Johnson & Johnson (JNJ) reports Tuesday morning before the bell, and we'll see if operationally, the healthcare giant can follow up on its nice run the stock has experienced since the re-configuration of the Synthes acquisition was announced.
After trading as low as the low $60's in the 2nd quarter, JNJ's stock has popped on the announcement that the Synthes acquisition, a $20 billion orthopedic company deal, would see the deal's financing reconfigured resulting in the acquisition being $0.22 accretive to earnings per share (EPS) instead of the original $0.03 to $0.05 dilutive.
If that doesn't sound like a big deal, you might want to re-think that, since a $0.25 positive swing in earnings per share is 5% of 2012's current consensus eps estimate of $5.14.
What JNJ did was instruct their Irish pharmaceutical arm, Janssen Pharmaceuticals, to use some of JNJ's non US cash, to purchase $13 billion of JNJ shares from two investment banks over the next 12 months. (The remaining difference of $7 billion will be paid in cash by JNJ) in what was essentially an accelerated share repurchase program. The Accelerated Share Repurchase (ASR) program was pretty innovative, and helped the stock price, as JNJ's shares have run from $61 to $69 on just this news alone.
However there are other reasons to be interested in JNJ: the company has replaced their long-time CEO Bill Weedon, with Alex Gorsky, who comes out of JNJ's faster-growing Medical Device and Diagnostics (MDD) division. Bill Weedon never seemed to get his arms around the various manufacturing issues at McNeill, which resulted in a numerous recalls and real tarnishing of the Tylenol brand and a slowing of growth in JNJ's Consumer division, home to pristine brands like Tylenol, Listerine, Neutrogena, Band-Aid and Visine.
Operationally, JNJ's growth has slowed from the mid 2000's high single digit organic revenue growth to today's low single-digit revenue growth, and is just barely positive today. By segment or division, JNJ is grouped into three primary product groups:
Consumer: 22% - 25% of total revenues, JNJ's Consumer division has borne the brunt of the Tylenol recalls and manufacturing issues. Revenue growth used to be high single digit to mid teens, but today is just low single digits. No question this division needs to put its manufacturing issues behind it, and start focusing on growth.
Pharma - 35% to 38% of total revenues, the Pharma segment has grown low single digits for the last decade, inline with the rest of the sector. However the other large-cap pharma stocks are starting to perk up. Does JNJ have the pipeline to grow organically ? We'll find out over the next 2 -3 years. Most analysts wax positive on the drug pipeline, however investors need some proof.
Medical Device - Medical Device and Diagnostics - 35% - 40% of total JNJ revenues: the Synthes acquisition will presumably fit into MDD since it is an ortho company. This is the best division in terms of secular growth prospects, and is the division from which the new CEO comes.
If the new CEO can light a fire under the previous pristine Consumer division and drive some organic growth in MDD, JNJ could trade in to the mid to high $70's where most analysts have fair value.
2012's consensus earnings per share of $5.14 is looking for just 3% growth in 2012 (versus the $5.00 in 2011) and for next year, analyst's are looking for $5.51 or 7%, versus the stocks current multiple of 13(x) on 2012's estimate.
As you would expect JNJ's cash flow and balance sheet are pretty rock-solid, with JNJ currently sporting a 7% free-cash-flow yield.
Operationally, JNJ needs to stem the margin erosion and restore the brand image, before JNJ can return to its former mid to high single digit organic revenue growth. The last two years, as earnings growth slowed to low single digits, JNJ has met analyst estimates from lower tax rates and non-operational items like interest income, and forex changes. These are earnings quality issues and are a far cry from the 1990's.
Investors need to see some real organic growth and revenues start to accelerate.
There are a couple of factors to consider or questions to ask when evaluating a turnaround of this magnitude:
1.) is the brand intact ?
2.) Is there sufficient cash-flow to support the turnaround ?
3.) Finally is there a catalyst to drive the reinvention ?
The catalyst is clearly the new CEO Alex Gorsky, and JNJ definitely has the balance sheet and cash-flow to support the proper investment. Is the brand still intact ? I would give it a "qualified" yes, but this now has to be proven.
Technically, JNJ is extended today. We'd like to initiate positions in the stock near $65 - $66, or on any decent pullback. JNJ's all-time was $72.76 in September, 2008. That previous high is a key technical level.
None (but very interested)
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JNJ over the next 72 hours.
