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Baby Shampoo, Drugs and Computerized Sedation

January 25, 2009 – Comments (9) | RELATED TICKERS: JNJ

Actually buying the stock last week combined with Mary953's post asking about dividend stocks gave me enough incentive to update my pitch for JNJ.

JNJ is organized into three operating segments, pharmaceuticals, consumer products and medical devices and diagnostics.  2008 revenue was fairly balanced across the three segments with pharma at 39%, MD&D 36% and consumer 25%.

The company reported essentially in-line earnings on Tues, 20 Jan with revenue slightly below estimates.  Earnings for 2008 were up 6.8% compared to 2007, 2008 sales increased 4.3% over 2007.  The company is forecasting only 1 – 3% EPS increase for 2009.  However, they did beat their guidance for 2008 in a very tough economy.

Among the highlights from the conference call, CEO Bill Weldon reported that integration of the consumer brands purchased from Pfizer last year is ahead of schedule and is now expected to be break-even or slightly accretive this year.  The earnings call includes a fairly detailed run down of drugs coming off patent and products in the pipeline.  It seemed like the pipeline is in pretty good shape to bring new products on line as older products come off patent protection.

A statement from Mr. Weldon that stood out to me was, “This chart will be familiar to most of you; it sizes the global healthcare market for 2007 at $4.1 trillion and breaks out those areas where we compete today and the areas of healthcare where we have not yet entered.”  That was followed shortly by, “There is plenty of opportunity for Johnson & Johnson in the global healthcare market as we grow share in our existing markets and move into fertile grounds for expansion.”  The CEO is doing what a CEO is supposed to do.  He’s not only paying attention to the current business, he’s focused on where JNJ can expand.

JNJ has been an active acquirer of businesses over the past year and is well positioned to continue acquiring as opportunities arise.  During the analyst Q&A, Mr. Weldon stated, “We’re always looking for the right opportunities and we think that the pressures in the economy right now are going to create very unique opportunities for us. We have our list of candidates that we think would be good opportunities and other ones are going to be popping up and coming to us as the year progresses.”

The JNJ balance sheet is a definite strong point in today’s credit environment.  The company has a AAA credit rating and $1 billion in net cash.  Over 2008, JNJ increased net cash by $1.2 billion.  I believe positive net cash is extremely important in a world full of financial instability.  JNJ is in a position to continue operations without missing a beat even if the credit markets were to dry up entirely.  The cash plus strong credit rating puts them in a great position to acquire as others need to sell to raise cash.

There are some risks.  JNJ has substantial operations outside the US so there is quite a bit of currency risk.  President Obama just took office and we don’t know what new regulations or policies his administration might implement and how that might impact JNJ.

Those risks are somewhat offset by a diverse business model – it’s unlikely changes to healthcare policy would all be negative for JNJ and several of their business units may benefit.

At Friday’s close of 55.97, the $1.84 annual dividend yields 3.29%.  If I did the math right, the dividend is 42% of the free cash flow.  Add a business that isn’t very sensitive to economic conditions and that means a safe dividend stream.  For reference, the 10-year treasury note yield was 2.62% and the 30-year treasury bond yield was 3.32% on Friday.

One more positive, JNJ has raised the dividend 46 years in a row.

If the economy strengthens and markets go on a new bull run, JNJ will probably underperform.  But, if we continue with a weak economy, challenging stock market and anemic bond yields, JNJ should provide steady income with limited downside risk.  I believe a dividend yield at a premium to the 10-year bond and about equal to the 30 makes JNJ a very attractive option to bonds for income investors.

All quotes from the conference call are from the transcript at Seeking Alpha.

Disclosure:  At time of posting, I’m long JNJ and planning to get longer.