Early today (10/09/2012), Goldman Sachs (GS), cut its price target for Johnson and Johnson (JNJ) to $72.00 and lowered its rating on the stock from Neutral to Sell. The firm cited concerns over the company's pipeline and future growth prospects inhibiting their ability to partake in shareholder-friendly capital allocation. Goldman also said that it sees upside for JNJ of only 7% versus 14% for that of its peer group. In response to the downgrade at Goldman Sachs shares of JNJ have traded down roughly 1.5% and can be bought for $68.35 at the time of this writing. In the wake of this downgrade, Johnson and Johnson shares may be coming to an attractive entry point for long-term investors.
Johnson and Johnson is so much more than just a pharmaceutical company. JNJ is a collection of more than 200 subsidiaries that are commonly referred to as the Johnson and Johnson family of companies. The company operates in three major segments including the consumer business known for producing BAND-AID, Tylenol, and Splenda, the pharmaceutical business, and medical devices and diagnostics.
While concerns over the strength of the JNJ pipeline are certainly not unfounded, the strength of Johnson and Johnson lies in the fact that as a large company with diverse product lines, it does not need to rely on the blockbuster drugs that have driven profits and revenue of some of its main competitors. For 2011, the JNJ consumer business brought in revenue of $14.9 billion (23%), pharmaceuticals brought in $24.4 billion (37%), and medical devices and diagnostics brought in $25.8 billion (40%). As you can see, each of the business segments brings in significant revenue for the company, and the low-performing consumer segment was subject to numerous recalls during 2010 and 2011.
Johnson and Johnson also has a broad geographic profile which gives the company the ability to quickly introduce new products in markets all over the world. While the company generates the largest portion of its revenue in the United States ($28.9B-45% in 2011), it has significant international exposure with roughly 30% of revenue comes from the emerging markets of Asia-Pacific and Latin America, and the remaining 25% generated in Europe.
Even with the company lacking "transformational" pipeline opportunities the company has 15 drugs up for review by an FDA panel or in phase III of clinical trials. The medical device and diagnostic pipeline also holds a number of candidates pending approval or to be submitted shortly which could contribute to earnings. In addition, the Synthes acquisition which was completed in June of 2012 should begin to contribute to earnings immediately, and is expected to contribute 10-15 cents to earnings during 2013.
JNJ is a giant in the pharmaceutical, medical device, healthcare, and consumer products industries with a market cap of over $190 billion. The company currently trades with a TTM P/E ratio of 22.1 which is well above the companies 5-year average of 15.0. Although the P/E ratio is high, JNJ earnings have been negatively impacted over the past year by manufacturing issues from the McNeil Pharmaceuticals subsidiary, costs associated with acquisitions, and litigation surrounding illegal marketing of drugs. JNJ is expected to grow earnings by 8% over the next year, and 6% over the next five years. The company has relatively low debt, but as it stands currently JNJ is paying out 72% of earnings to investors as dividends. While the payout ratio is high, JNJ has 49 years of consecutive dividend increases saying that the dividend will continue to grow, and over the past five years it has grown at an 8% annual clip.
JNJ is a terrific company and the future is brighter than many analysts would have you believe. While the company has been plagued by product recalls and litigation over the past few years it appears that new CEO Alex Gorsky has reined in some of those issues. As Johnson and Johnson stays out of the news for the wrong reasons, earnings should get back on track, and likely outperform the expectations that have been set for the company. In addition, Gorsky has additional options at his disposal to add value for shareholders. JNJ has the ability to pursue strategic acquisitions, like that of Synthes, which would contribute to earnings immediately without burdening the balance sheet with debt. In addition, if other measures fail, JNJ could consider a break-up of the various business segments, similar to what Abbot (ABT) is pursuing with their AbbVie and ABV split.
Johnson and Johnson may not be the only stock for investors in the pharmaceutical market, but it is stalwart for dividend growth investors providing dividends and capital appreciation they can rely on. While Merck (MRK), Pfizer (PFE), GlaxoSmithKline (GSK), AstraZeneca(AZN), Bristol Myers Squibb (BMY), and Eli Lilly (LLY) are all pharmaceutical stocks worth considering, JNJ represents one of the most rounded and diversified stocks an investor can own. While challenges do lie ahead for the company in the short term, I would look to add to or initiate a long-term position if shares trade at or below $65.00.
Disclosure: I am long JNJ.