The stock price of Johnson & Johnson (JNJ) has advanced from $69 in January to $81 recently, a decent 17% increase in just three months. The question in investor's mind is: will this run continue? How much is JNJ really worth? In this article, we perform a stock valuation for Johnson & Johnson based on its 2012 annual report released in February, 2013. From our projected income statement (Table 1), JNJ's revenues could grow from $71B in 2013 to $86B in 2017, whereas the adjusted earnings per share (EPS) could increase from $5.5 to $7.6. Using our projected free cash flow numbers (Table 4), we derived an estimated fair value for JNJ at $86. Thus, with the stock currently trading at $81, it is being traded at 6% discount to its intrinsic value. The stock also provides a 3.0% dividend yield, thus appealing to both growth and income investors.
Financial data before 2012 are based on the JNJ 2012 annual report Feb 2013. The data from 2013 to 2017 are projections based on JNJ's historical data or revenue estimates.
The most important items in the projected income statement are revenues. JNJ's revenues came from three segments: pharmaceuticals, medical devices, and consumer products. We used a historical 4% growth for medical devices and consumer products as their growth is relatively stable and in line with nominal GDP growth.
With pharmaceuticals, we identified the drugs launched within three years, including Simponi, Stelara, Invega, and Zytiga, and assigned them high growth rates. Remicade and Velcade have steady 10%-15% growth rates in the past two years. We assume an 8% growth rate going forward. The remaining pharmaceutical drugs will either be experiencing slow growth or facing competition. So, we assigned them an annual 4% decline in growth rate.
New drugs to be launched in 2013 include Xalrelto, Invokana (canagliflozin), and Sirturo (bedaquiline). Xalrelto has been approved for the prevention of deep vein thrombosis (DVT) and for reducing the risk of stroke and systemic embolism in patients with atrial fibrillation. Invokana (canagliflozin) was just approved by the FDA recently for the treatment of type 2 diabetes on March 29, 2013. Sirturo (bedaquiline) is an oral treatment for pulmonary, multi-drug resistant tuberculosis (MDR-TB) in adults. We estimate that the combined revenues for these new drugs will be $750M, $1.35BM, $2.1B, $3B, and $3.6B from 2013 to 2017.
JNJ's drug pipeline includes ibrutinib (Btk inhibitor) for chronic lymphocytic lymphoma and mantle cell lymphoma, siltuximab (anti-IL6) for oncology, and simeprevir (protease inhibitor) for HCV. Since these drugs are still in phase 3 clinical trials, we do not include their potential revenues in our projection.
Altogether, the estimated total revenues for JNJ are $71B, $75B, $79B, $82.6B and $86.4B from 2013 to 2017. This suggests that JNJ's revenue compound annual growth rate (OTCPK:CAGR) is approximately 5%.
Other Income Statement Items
On the expense side, we used JNJ's historical gross margin and EBIT margin as a guide. Its cost of goods sold (COGS) and selling and general administration (SG&A) expenses were about 30% and 44% of net sales, respectively. We also assumed its effective tax rate staying the same as its 2012 level (23.7%) going forward.
Interest expenses were derived from our projected debt and interest schedules. Overall, JNJ's long-term debt balance will range from $13B to $15B, while short-term borrowing is expected to be about $2.5B. The average interest rate for JNJ's debt is approximately 5%.
Our income statement projects earnings per share at $4.12 (2013), $4.51 (2014), $4.92 (2015), $5.34 (2016), and $5.77 (2017). JNJ also reports adjusted earnings by adding back non-cash charges, restructuring costs, and one-time items. The adjusted earnings estimates will be approximately $5.53 (2013), $6.02 (2014), $6.54 (2015), $7.07 (2016), and $7.63 (2017).
JNJ's cash flows from operations (CFO) are estimated to be between $14B and $18B from 2013 to 2017. Capital expenditures are $2.4B to $3.2B, representing an average of 17% of CFO. Therefore, its free cash flows are in the range of $12B to $15B. The free cash flow numbers are used to derive JNJ's intrinsic value (see below).
JNJ will pay $2.44 in dividends per share ($6.7B total) in 2013. In our projections, we assumed that JNJ would increase its dividend by 7% and buy back $2.5B worth of common stock every year. The combined cash requirements will be $9B-$11B from 2013 to 2017, which can be comfortably funded by its free cash flow.
Summary of financial ratios and growth rates
Based on its previous 3-year averages, JNJ's gross profit margin, earnings-before-interest-and-tax (EBIT) margin, and net profit margin are 68%, 24%, and 15.6% respectively. Its average return on invested capital (ROIC), return on equity (ROE), and return on assets (ROA) are 20%, 17.8%, and 9.2%, respectively. These ratios suggest that JNJ has great operating efficiencies and its profitability based on return on investment is within the industry average.
Overall, JNJ has a strong balance sheet. Over the next five years, JNJ could maintain a total debt to total capitalization at 20%. Its interest coverage ratios are in the range of 30x-36x. This suggests that the company has the ability to service its debt.
We utilized the Discounted Free Cash Flow model to derive JNJ's intrinsic equity value. Based on the free cash flow numbers from 2013 to 2017 and a long-term growth rate of 4.5%, the estimated per share stock value is ~$86. Apparently, the fair value is greatly impacted by long-term growth rate. For instance, a 5% growth rate would elevate the fair value to $92. We believe JNJ is capable of maintaining a 4.5% long-term growth rate, mostly attributed by the new drugs approved within last five years.
JNJ is currently traded at $81.25 as of 3/27/2013. This price represents a 14.7x multiple to the 2013 adjusted earnings. With a 3% dividend yield and a sustainable 4.5% growth rate, JNJ is appealing to both income and growth investors for the long term.