Is Amgen Better Than Johnson & Johnson For Dividend Growth Investors?

| About: Amgen Inc. (AMGN)

Summary

I take a look at 9 potential replacements for JNJ in my portfolio.

AMGN has a good risk/reward profile that should double the return of JNJ over the next few years.

AMGN is on track to deliver 9% CAGR through 2018.

Introduction

From time to time, I like to take a step back and look at my portfolio and ask various questions. For example, I hold Johnson & Johnson (NYSE:JNJ). What is there not to love? The company is a diversified healthcare organization. The majority of the money comes from the pharmaceutical side of the business, but JNJ also has great consumer products and medical devices divisions. The company has been so successful that had you put money into it 20 years ago, it would have generated a CAGR of 8.8%. In all the ups and downs since 1995, that is pretty good. Even as great as its historic performance is, the future cannot be ignored. The company is still growing and has a great pipeline within pharmaceuticals. At current EPS estimates, the rate of return based on a 3 year timeline and a 10 year historic P/E ratio is only 6.8%; half of that return comes from the generous, safe 3.1% yield that has been growing at 8%. As the payout ratio nears 50%, this growth rate is likely to slow. Thus, the question enters my mind, is JNJ the best healthcare company for my DGI Portfolio?

JNJ

My Goals

A couple of times below I will make reference to my goals. This investment sits in my education series of investments. You can read about it in this article. My goals may be different than your goals.

Why I Like Investing in Healthcare

When you are sick, do you consider how much money you spend going to the doctor? Do you care how much you spend to get treatment? Do you even know how much the total bill is that gets covered by insurance? In the US, most of us have the luxury of having health insurance that will pay for the majority of the cost associated with expensive healthcare treatments. With that, as consumers of healthcare, we can make an informed decision that is based on the best, safest treatment for our ailment.

As a business, this constant, non-cyclical demand means there are opportunities to generate stable revenue. The downside is it takes a lot of cash to research and develop new drugs. Fortunes can be made overnight with small cap organizations that get approval for a new drug with a sizable addressable market. For my portfolio to meet its goals, I do not need to take on this risk/effort to find the next overnight success. Instead, I want to look only for organizations that are large and have the ability to grow over time. They have the benefit of scale in terms of research ability as well as their ability to acquire and partner with smaller organizations. They have a bit of the best of both worlds.

Data

The data below has all been compiled using FAST Graphs. The data in FAST Graphs comes from the average of analyst's forecasts as collected by the S&P organization.

The Contenders

The healthcare space is divided into what I consider the old guard and the up and comers. I have selected 9 organizations to put up against Johnson and Johnson in various metrics to see who is the best. Those organizations range from the old guard folks like Eli Lilly (NYSE:LLY) to new dividend payers like Gilead (NASDAQ:GILD). Below see the list with their S&P Credit Ratings, current P/E ratios, Dividend Yield and Long Term Debt to Capital Ratios.

Ticker

Name

S&P CR

P/E Ratio

Yield

LT Debt to Capital

ABBV

AbbVie Inc.

A

13.6

3.90%

84%

AMGN

Amgen Inc.

A

15.4

2.60%

51%

CAH

Cardinal Health, Inc.

A-

16.7

1.90%

42%

GILD

Gilead Sciences Inc.

A

7.5

1.90%

54%

GSK

GlaxoSmithKline plc

A+

16.6

5.70%

58%

JNJ

Johnson & Johnson

AAA

15.6

3.10%

15%

LLY

Eli Lilly

AA-

23.9

2.50%

34%

MRK

Merck & Co. Inc.

AA

14.3

3.60%

33%

PFE

Pfizer Inc.

AA

14

3.90%

27%

SYK

Stryker Corporation

A+

18.3

1.60%

20%

Click to enlarge

The first thing that stands out on this list more than anything else is that healthcare credit ratings are amazing. Is there another industry where you can compile 10 random organizations and all of them have equal or above an A- credit rating? Also, they all seem to have reasonable P/E ratios except for Eli Lilly.

Next, I want to move on to take a look at EPS Growth rates over various time frames.

