Buy This Pharma Giant Now For A 30% Return In 2013

May.30.12 | About: Johnson & (JNJ)

Just recently, an FDA Panel narrowly ruled against the prescription of Johnson & Johnson (NYSE:JNJ) and Bayer's (OTCPK:BAYRY) blood-thinning drug Xarelto for patients with serious heart problems.

Johnson & Johnson applied for the expanded use of Xarelto in December 2011 as a blood thinner for those with Acute Coronary Syndrome - but the FDA panel reviewing the application was swayed by clinical trials that showed excessive bleeding among test subjects. That meant that patients taking Xarelto ran the risk of experiencing severe brain damage arising from possible bleeding caused by Xarelto.

Johnson & Johnson has been competing with Pfizer (NYSE:PFE), Bristol-Myers Squibb (NYSE:BMY) and privately held Boehringer Ingelheim in the market for blood clot treatments. Johnson & Johnson had been hoping that expanded use of Xarelto would allow it to gain a decisive edge over Pfizer and Bristol-Myers' Eliquis and catch up to Boehringer Ingelheim's Pradaxa in the $10 billion market.

As it stands, Pradaxa has the biggest market share among anticoagulant treatments, having been approved by the FDA in 2010, whereas Xarelto was approved in the 3rd Quarter of 2011. Eliquis isn't even on the market yet - an FDA decision on its application is expected by June.

The FDA's ruling notwithstanding, Johnson & Johnson is still looking to expand the use of Xarelto for the treatment of Venous Thromboembolism and is currently in Phase III of clinical trials.

The market sold Johnson & Johnson's shares in the wake of the FDA's decision, but I believe that it should remain a staple in any investor's portfolio.

Specifically, Johnson & Johnson still has a sizable pipeline of new treatments pending approval - on top of existing products like Xarelto that it is seeking expanded uses for. In 2011, for example, it received approval for 5 new treatments. That's in contrast to Pfizer, which is still reeling from the effects of R&D cuts in 2011, the loss of Lipitor's exclusivity and is still waiting on Eliquis' approval. It is now just beginning to chart a new direction.

New products are critical in the Pharmaceutical Industry as these drive revenue growth - particularly when older products enter the final stages of exclusivity and become available for generics-makers such as Ranbaxy Labs (OTC:RBXZF) to manufacture.

Given this paradigm, it's to its benefit that Johnson & Johnson is well diversified in the health care business. Beyond pharmaceuticals, which account for 38% of revenues, it has a catalogue of consumer healthcare and medical devices and diagnostic products that account for 62% of revenues - these other two divisions consistently provide Johnson & Johnson with additional cash resources to spend on R&D, which accounts for nearly 25% of its operating expenses.

That continued R&D spending is critical because Pharmaceuticals represent the growth area among Johnson & Johnson's three broad product categories, having climbed by 8.8% in 2011 while Consumer Products and Medical Devices grew by only 2% and 4.8%, respectively.

Given the relative flatness of earnings in its other divisions, it's not surprising that a lot of Johnson & Johnson's top line growth depends on execution in the Pharmaceuticals space. With plenty of products still in earlier stages of trials, Johnson & Johnson's total revenue is only expected to rise by 2.2% this year - but, as more pharmaceuticals enter the market in 2013, revenues are expected to rise by 5.3%.

Regardless of its revenue growth rates, Johnson & Johnson's financial metrics are very stable - critical in an industry that requires heavy investments in R&D and long runways to product approvals.

In terms of liquidity, Johnson & Johnson's current and quick ratios are close together at 2.4 and 2.1, respectively - that suggests that it manages its to receivables very well and that it shouldn't experience tightness. Consequently, it doesn't have to borrow to fund its operations, thereby keeping its interest expense low and long-term debt very manageable.

Contrast that with Pfizer, which has a current ratio of 1.2 but a quick ratio of only 0.76. Pfizer has access to credit facilities to help it bridge its working capital requirements but because its actual liquidity is not strong, it can't pay down much of its long-term debt, of which it had nearly triple Johnson & Johnson's level ($34 billion to $12 billion).

In fact, Johnson & Johnson's liquidity ratios are an outlier. On aggregate, the Health Care Industry has a quick ratio of 1.4 and a current ratio of 1.7. Meanwhile, the S&P 500 has a quick ratio of 1.1 and a current ratio of 1.6

However, Johnson & Johnson's healthy level of cash comes at a price to investors; its current dividend yield is 3.8% compared to the industry's 4.2%; money that could've gone to investors as dividends is being reinvested in the company's operations.

That shouldn't deter investors, however; after trailing the industry's growth 4% to 2%, its revenues will accelerate over the next two years to 5.3%. What's more, it has less debt than the industry, with just a dollar of debt for every five dollars of equity. That means that, rather than re-capitalizing itself by paying dividends and borrowing long-term, it has funded itself organically.

All that said, investors still earn more on Johnson & Johnson stock than on 30-year US Treasuries at a yield of 2.8%.


Johnson & Johnson represents a safe bet in the Health Care industry, with solid prospects for growth and very little embedded financial risks. At a Price-Earnings (P/E) ratio of 17.4, it is ever-slightly cheaper than the Health Care industry at 17.8 - and also cheaper than the S&P 500's 21.

Going forward, I expect Johnson & Johnson to sustain its guidance - but because it's already fairly valued, I do not expect it to outperform the broader market by much. Consequently, I see Johnson & Johnson shares poised for a 30% rise by mid 2013. Ultimately, it's a safe-bet, not a growth stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.