Paired Trade: Sell Allergan, Buy Johnson & Johnson

This is the second in a series of paired trade ideas that I intend to share over time. As I stated in the original article, these pieces will be hopefully quite succinct, with the goal of sharing the overall thesis. By the way, that first trade recommendation, which was 5 weeks ago, has been marginally profitable thus far, with the buy up 34% and the sell up 26%.

I have followed Allergan (AGN) more closely than Johnson & Johnson (JNJ) but currently own JNJ in a portfolio I manage for my family as well as in both of my model portfolios, Conservative Growth/Balanced and Top 20. I typically prefer AGN, as it has a better growth profile over the long-term, but these aren't typical times. AGN has run up lately on acquisition rumors that may or may not pan out, while no one will be acquiring JNJ! Here is the "score sheet":

I believe that AGN is properly labeled as a mini-JNJ, as both are in pharmaceuticals, devices and consumer products. In the device area, both have extensive facial and breast franchises. They actually compete in the eye area too. In any event, it is clear that AGN has more growth, which is primarily a function of its size. Note that the balance sheet metrics are extremely similar. The only glaring differences are in valuation (click to enlarge).

The longer-term relationship has regressed towards the mean after a spike last year that left AGN quite cheap on a relative basis. The recent acquisition rumors along with Botox not falling off as much as feared has propelled AGN to a level that is quite overextended in the short-term, while JNJ is somewhat oversold still. This trade is a conservative trade, taking advantage of the recent spike in AGN to get a "median" type of valuation swap at a time when one might suggest that the better diversified company (JNJ) would command a premium. AGN has more exposure to a weakening economy in my opinion, and it makes sense in this environment to take the higher dividend and lower absolute valuation. Coming out of the economic downturn should prove to be a better time to pay up for AGN.

Disclosure: Long JNJ

Comments

[Old Trader:]

I also like JNJ because of its exposure to foreign markets, despite the exposure to currency risk (disclosure: long JNJ).

Apr 19 12:21 PM

[ArtfulDodger:]

Good work, as usual, AB! Thank you.

I keep looking at JNJ, but can't pull the trigger, because I fear what our government may do to the drug companies.

The best to you on your investment, though.

Apr 19 06:11 PM

[Alan Brochs...:]

You are probably aware, ArtfulDodger, that I tend to favor smaller and growthier companies than JNJ. It is too cheap though. I appreciate its massive diversity. I also really respect its management team - they sure made PFE look rather stupid regarding their purchase of Pfizer's consumer division. I concur with your sentiment regarding drug companies generally, though.


On Apr 19 06:11 PM ArtfulDodger wrote:

> Good work, as usual, AB! Thank you.
>
> I keep looking at JNJ, but can't pull the trigger, because I fear
> what our government may do to the drug companies.
>
> The best to you on your investment, though.

Apr 19 06:52 PM

[ksmithdc:]

Interesting read, thanks.

Apr 19 08:26 PM