Johnson & Johnson: Fairly Valued, Quality Blue Chip... With One Small Chink

Jan.20.14 | About: Johnson & (JNJ)

Johnson & Johnson (NYSE:JNJ) reports their Q4 '13 earnings before the bell on Tuesday morning January 21, 2014.

Analyst consensus is expecting $1.20 in earnings per share (EPS) on $17.945 billion in revenues for expected year-over-year growth of 1% in EPS and 2% in revenues. If analyst consensus is met, JNJ will have grown full-year 2013 EPS and revenues 7% and 5.5% respectively.

Since the October earnings report, the Q4 '13 consensus EPS has remained constant at $1.20 while the revenue estimate has ticked up slightly.

Pharma has supposedly been the big driver of the stock over the last year to 18 months. The JNJ segment has really caught fire as Medical Device and Diagnostics (MDD) and the Consumer segments work through their respective issues.

Here is a quick chart showing the Pharma segments as both a percentage of JNJ's revenues and its y/y growth in the last 4 years:

% of rev's

y/y gro

q4 13
q3 13 39.4% 10%
q2 13 39.3 12%
q1 13 38.7% 10%
q4 12 37% 7%
q3 12 37% 7%
q2 12 38% 1%
q1 12 38% 1%
q4 11 37% 7%
q3 11 37% 9%
q2 11 37% 12.5%
q1 11 37% 7.5%
q4 10 36% -5%
q3 10 37% -5%
q2 10 36% 1%
q1 10 36% -2%
Click to enlarge

* Source: internal spreadsheet from 10-Qs, earnings reports

JNJ's Pharma unit struggled post the 2008 Recession, but has picked up steam in the last 2 years on the success of all major products, or at least all the major Pharma drugs performed well in Q3 '13. The segment looks to be in the sweet spot of its Pharma cycle.

JNJ's Pharma segment as a percentage of total JNJ operating profit has varied from 48% to 63% over the last 2 years.

With an AAA-rated balance sheet and just a 7.5% debt to capital ratio, and fairly stable businesses to boot, there is little not to like about JNJ, and it is the proverbial widows-and-orphans stock that can be tucked away in a portfolio with little risk of it opening down 20% post earnings. (I didn't say no risk of that happening, just minor risk, given the stability and consistency of earnings growth around the blue chip.)

There is one thing that caught our eye when looking over our spreadsheet: despite a lot of cash flow being spent on share repurchases the last 2-3 years, the shares outstanding have changed very little which tells me all this money being spent on buybacks is simply offsetting dilution. Here are the details:

Period F/d shares o/s $'s spent on buyback
2013 (9/30) 2.881 bl $3.0 bl
2012 2.833 bl $12.920 bl
2011 2.769 bl $2.524 bl
2010 2.782 bl $2.796 bl
Click to enlarge

JNJ didn't repurchase any shares in the first two quarters of 2013, and then spent $3.0 bl in Q3 '13 on the buyback.

As you can see JNJ spent almost $20 bl or about 18 months cash flow on share repurchases over the course of 4 years that didn't lend itself to any accretion.

Part of the dilution may stem from JNJ's acquisition of Syntheses, which was folded into the MDD segment. JNJ employed a unique strategy to buy Syntheses: they employed their Ireland Janssen unit to issue the shares to Syntheses and then buy back the JNJ stock, which I thought helped avoid the repatriation tax on cash kept overseas by US corporations. (I also wondered if Microsoft could employ the same strategy with Nokia. My guess is no.)

The point to the cash flow and buyback analysis is that once JNJ is through the Syntheses dilution, the buyback and substantial free-cash-flow should be accretive to EPS.

Conclusion/summary: Pullbacks in JNJ are few and far between. We had a sell-off after the Syntheses acquisition, which represented a great buying opportunity. The stock is now overbought on a longer-term basis, with the trendline off the 2009 lows, near $70 per share.

Fundamentally, I don't know of anything that would drive a decline in the stock price from $95 to $70. $72 - $73 are the 2008 highs, so it looks like a decline into this area would be rock-solid support, but you could wait forever for the stock to get there.

JNJ is a fairly valued, rock-solid balance sheet with a business model that generates stable, consistent earnings growth. We like the new CEO Alex Gorsky: we think he has the chops to take JNJ to the next level after the company struggled during the latter stages of Bill Weldon's tenure.

$90, $85 and the low $70s are all areas of technical support.

Our internal earnings-based model values JNJ at $103 per share in terms of an intrinsic value while Morningstar values JNJ closer to $90 in terms of its intrinsic value. Current forward consensus revenue and earnings estimates expect mid single digit revenue growth of 4% - 5% the next 3 years with 7 - 8% earnings growth.

This business is as fortress as they come, if Alex doesn't let happen what happened to JNJ's consumer unit in the mid 2000s.

Thanks for reading...

Disclosure: I am long JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.