By Matt Doiron
A number of hedge funds managed by billionaires bought Johnson & Johnson (JNJ) in the second quarter of 2012. Renaissance Technologies, managed by Jim Simons, doubled its position to 6.7 million shares. Steve Cohen's SAC Capital increased its position by over a factor of 10, to 2.5 million shares, and D.E. Shaw raised its stake 72% to 1.4 million shares. Many other hedge funds also increased their holdings or initiated a new position. But who sold over 60% of its Johnson & Johnson position in the second quarter? Berkshire Hathaway (BRK.B), (BRK.A). Warren Buffett's firm still owns over 10 million shares, larger than any of the individual positions built up by hedge fund billionaires, but the large decrease in just three months combined with the fact that the stock price was flat for the first quarter and decreased for most of the second quarter suggests that Buffett no longer considered the company a good value.
Revenue in the company's second quarter dropped by 1% compared to the second quarter of 2011, and due to a number of miscellaneous expenses earnings fell by about half. Over the first six months of the year Johnson & Johnson has reported flat revenue and earnings which have declined by 15%, though this earnings decline was entirely caused by Q2 operations (which, in turn, was entirely caused by miscellaneous expenses).
Johnson & Johnson has three divisions, each of which reported separate results for the U.S. and internationally. The Medical Devices & Diagnostics division reported a 2% increase in U.S. revenue but a 2% decrease in international revenue over the first half of 2012. These changes netted each other out, but increases in margin drove operating income 23% higher than in the first half of 2011. It is now the largest division by operating profit as well as by revenue, passing the Pharmaceutical division. In Pharmaceuticals the situation was reversed: revenues fell 8% for the U.S. but rose 11% internationally, netting out to a 1% gain, but operating income fell 21%. Finally, the well-known Consumer segment lost revenue both in the U.S. and worldwide, pulling segment revenue down 4% and operating income down 35%.
Looking at these figures, we can see why an investor like Buffett would get out. He might prefer a company that depends on a strong consumer brand- which Johnson & Johnson's consumer segment does, but that business is shrinking and the firm is becoming more and more of a healthcare technology and pharmaceutical company. On the other hand, other investors might see this as an opportunity for Johnson & Johnson to get growth out of these new business opportunities.
The best comparables for Johnson & Johnson are Covidien (COV) and Novartis (NVS), which have a similar segment profile: pharmaceuticals, either medical devices or diagnostics, and some consumer products. On a trailing basis these companies are priced at lower valuation multiples than Johnson & Johnson- P/E multiples of 15 and 17 respectively compared to 22- but sell-side analysts expect more earnings growth from Johnson & Johnson. As a result, forward P/E ratios for all three peers are between 11 and 13. Covidien pays a lower dividend yield, at 1.6% to Johnson & Johnson's 3.6%, and Novartis pays a higher one at 4.2%.
Overall the three companies seem about even, though a greater share of Johnson & Johnson's value comes from growth expectations and we'd rather not rely too heavily on that. Pfizer (PFE) is another peer; it is not quite a pure-play pharmaceutical company as it does manufacture some consumer healthcare products. Pfizer's dividend yield is about equal to Johnson & Johnson's, and its P/E ratios are slightly lower at 18 on a trailing basis and 10 on a forward basis, so it might make a slightly better buy on those terms, but we are intrigued by the hedge fund activity. We don't think that the shift in Johnson & Johnson's business will bring it a higher multiple, particularly as its recent growth has been the lowest of all four companies, so that can't be the driving factor here. We are hesitant to trust the hedge funds so completely, particularly as Buffett heads in the other direction, but an investor might be willing to take that plunge.