Johnson & Johnson: Strong Dividend Play

| About: Johnson & (JNJ)
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When it comes to pharmaceutical companies, patents are the competitive differences that make a business thrive, but it can also be a company's undoing. It goes like this, a company discovers a new drug and patents it. It then has the right to sell that drug exclusively for a period of time. Once that period lapses, the patent can be used by other companies to make a generic version of the drug. The thing is that sometimes pharmaceutical companies don't agree with the dates.

Johnson & Johnson (NYSE:JNJ), one of the largest and most diversified healthcare firms in the world, together with Forest Laboratories (NYSE:FRX), is suing several of its peers for, allegedly, planning to offer generic versions of Bystolic, a hypertension drug developed by Forest Labs and Johnson & Johnson's Janssen Pharmaceutica NV in partnership, before the patent expired. Johnson & Johnson and Forest Labs aver that their patent on Bystolic doesn't expire until December 2021.

The suit names Watson Pharmaceuticals (WPI), as well as Amerigen Pharmaceuticals, Glenmark Pharmaceuticals, Hetero USA and Torrent Pharmaceuticals, amongst others. Johnson & Johnson, the maker of drugs like Tylenol, Motrin and Concerta devotes a significant amount of its resources in developing new products in order to maintain its leading position in the industry - so protecting its patents is paramount.

Johnson & Johnson spent $7.5 billion in research and development in 2011, which is nearly 12% of its sales. As of January 2012, Johnson & Johnson had about 17 drugs under late stage development. Most of these new products are in Phase III trials or under the revision of FDA. We think the new products will boost Johnson & Johnson's pharmaceutical segment.

In addition to internal growth from product development, Johnson & Johnson also tries to expand its business through strategic acquisitions. The company has made a number of acquisitions over the last few years. It acquired Crucell in the first quarter last year for about $2.5 billion in cash. Then, in April 2011, Johnson & Johnson announced that it had agreed to purchase Synthes Inc (SYST) for $21.3 billion. The latter deal positioned the company as the market leader for devices that treat trauma victims. The Synthes deal is expected to be completed in the first half of 2012.

The deal, if approved, which it is rumored to be, is the largest in Johnson & Johnson's history. We think Johnson & Johnson is going to see great operating synergies from the Synthes deal not to mention a stronger presence in the orthopedics industry. The deal is especially important because medical devices and diagnostics accounted for over 40% of Johnson & Johnson's turnover in 2010 and the acquisition will allow the company to more effectively compete in that arena.

Over the last year, Johnson & Johnson generated $65 billion in revenue, $9.7 billion in net income, and $11.4 billion in free cash flow. As of the end of 2011, the company had $32.2 billion of cash and investments and $19.6 billion of debt on its balance sheet, indicating about $12.6 billion of net cash. Johnson & Johnson is currently trading at just under $65 a share. The company's projected operating EPS for 2012 is $5.05 to $5.15, assuming foreign currency exchange rates remain constant at mid-January 2012 levels. This means Johnson & Johnson has a forward P/E ratio of about 12.3 - a discount to the industry average of 16.90.

Johnson & Johnson's biggest competitors are Abbott Laboratories (NYSE:ABT) and Bristol-Myers Squibb Company (NYSE:BMY). In comparison to these peers, Abbott seems to be trading at a discount while Bristol-Myers looks a bit overvalued. Bristol-Myers is expected to make $1.96 per share in 2012 and $1.94 per share in 2013, making its P/E ratio for 2013 about 17, which is significantly higher than Abbott's 11.2 and Johnson & Johnson's 11.8. Moreover, Johnson & Johnson and Abbott also have relatively stronger projected growth than Bristol-Myers. Over the longer term, Johnson & Johnson's earnings are expected to grow at 6% per year, Abbott's earnings by 7.5% annually, and Bristol-Myers' by just under lower than 2%. Looking at these numbers, Abbott seems to be a better pick, but we are also bullish on Johnson & Johnson.

Johnson & Johnson is a dividend champion. It pays a decent 3.51% dividend yield after steadily increasing its dividends for nearly 50 consecutive years. Plus, it has a low payout ratio, of just 64%. Between its relatively low payout ratio and its stable growth, Johnson & Johnson has the ability to maintain or increase its dividend payments. In 2011, Johnson & Johnson increased its quarterly dividends from $0.54 per share to $0.57 per share. We think Johnson & Johnson will continue to increase its dividend payouts in the future and we believe it is a good dividend growth stock for long-term investors.

Abbott and Bristol-Myers also have attractive dividend yields. Abbott's dividend yield is 3.38% and its payout ratio is 62%. Abbott's dividend history is nearly as strong as Johnson & Johnson's. It has been raising its dividends for 39 consecutive years. Bristol-Myers has a higher dividend yield of 4.11% and a lower payout ratio of 61% out of these three companies, but its dividend history is a bit weaker. Its current quarterly dividend is $0.34, up by only 20% from the $0.28 per share it paid to shareholders a decade ago.

To its credit, Johnson & Johnson is also one of the most popular healthcare stocks among hedge funds. As of the end of last year, 59 of the 350-plus hedge funds we track owned a stake in the company, up from 57 hedge funds at the end of the third quarter. Together, these 59 hedge funds had about $4.6 billion in Johnson & Johnson as of December 31, 2011, including some very prominent funds.

Warren Buffett was the most bullish fund manager about Johnson & Johnson. His Berkshire Hathaway had nearly $2 billion invested in this stock at the end of December. Other well-known money managers in favor of Johnson & Johnson include Ken Fisher, Ric Dillon, Bill Miller, and Cliff Asness. Abbott and Bristol-Myers are relatively less popular among hedge funds compared with Johnson & Johnson. In comparison, as of the end of 2011, there were 40 hedge funds with positions in Abbott and 30 positions in Bristol-Myers.

Note: This article is written by Guan Wang and edited by Meena Krishnamsetty.

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