Johnson and Johnson (JNJ) shares were mildly higher Monday morning after investors dissected what was a pretty strong quarterly report (press release available here). JNJ earnings of $1.24 compared favorably to analyst expectations of $1.20 while its $18.4 billion in sales beat by over $400 million. For the entire year, JNJ earned $4.81 on $71.3 billion in revenue as the company worked through some legacy problems. Management is looking for a much stronger performance in 2014 with earnings of $5.75-$5.85 while analysts had been forecasting $5.75-$5.85. While these results were strong, valuation still looks rich after a 30% run over the past 12 months.
In this quarter, we saw positive results from the company's shift towards pharmaceutical products and lower emphasis on medical devices. U.S. pharma revenue was up a robust 17.9% in the quarter to $3.55 billion, and International was up 6.6% (including a negative currency impact of 2.4%) to $3.745 billion. Its pharmaceutical business should continue to power growth going forward thanks to FDA approval of new drugs like Olysio, which treats Hepatitis C.
Its consumer businesses, including over the counter drugs like Tylenol, continue to perform steadily with 5% growth in the U.S. and 1.7% growth overseas. JNJ's medical device unit does remain a relative laggard with sales down 1.4% in the U.S. to $3.2 billion and 0.7% overseas internationally to $4.1 billion. As issues with the hip implants fade, sales should improve, thanks in part to the Synthes acquisition. I would look for 0-3% sales growth from this unit in 2014. Essentially, J&J has a steadily growing consumer business, weak but turning medical device unit, and high growth pharmaceutical unit.
One point of concern for the business is the geographic breakdown of revenue. The U.S. continues to be a powerful growth market for JNJ with sales up 7.4% in the quarter. Thanks to continued drug approvals, U.S. growth should remain robust in 2014. Europe was also a surprising source of strength with sales up 7.9%, though currency was a major driver of this growth as constant-currency growth was 4.8%, still a solid number from the beleaguered continent. Finally, Latin America and Asia were down 2.6% and 2%, though a 7.4% and 9% decline in currencies were the driver of this decline. As the taper has crushed some emerging markets, currencies in emerging economies, especially those in Latin America, should continue to be a headwind for the company. While emerging markets will power long-term growth for JNJ, they will likely be a mild headwind in 2014.
Finally, let's look forward to 2014 where management issued guidance slightly below consensus. Importantly, current management has focused on beating expectations, and as a consequence, I expect there is some sand-bagging going on here to provide a margin of safety. I would expect the company to earn at least at the high-end of its range of $5.85, which would match expectations. At this price, JNJ has a forward multiple of 16.3x, which is a pretty fair valuation.
Further, many investors own JNJ for the dividend, and I would expect another hike in the 8-10% range in 2014. However thanks to the strong run in the stock price, the dividend is less juicy than it used to be. In fact, JNJ now yields 2.78%, which is not particularly attractive when you consider the S&P 500 yields nearly 2%. While JNJ provides a solid growing dividend, it is not large enough to merit buying shares on its own like it did when JNJ was yielding 3.5% two years ago.
On the whole, this was a strong quarter for JNJ, and it was evident that focusing on pharmaceuticals is generating significant growth. However, the market recognizes this growth, which is why shares are up 30%, which has outpaced fellow Dow components Pfizer (PFE) and Merck (MRK). After this run, JNJ looks pretty fully valued on a forward earnings basis, and its dividend does not offer the same level of yield support as it has in the past. Investors would be wise to wait for $90 before buying shares when valuation would be a more reasonable 15.3x. JNJ is once again a great company, but it is being valued as such. Upside potential is limited at current prices, and investors should wait for a better entry point.