Johnson & Johnson: Future Of Growth

Jan.22.14 | About: Johnson & (JNJ)

Johnson & Johnson's (NYSE:JNJ) 2.8% yield and commitment to growing the dividend in the future makes for a good combination with the consensus estimates for higher growth. Johnson & Johnson is a great candidate for a staple holding in any dividend growth investor's portfolio provided the company doesn't make any more management missteps.


Johnson & Johnson is engaged in the research and development, manufacture and sale of a broad range of products in the health care field. The company has more than 275 operating companies in more than 60 countries that serves three categories in the healthcare sector: Pharmaceuticals, Medical Devices and Diagnostics, and Consumer.


2008 2009 2010 2011 2012
Revenue $63,747 $61,897 $61,587 $65,030 $67,224
% Growth n/a -2.9% -0.5% 5.6% 3.4%
Gross Profit 45,236 43,563 42,795 44,757 45,966
% Margin 71.0% 70.4% 69.5% 68.8% 68.4%
EBITDA 19,001 19,550 19,466 19,398 21,098
% Margin 29.8% 31.6% 31.6% 29.8% 31.4%
Net Income 12,949 12,266 13,334 9,672 10,853
Avg Diluted Shares 2,835.6 2,789.1 2,788.8 2,775.3 2,812.6
% Growth n/a -1.6% 0.0% -0.5% 1.3%
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Note: All figures are MMs (except per share data) unless noted otherwise

Johnson & Johnson's revenue has been relatively flat over the past five years. The company's revenue contracted twice in the past four years. In 2009 revenue contracted at a rate of 2.9% and to a lesser extent revenue contracted in 2010 at a 0.5% rate. Despite the two years of revenue contraction in 2009 and 2010, the end result was a positive compounded annual growth rate of 1.3% since 2008. The gross margin has trended negatively staying within a tight 2.6% range over the past five years (bottoming at 68.4% and peaking at 71.0%). On the other hand, EBTIDA margins have expanded from 29.8% in 2008 to 31.4% in 2012 resulting in EBITDA expansion from $19,001MM in 2008 to $21,098MM in 2012 (11% expansion) over the five-year period.

Per Share Data

2008 2009 2010 2011 2012
Revenue $22.48 $22.19 $22.08 $23.43 $23.90
% Growth n/a -1.3% -0.5% 6.1% 2.0%
Gross Profit 15.95 15.62 15.35 16.13 16.34
EBITDA 6.70 7.01 6.98 6.99 7.50
Net Income 4.57 4.40 4.78 3.49 3.86
Dividends 1.80 1.93 2.11 2.25 2.40
Payout Ratio 39.3% 43.9% 44.1% 64.6% 62.2%
Dividend Growth n/a 7.5% 9.3% 6.6% 6.7%
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Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, the story is much the same. The company had relatively flat weighted average shares outstanding, only slightly decreasing from 2,836MM to 2,813MM over the period (a 0.8% decrease). EBITDA per share has expanded from $6.70 to $7.50 (a 12% increase as compared to an 11% increase at the company level). The company's dividends per share have been growing, increasing from $1.80 per share in 2008 to $2.40 per share in 2012 (a 34% increase or a 7.5% compounded annual growth rate) while the payout ratio has increased from 39% to 62%.


Market / Par Value EBITDA Multiple
- Cash and Equivalents $25,228 1.1x
+ Total Debt $15,107 0.7x
+ Market Capitalization $267,670 11.8x
Total Enterprise Value $257,549 11.4x
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Note 1: Based on TTM EBITDA of $22,686MM as of 9/29/13.

Note 2: Market Cap based on 2,821.4MM shares outstanding and a $94.87 market price as of 1/17/14.

Johnson & Johnson has an under leveraged (and over equitized) capital structure. The company is levered at 0.7x TTM EBITDA (totally covered by cash on hand) with a total enterprise value of 11.4x TTM EBITDA. Ideally, the company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage the company would have a low cost of debt and maintain significant financial flexibility while enhancing returns to the equity holders.


2013 2014 2015 2016 2017
EBITDA $23,393 $24,844 $26,678 $28,377 $28,377
% Growth 10.9% 6.2% 7.4% 6.4% 0.0%
Interest Expense 455 455 455 455 455
Taxes 3,491 3,713 3,993 4,253 4,253
Capital Expenditures 3,421 3,633 3,901 4,150 4,150
Dividends 7,448 7,448 7,448 7,448 7,448
Addl' FCF $8,577 $9,593 $10,879 $12,070 $12,070
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Note: All figures are MMs (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Johnson & Johnson are aggressive, projecting a growth rate between 6.2% and 10.9% annually through 2016 at the EBITDA line (projections unavailable for 2017). Under the consensus case the company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

2013 2014 2015 2016 2017
Addl' FCF $8,577 $9,593 $10,879 $12,070 $12,070
Share Redemption Price $109.10 $125.47 $144.29 $165.93 $190.82
Shares Redeemed 78.6 76.5 75.4 72.7 63.3
Wtd Avg Diluted Shares 2,734.0 2,657.5 2,582.1 2,509.4 2,446.1
Dividends Per Share $2.72 $2.80 $2.88 $2.97 $3.05
Dividend Growth 13.5% 2.9% 2.9% 2.9% 2.6%
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The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The company's share redemption would allow for a 3% increase in the dividend annually from the share redemptions alone. Additionally, the company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the company's earnings (using EBITDA as a proxy) would be increasing.

If the company performs in line with the consensus estimates and pays dividends / redeems shares as outlined above, the company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple

8.9x 9.4x 9.9x 10.4x 10.9x 11.4x
IRR 5.3% 6.7% 8.0% 9.3% 10.5% 12.3%
Cash on Cash 1.22x 1.28x 1.34x 1.40x 1.46x 1.56x
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While Johnson & Johnson had a relatively flat performance on the top and bottom lines between 2008 and 2012, the company is well poised for growth in the future. There is no doubt that the multiple product recalls over the last decade have impacted the company's financial performance and reputation. In 2008 the company recalled liquid Tylenol, Motrin, for pain, Zyrtec, for allergies, and Benadryl, for allergies in infants and children, because of quality control problems. Then in 2012, J&J recalled thousands of bottles of Tylenol again, this time removing 500,000 bottles of infant Tylenol because of dosing problems.

Outside of product recalls, management has also made some missteps including being fined for illegal marketing in 2013 to the tune of $2.2B. If management can execute cleanly and put the missteps behind them now, the company is poised for a significant expansion of EBITDA as demonstrated in the LTM period and projected in the future.

The company should be able to maintain the 2.8% dividend yield while growing it nicely without having to resort to expanding the payout ratio like they have over the past five years. On the other hand, if continued product recalls and management missteps continue to plague the business, other healthcare stocks may make for a more suitable investment.

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.