Earning Per Share Growth Rates

Ticker

1Y EPS Growth

5 Yr

10 Yr

15 Yr

ABBV

5.7%

--

--

--

AMGN

14.5%

12.1%

13.7%

15.6%

CAH

14.1%

14.6%

3.3%

6.5%

GILD

296.6%

41.8%

42.2%

--

GSK

-19.3%

-5.4%

0.3%

3.5%

JNJ

8.2%

5.2%

6.8%

10.6%

LLY

-33.0%

-8.9%

-0.1%

1.3%

MRK

0.0%

1.4%

2.9%

2.4%

PFE

1.8%

2.3%

0.6%

7.0%

SYK

11.8%

9.9%

12.7%

17.8%

Click to enlarge

In the chart above, there are a couple things that stand out. First, there are only 2 organizations that are not growing. These are LLY and GSK. If I am looking to trade off vs. the 10% growth rate of JNJ over the past 10 years, then a negative growth company does not give me too much comfort. I am going to rule those two out.

Looking at the other organizations, we can see there are a couple of new organizations (ABBV, GILD). You also see there are some slow growers (MRK, PFE). Slow to no growth is not going to beat JNJ so I will cut them as well.

Next, since we do not invest in history, I want to take a look at EPS growth going forward.

Ticker

Price

P/E

EPS Today

2 Yr CAGR EPS

Target EPS

ABBV

$58.83

13.6

$4.33

20.48%

$6.28

AMGN

$156.08

15.4

$10.14

9.84%

$12.23

CAH

$81.59

16.7

$4.89

14.97%

$6.46

GILD

$91.83

7.5

$12.24

7.27%

$14.09

GSK

$40.03

16.6

$2.41

-4.66%

$2.19

JNJ

$96.75

15.6

$6.20

4.77%

$6.81

LLY

$82.48

23.9

$3.45

12.49%

$4.37

MRK

$51.35

14.3

$3.59

5.81%

$4.02

PFE

$30.71

14.0

$2.19

6.99%

$2.51

SYK

$93.91

18.3

$5.13

8.52%

$6.04

Click to enlarge

I take the Target EPS value and calculate a CAGR for the upcoming 2 years. For P/E, I take the lower value of current P/E, historic 10 year P/E rate, and 15. This hurts some folks that have been earnings a premium in the market, like CAH. I do this as a conservative estimate.

Ticker

Price

P/E

Historic P/E 10 Yr

P/E Used

Target EPS

Target Price

Price CAGR

ABBV

$58.83

13.6

--

13.6

$6.28

$85.39

20%

AMGN

$156.08

15.4

15.1

15

$12.23

$183.42

8%

CAH

$81.59

16.7

16.3

15

$6.46

$96.87

9%

GILD

$91.83

7.5

22.5

7.5

$14.09

$105.67

7%

GSK

$40.03

16.6

15.3

15

$2.19

$32.88

-9%

JNJ

$96.75

15.6

15.4

15

$6.81

$102.12

3%

LLY

$82.48

23.9

14

14

$4.37

$61.14

-14%

MRK

$51.35

14.3

12.8

12.8

$4.02

$51.46

0%

PFE

$30.71

14.0

11.1

11.1

$2.51

$27.87

-5%

SYK

$93.91

18.3

20.3

15

$6.04

$90.65

-2%

Click to enlarge

The results of this exercise show that my suspicions on LLY, GSK, MRK and PFE are confirmed. Going forward, it does not look like the analysts' forecasts expect any of those organizations to make a recovery. It also shows me that none of the remaining candidates is particularly overpriced relative to their historic P/Es. The only organization that stands out on this list is SYK. They have historically earned a premium in the market place in terms of P/E. This hurts relative to my decision to cap the P/E of future estimates based on a rate of 15. Using the first table, EPS are estimated to grow by 8%. As with all decisions, it is important to buy at the right price. I do not let this rule out SYK from consideration. That being said, using this methodology, the top 4 organizations all outperform JNJ in this test.

Now let's turn to the dividend.

Ticker

Yield

1 Yr Div Growth

5 Yr

10 Yr

15 Yr

ABBV

3.90%

9.40%

--

--

--

AMGN

2.60%

29.80%

63.30%

--

--

CAH

1.90%

14.70%

16.00%

26.40%

21.60%

GILD

1.90%

New!

