Johnson & Johnson (JNJ) remains one of the largest healthcare companies in the world by market capitalization. Despite its large fleet of consumer goods and over-the-counter drug store consumer products, the company continues to derive most of its profitability from its medical devices and pharmaceuticals. For the short-term 12-month investor, the stock is a safe buy with a modest upside. For the long-term 3-year investor, there is little standing in Johnson & Johnson's way as it continues to expand its multipart operations.
Johnson & Johnson shares are trading at around $66, which is close to their 52-week high of $68. On a forward price/earnings basis, the company is valued within the average range for the sector with a multiple of 13, which tracks the S&P healthcare sector index. Pfizer (PFE) and Merck (MRK) both have forward P/Es of around 10. Given my long-term positive outlook on the company, I therefore expect there to be a significant growth in Johnson & Johnson's earnings, which, as detailed below, will likely be derived from its pharmaceutical division.
The company's price/sales is 2.78, which is between the sector's upper quintile value of 3.55 and lower quintile value of 0.56. Its price/cash flow multiple is around 13, which tracks the sector average of 12. Both of these metrics also suggests fair valuation. The short-term upside for Johnson & Johnson, based on my value-centered thesis, is limited. However, with a steady uptick in consumer and medical spending as the result of a potential additional round of stimulus from the U.S. Federal Reserve, the company could see added sales revenue that, along with its new drug development, will make for a solid 18-month investment.
J&J's Profitable Drug Development
Johnson & Johnson does not often get press for its large pharmaceutical development wing. Indeed, 40% of earnings in 2011 were derived from drug sales, and the pharmaceutical part of its business remains Johnson & Johnson's strongest driver of strong margins. The company's net margin is presently about 15%, which is higher than Pfizer by three points and Merck by one point, impressive given the fact that Johnson & Johnson maintains a consumer wing that (in theory) should not be bolstering margin.
Additionally, there are a number of new drugs that will drive earnings for Johnson & Johnson over the coming years. New products are set to include Xarelto (a blood thinner), Incivo (a hepatitis C treatment), Zytiga (prostate cancer), and Edurant (for HIV), which will improve the company's overall market presence. One of these, Zytiga, recently saw great success in a research trial showing that the drug was very effective in treating patients with prostate cancer that had not yet received chemotherapy. With an average increase in survival rate of 9 months, Johnson & Johnson is seeking to expand the approved applications for the drug (it is presently only designated for later-stage prostate cancer). Collectively, Zytiga and other new drugs have the potential to become blockbusters.
The first quarter 2012 brought with it a 2.6% increase in pharmaceutical sales. Sales of some of the company's most prominent immunological medicines Remicade, Stelara and Simponi - were up 20%. Additionally, the company should benefit from its medical devices trade as it plans to acquire Synthes, an orthopedics manufacturer. The acquisition was finalized this week. This should help clear the way for Johnson & Johnson to regain territory in the medical device sector, a business area which has been marred by several recent lawsuits under the company's DePuy brand name. Though the company ceased its stent-development efforts last quarter, its non-stent medical diagnostics and device (MD&D) grew 2.0% in the first quarter 2012.
The Benefits of Being a Titan
Johnson & Johnson is largely immune from major market fluctuations due to its diverse product set and lack of reliance on any specific product. Even among its pharmaceuticals, it has a large spread of drugs that both have lost their exclusive marketability, drugs that are earnings war horses, and drugs that are presently in development. The company's direct exposure to the economic swings in consumer goods is lessened by the fact that only 10% of its business is in consumer healthcare. Companies like Bristol-Myers Squibb (BMY) and Merck experience greater fluctuations as a given drug comes on or off patent, thus relying on constant drug development and innovation. Johnson & Johnson, on the other hand, has a hefty $183 billion market cap and a large store of cash. The company has taken measures to improve its cash stores over time: At the end of 2010, the company had less than $2 billion cash, compared to the $14 billion in cash it presently maintains. This extra store of cash allows for agile acquisitions and business maneuvers.
The company, in addition, maintains investor-grade debt, with an S&P debt rating of AAA. The debt/capital ratio for the company is steady at 25%. In all, the scale of Johnson & Johnson's business and its capacity to maintain international sales makes the company quite formidable. Though it is also a strong company, Pfizer's share price is much more dependent on the strength of the pharmaceutical industry in particular.
Johnson & Johnson is a blue-chip standard in any portfolio. Based on new drug developments and the expected increase in consumer and medical spending, I think the stock will climb roughly $8 higher to $74 over the next 12-month period. In all, the company still boasts a classic line of consumer products, including Listerine, Bengay, Tylenol, Band-Aid, and Neutrogena, which comprise 23% of the company's total revenue. This diversity of consumer health products, pharmaceuticals, and medical device wings of the company make Johnson & Johnson a solid pick for any value investor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.