Why I Sold Johnson & Johnson to Buy Abbott Labs

Includes: ABT, JNJ
by: Analytical Chemist

Johnson & Johnson (NYSE:JNJ) and Abbott Labs (NYSE:ABT) are both large, diversified pharmaceutical and health care companies. While both have impressive records of sales, earnings, and dividend increases, Abbott Labs is a much better investment. This is mostly due to Abbott’s superior medium- and long-term growth prospects but is also partially due to Johnson & Johnson’s continuing manufacturing, quality control, and legal problems. Abbott also trades at a lower P/E ratio and has a higher dividend yield than Johnson & Johnson. With all of these considerations, Abbott is a slam-dunk winner over J&J.

Johnson & Johnson has products in pharmaceuticals, medical devices and diagnostics, and consumer segments. The pharmaceuticals segment contributed 36% of 2010 sales with products in a wide variety of therapeutic areas. Its best sellers include Remicade ($4.6 billion in 2010 sales), Procrit ($1.9 billion), Risperdal Consta ($1.5 billion), and Floxin/Levaquin $1.4 billion). With more than $61 billion in total sales, highest seller Remicade made up just 7.5% of sales while second-highest seller Procrit comprised 3.1% of sales. This is a well-diversified pharmaceutical portfolio, and this diversification reduces sensitivity to 1 or 2 products losing patent protection in a given year. This diversification is actually one of J&J’s advantages over Abbot.

J&J’s medical devices and diagnostics division had 40% of company revenues in 2010. These include Lifescan blood glucose monitoring products, Ortho-Clinical diagnostic products, and Depuy’s joint and spinal reconstruction products. J&J’s consumer care products division was responsible for 24% of 2010 sales, featuring personal care products including Neutrogena skin and hair care products, Band-Aids, and Tylenol.

J&J has had a number of recent product recalls. In fact, there have been 22 in the last 19 months. The most damaging included a recall of the anti-seizure medicine Topamax and a 50-million bottle recall of its products in January. Its Fort Washington, PA plant has been shut down for about one year. Johnson & Johnson has banked on its reputation for high quality products, and sales of products like Children’s Tylenol are likely to be impacted by continuing quality control issues and product recalls.

Abbott Laboratories also has a diversified product line, although it is more heavily weighted toward pharmaceuticals than Johnson & Johnson. 56% of sales were from pharmaceuticals in 2010, along with 18% from nutritional products, 11% from diagnostics, 9% from vascular products, and 8% from other lines. Abbott’s largest source of revenue is its arthritis drug Humira, with $6.5 billion in 2010 sales and patent protection through 2016. Other major pharmaceutical products include the anti-HIV Kaletra ($1.3 billion in 2010 sales) and the cholesterol treatments TriCor and Trilipix ($1.6 billion). Abbott invests 10% of sales in research and development, resulting in one of the stronger drug pipelines in the industry. Abbott added 4 new candidate drugs to late-stage development in 2010. By the end of 2011, it expects to have 20 candidates in Phase 2 or Phase 3 clinical trials. The candidates are in a wide range of therapeutic areas.

Abbot’s nutrition products include Similac and Isomil infant formula, Ensure, and Prosure. Its diagnostics products include screening tests for a wide range of diseases that are sold to blood banks, hospitals and labs. Both of these segments are a smaller percentage of Abbott’s revenues than for J&J. Abbott Vascular manufactures or markets coronary stents and catheters. The leader in this segment is the Xience drug-eluting stent. R&D continues in these areas for both product advances and new product lines, such as MitraClip, which treats significant mitral regurgitation, the most common heart valve defect.

Although Johnson & Johnson has grown earnings at a faster pace over the last decade, Abbot Labs has grown faster in the most recent years. Perhaps more importantly, Abbott Labs is projected to grow faster than J&J over the coming years. S&P projects a 3-year annual growth in earnings per share of 10% for Abbott Labs and only 4% for Johnson & Johnson. Zack’s expects 7.6% annual growth for the next 5 years for Abbot Labs, and 5.8% for Abbot Labs. Zack’s consensus forecasts for 2011 earnings are $4.60 for Abbott Labs and $4.84 for Johnson & Johnson, giving 2011 P/Es of 11.1 for Abbott and 12.5 for J&J. Abbott pays a 3.7% dividend while J&J pays a 3.6% dividend.

Abbott Labs has better growth prospects, a higher dividend yield, and sells at a lower P/E than Johnson & Johnson. Johnson & Johnson has 22 product recalls in the last 19 months. Johnson & Johnson is not a bad investment, but Abbott Labs is clearly the much better buy. I sold my Johnson & Johnson to buy Abbott; I strongly recommend Abbot for your portfolio.

Disclosure: I am long ABT.