--

--

--

GSK

5.70%

-3.50%

4.80%

4.50%

5.00%

JNJ

3.10%

6.60%

7.40%

9.70%

11.40%

LLY

2.50%

0.00%

0.00%

3.30%

5.20%

MRK

3.60%

2.30%

3.00%

1.70%

3.10%

PFE

3.90%

8.30%

5.40%

4.30%

8.50%

SYK

1.60%

14.50%

38.20%

30.20%

27.60%

Click to enlarge

Relative to their respective yields, CAH and SYK are growing low yields quickly. AMGN, ABBV, and GILD are all new dividend payers. This is where things will get a little bit different in terms of my decision and what others might decide. A younger dividend growth investor may consider the new players where some at or near retirement may want to stay away and go with the old stalwart.

The unknown right now is what is GILD going to do with all that cash. Anyone who follows the organization knows that GILD took out a lot of debt recently. Could that be used for an acquisition or share buybacks? It is unknown at this point. Will it grow the dividend aggressively over the next couple of years?

Below, I want to zoom in on payout ratios. The data below is based on the trailing 12 months as reported by Guru Focus.

Ticker

TTM Dividends Paid

TTM FCF

TTM EPS

FCF Payout

EPS Payout

ABBV

1.93

2.72

1.71

71%

113%

AMGN

2.98

11.30

8.37

26%

36%

CAH

1.46

6.23

3.99

23%

37%

GILD

1.72

11.42

10.92

15%

16%

JNJ

2.90

5.31

5.23

55%

55%

SYK

1.38

1.70

3.08

81%

45%

Click to enlarge

AMGN and GILD are putting out some crazy numbers in terms of FCF generation. ABBV and SYK are the two that stand out as being a little high on this list.

Note, for those of you that use FAST Graphs, the EPS numbers are not the same as those reported in Yahoo, Google and Guru Focus. The best that I can distill is that the numbers in FG use an operating margin EPS value as opposed to that of the others that use the net margin. I can be 100% wrong here, but for reference, FG shows EPS of 4.29 for ABBV vs. the 1.71 reported everywhere else.

Conclusion

After looking at various metrics of EPS growth estimates, dividend yield, dividend growth, and payout ratios, there is one clear trade-off that I think could be made to replace JNJ in a dividend growth portfolio and that is AMGN.

I want to take a deeper look at what that means going forward for my portfolio.

AMGN

JNJ

Starting Value

$10,000

$10,000

Share Price

$153.00

$96.38

Shares Bought

65

103

Dividend Earned Y1

$260

$309

Dividend Growth Est.

20%

7%

Dividend Y2

$312

$331

Dividend Y3

$374

$354

Total 3 Year Collected

$946

$993

Estimated Share Price

$183.42

$102.12

Ending Value

$12,868.70

$11,511.76

Estimated Return*

8.8%

4.8%

Click to enlarge

*Excludes dividend reinvestment - only calculated as cash in hand at the end of Y3.

For starters, the initial dividend paid would be lower for AMGN and this would be true in Year 2 as well. By year 3, the dividend would outweigh that from JNJ due to the aggressive growth that AMGN has been on since it initiated the dividend a few years ago. Next, I take a look at the price appreciation from today to my estimate that I calculated above. This is where there is a bigger return in favor of AMGN. In the end, the combined return for AMGN at today's prices is almost double that of JNJ.

Many people know the story of JNJ. It is safe. It is predictable. It is valuable over time. So what makes AMGN better?

So who is Amgen?

So for those of you unfamiliar with Amgen, here is a quick introduction from their website:

Amgen is committed to unlocking the potential of biology for patients suffering from serious illnesses by discovering, developing, manufacturing and delivering innovative human therapeutics. This approach begins by using tools like advanced human genetics to unravel the complexities of disease and understand the fundamentals of human biology.

Amgen focuses on areas of high unmet medical need and leverages its biologics manufacturing expertise to strive for solutions that improve health outcomes and dramatically improve people's lives. A biotechnology pioneer since 1980, Amgen has grown to be one of the world's leading independent biotechnology companies, has reached millions of patients around the world and is developing a pipeline of medicines with breakaway potential.

Every time I read a pharmaceutical company's About Me section, they all sound the same. We find drugs that make the world better! In Amgen's case they have been pretty successful.

In addition to the current products, it also has a robust pipeline. It has 16 drugs in Phase III trials. These are things that can generate great growth for the organization. One example of a recent approval is Repatha. This drug helps treat high cholesterol and was approved a few months ago in both Europe and the United States and a few days ago for use in Japan.

