Johnson & Johnson: Dividend Aristocrat At A Fair Price For Long-Term Investors

by The Compound Investor

Although it comes under a single ticker, Johnson & Johnson (JNJ) is more akin to a giant one-stop healthcare shop. Folks likely know the consumer division thanks to brands like Listerine, Neutrogena and Tylenol. Its pharmaceutical segment sells patented drugs across a range of areas – oncology, immunology, neurology, infectious disease, cardiology and so on. Finally, it operates a multi-billion dollar medical devices business selling surgical tools, hip & knee replacements, contact lenses and so on. Throw it all together and you get a circa $80b-plus annual revenue business, $20b of which hits the bottom line.

On a fundamental level, I like the stock for much the same reason I expect readers do: it generates a boat load of cash every year and doesn’t mind sharing it with stockholders. Cumulative free cash flow here has registered in the $60b region over the past three years alone, and $30b after dividend payments. Sure, you have to put up with the usual healthcare sector issues – flops in the drug pipeline, litigation, patent expiries and so on – but the empire is vast enough to deal with those. All of the firm’s segments are quite ‘moaty’ too, benefitting from things like patent protections, branding power on its consumer products and so on. The company can afford to spend well over $10b on R&D each year as well.

Johnson & Johnson (JNJ) cumulative free cash flow after dividend payments to shareholders (2011 - 2020)

Oh, and Johnson & Johnson typically operates one of the most conservative balance sheets in the blue chip space. Cash, cash equivalents and marketable securities amounted to circa $24b at the end of 2020. Total debt came in at around $35b. It could swallow its net debt position in about a year based on current rates of post-dividend free cash generation. All in all, there is just a heck of a lot to like with this one.

Back On Track

2020 represented a bit of a mixed bag for the company. Its Medical Devices segment fared worst, with full-year sales dropping by double-digits to $23b as non-essential surgeries were put off because of COVID. Pharmaceutical sales increased 8% to $45.5b, offsetting the decline from Medical Devices in USD terms. That was driven by strong growth in immunology and in oncology from blood cancer medication Darzalex. At circa $14.1b, the stodgier consumer health segment saw sales grow by just over 1%. That led to overall company-wide sales growth of just 0.6% last year, albeit including a similarly sized headwind from currency. Adjusted net income fell 8% to $21.4b for the year, or $8.03 per share, due to the sales drop in Medical Devices and associated fixed cost deleveraging.

Johnson & Johnson (JNJ) 2020 pre-tax profit by business segment
(Source: Johnson & Johnson Q4 2020 Results Presentation)

I’ll ignore the COVID vaccine stuff; as positive as J&J’s one-shot vaccine is for mankind, it doesn’t really impact the business much at all. In any case, things should be back on track this year as the pandemic abates. Medical Devices should normalize for obvious reasons, while management also expects volume growth to carry on offsetting modest price decreases in the Pharmaceutical segment. Overall sales growth is expected to clock in at circa 10-11%, including currency, with EPS growth seen running several points ahead of that.

Valuation

Johnson & Johnson stock currently trades around the $166 per share mark. C-suite guidance points to underlying earnings per share in the $9.50 area this year, including currency, which means the stock trades at a rather modest looking 17.5x earnings. Now, the firm faces a couple of fairly sizable headwinds going forward. Healthcare provision and drug pricing is obviously a major political issue in the United States, so the risk on that front is pretty clear. Bear in mind that US pharmaceutical sales represent around $25b of the $85b top line. The pre-tax profit margin is also fattest in that segment. On top of that, the company has also been all over the news in recent years due to a bunch of lawsuits, with the cumulative bill stemming from its talcum powder and opioids issues running into the billions of dollars so far. The threat of litigation is an evergreen issue.

Johnson & Johnson (JNJ) 2021 EPS guidance
(Source: Johnson & Johnson Q4 2020 Results Presentation)

Still, I can’t help but think of all that cash flow – $10b per year after dividends to be more precise. We are talking almost a billion dollars a month winding up in the corporate coffers for things like buybacks, acquisitions, debt reduction and so on. The $4.04 per share annualized dividend represents a current yield of around 2.45%. Note that the S&P 500 offers a dividend yield of approximately 1.5% on an earnings yield of around 4.5%. Note also that the current risk-free ten-year Treasury yield is 1.75%, while the Baa corporate bond yield is around 3.4%. Is Johnson & Johnson stock the greatest bargain in the history of the world? No. Is it reasonably valued compared to what is else is on offer? Yes, I think so. More importantly, the current valuation is not so aggressive that you can’t scratch out decent real-terms wealth creation.

Note

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