospects indicate that the firm will be able to maintain its dividends.

Source: How Safe Are Johnson & Johnson's Dividends?