In a recent presentation at the JP Morgan (NYSE:JPM) Healthcare conference, the AMGN team shared the following slide that sums up 2015 pretty well.

Click to enlarge

Then they shared a forecast for what is to come. The exciting thing below is the company's focus on shareholders. The goal is to return 60% of net income to shareholders. This is through a combination of aggressive growth in the dividend as well as share buybacks to the tune of $4B to $5B Oct 14 to FY2016. The company had about 965M shares outstanding in 2010. That has been reduced 20% since then to a total of 764M…and shrinking.

Click to enlarge

Last there is the 2016 guidance slide. The dividend growth has been announced. The share repurchases could buy back another 12M shares (1.5% of current shares outstanding). Last, with the current P/E (15.4) the EPS estimate generates a share price of $160. That is only slightly up vs. the current price of $153. It makes my target of $12.23 EPS above look realistic in the next 3 years.

Click to enlarge

Upcoming Events

On Thursday, the company has its Q4 conference call.

Risks

There are so many to count I do not know that I ever want to get into it. The pharmaceutical business is big money vs. big money. It seems like every company is constantly in a legal battle with one another. It reminds me of the tech industry. A reading of the company's quarterly or annual reports will give you an overview on this topic.

In addition, the company operates on its ability to continue to research and develop new drugs. The current pipeline is robust, but the company needs to continue to grow or acquire its success. While things are looking positive now, there is always the possibility that trials turn out poor and the company has to spend incremental R&D to develop various new drugs.

Last, the company operates on a very good margin. The success of translating the operational margin to the net margin requires discipline. AMGN has been successful historically and is on track for its plan through 2018. If things change in this space, there is a risk to EPS estimates.

Free Cash Flow Metrics

Last, I want to present a few FCF metrics because after all I am a dividend growth investor. Part of the justification for trading out JNJ for AMGN is based on the aggressive growth of the dividend. To pay for that, the company needs to be growing its cash flow. So how has it done? The chart below shows that FCF has doubled since a dip in 2011.

Click to enlarge

This dip was caused by a group of things. Notably there was an increase in SG&A, R&D and 'other operating expenses'. Going back to the 2011 Annual report, the management comment that is relevant to this dip is:

"The increase in operating expenses for 2011 was driven primarily by a legal settlement charge and higher SG&A expenses."

This does not seem to be an ongoing concern outside of the generic risk noted above for additional legal risks.

Next, I want to look at the money that I do not get to keep. How is AMGN at utilizing and growing its invested capital? For this I would take a look at the Joel Greenblatt metric - Return on Capital. For those unfamiliar, it is calculated by looking at EBIT / (net fixed assets + net working capital). This should give us a good idea of how effective the company is generating a return on the money it invests in the business. I have shown in here compared to JNJ. Both perform very well with each besting each other from time to time.

Click to enlarge

The last metric I like to look at is the FCF to LT Debt ratio. This gives you an idea of how much leverage the company has as well as how long it would take to pay it off if it had to do so.

Click to enlarge

Things do not look good over time. The orange line and blue line are judged against the left axis. The green line is the ratio of FCF to LT debt. As you can see, back in 2015, there was over 100% coverage. Debt has grown at a significantly faster rate than that of FCF. It still is at a respectable 25% FCF to LT Debt ratio. There is plenty of room to pay for a growing dividend as well as maintaining the current debt level. As a reminder, the S&P Credit Rating is A and the weighted cost of capital is under 9% (although historically it has been around 5%).

Conclusion

I started off trying to identify a stock, which could replace JNJ in my portfolio. I do not hate JNJ or think it is a horrible investment. It is great for an individual who is in retirement that needs confidence and limited risk. For someone in the accumulation phase, I need to take a bit more risk to generate a little more reward long term. The trade-off from JNJ to AMGN seems to be a reasonable one. AMGN has been successful at growing its business. It has a great pipeline going forward. It is at or near a reasonable valuation to generate a reasonable return over the next few years. The dividend is decent at 2.5% and it is growing aggressively. Also, the company can afford to continue to do the things that will generate its success - pay down debt, reinvest in company shares and grow the dividend.

Disclosure: I am/we are long ABBV, JNJ, AMGN, GILD, JPM.

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.

Additional disclosure: I am also long all stocks listed via various total market ETF funds.