One of my “core” holdings, Johnson and Johnson (ticker: JNJ), has been in the news A LOT more recently. And while I typically do not reach to news especially when I consider is “noise” as far as my long-term outlook of the business, when the news item has a significant impact on my strategy, it is worth bringing-up here and laying down my thoughts on the subject.
So late last week (12th of Nov, 2021), news broke out that JNJ is planning on splitting its consumer products business from its pharma and medical devices businesses and create two independent publicly traded companies.
The press-release on JNJ’s investor page states that the “new Johnson and Johnson” i.e. the business division containing the pharma and medical devices portfolios, will be headed by Joaquin Duato, current Vice-Chairman of the Executive Committee, after Alex Gorsky, the current CEO, transitions over that role. Alex Gorsky would continue to serve as Executive Chairman. The new Consumer Products company (name TBD) will have a separate board of directors and executive leadership which will be announced in due course.
The split-up is planned to be completed by end of 2022. It is intended to be a tax-free separation.
The news release also states the following regarding shareholder dividend:
In addition, it is expected that the overall shareholder dividend will remain at least at the same level following the completion of the transaction.
Obviously, there are not a whole lot of details in this press release and we will need to wait and see how this whole thing plays out.
Having said all that though, I am not very surprised by this decision. In my deep-analysis post for JNJ on this blog back in August this year, when I analyzed the major drivers for the revenue for the company in the last five years, I was surprised to see that the consumer health and medical device’s revenue contribution percentage was essentially flat or even slighting declining for the last 5 years.
This trend is consistent for a few more years before that as well. Most of the growth in the company has been from the pharma business segment. This changed my outlook slightly, because I was under the false impression that JNJ was like a “healthcare ETF” given the diversification within its business. At least this is the narrative that is touted all around the internet whenever you read about JNJ.
So how do I view this news then? I think it is a positive decision. In Peter Lynch’s “One Up On Wall Street“, he states that huge companies are slow movers in terms of their revenue growth. JNJ is a massive business with a market cap in excess of $430 billion. This split-up will help each individual company focus on its business and help drive revenue growth better.
Am I as excited about the consumer health business as I am about the “new JNJ”? Not so much. I never really owned JNJ for its consumer health business alone, but rather for the overall conglomerate and also the quality of its management. I think the “new JNJ” piece of the business has still a lot of value and growth left.
I have not yet made up my mind about the consumer health piece of the business. A lot will depend on how to business is structured, the quality of the management and the overall brand value. I will need to research that independently to make a decision on what I intend to do with that.
The point of this post is not a “I told you so..” moment. Rather, it is reinforce this notion that all businesses, as with life itself, are subject to change. And the value of doing your own research by reading the fine print of the businesses you own, is priceless.
Disclosure: JNJ part of “core” category of my dividend portfolio. No positions in PFE or MRK at this time.
In this post, I would like to analyze Johnson and Johnson (ticker: JNJ). This is the first of what should be a continuing series of posts, where I attempt to analyze every single holding in my dividend stock portfolio. Before going ahead, I want to state that this is by no means a recommendation to invest in Johnson and Johnson. I am simply sharing my analysis on this company for education. Please read my full disclaimer here. So, lets dive in!
My first introduction to JNJ was through their baby care products such as baby powder and baby shampoo. But very soon, I also noticed some other products around the household that also had a JNJ imprint on it, such as Band-aid, Tylenol etc.
JNJ was founded way back in 1886 by three brothers, Robert Wood Johnson, James Wood Johnson and Edward Mead Johnson. It was interesting to read that around this time, the practice of sterilizing equipment prior to a surgery was not common and this is what motivated Robert Wood Johnson to join his brothers into launching this business. Their first line of products included sterile surgical supplies and household medical equipment.
JNJ went public in the year 1944 and around this time, Robert Wood Johnson II drafted what is called the “Credo” document, basically a mission statement for the company. It is interesting that the Credo finds mention on JNJ’s website and their earning’s presentation even to this day and the statements are relevant in today’s context as well.
JNJ’s business can be broken down into three primary segments: Pharmaceuticals, Consumer Health and Medical Devices. I found it particularly interesting looking at their recent and past 10-Ks SEC filings that Consumer Health is not the dominant part of their business, even though they have so many strong and well-known brands in the market. From the last 10-K, Consumer Health only represents about 17% of all the overall revenue, with Medical Devices making about 31% and Pharma making up the remaining 52%. Given this broad moat, JNJ is unlike other company in this domain. In fact, it is more like a healthcare ETF in its own right!
I was interested to see how the segments have been performing over the last few years. From what I could tell, most of the revenue growth seemed to be from the Pharmaceuticals segment, with the other two segments appearing relatively flat/tapering down slightly.
JNJ has been consistently spending on R&D, as it should given the very competitive nature of the business they are in. This is something that I am paying a close attention to it in their earnings presentations. From the earnings presentation in their last 10-K, I noticed that their pipeline for regulatory submissions to the US. FDA on the equivalent counterpart in the EU is reasonably full, thus driving growth for the coming few years.
Another noticeable aspect of JNJ’s sales is its geographic spread: while 50% of sales revenue comes from the US, close to 22% of revenue comes from Europe, and a good 18% or so comes from Asia-Pacific and Africa with the remaining coming from the western hemisphere. This diverse international exposure de-risks the business from over exposure to only one geographical market.
JNJ gets a lot of love in the dividend investing community. And it is not surprising to see why. The company has a history of increasing their dividends consecutively for 58 years, at the time of writing this. Just let that sink in for a second. 58 years includes things like the dot-com boom in the late nineties, and then the Great Financial crisis in 2008-2009. The company has been un-affected during all that turmoil and managed to return value back to their shareholders in the form of dividends.
I looked at the more recent dividend history to get a sense of the recent dividend growth rate. Here is what I could glean:
3-year Dividend CAGR
5-year Dividend CAGR
10-year Dividend CAGR
So the dividend growth has been steady over the last decade with no apparent sign of slow-down. The last dividend hike was announced in April this year and it was about 5%.
The central question that a dividend investor is interested in is how safe is the dividend in the long run. To answer this, I look over the company’s financial statements to decipher the following:
Is the company’s revenue growing?
How profitable is the company?
What are the company’s assets and how much does the company owe in the short-run and the long-run?
To determine is the revenue is growing, I looked at the basic EPS trend from the period of 2008-2020.
While I can see the revenue growing, the growth rate here seems to be slower than the dividend CAGR seen above. This was further confirmed when I looked at the dividend payout ratio, I could see a gradually increase in payout ratio during the same period. At the time of writing this, JNJ just released strong Q2 results for this year and raised the EPS guidance for the full year. This is a great sign and I am confident that the dividend payout ratio will sneak back into a safer range.
A quick note: For the year 2017, notice that the EPS drops alarmingly in the graph above. This is due to a change in the tax code for that financial year.
While I was on the income statements, I also looked at the Net Margin (Net Income as a percentage of the Revenue). Aside from 2017, the Net Margin seems to be around the 20% mark on an average. A steady Net Margin usually points to a strong and stable business.
From the balance sheet, I took a quick look at the debt to equity and debt to asset ratios. Here is a plot of the total debt/liabilities compared to total assets.
I am generally looking for trendlines that are converging that will prompt me to dig deeper. In this case, the trendlines seem like parallel trains, so nothing to worry about. However, when I looked deeper into the assets I could see that Goodwill is a fairly substantial portion of the total assets and it has been steadily growing in the past decade. This is not a concern at this moment, but this is something that will need to keep a close eye on in the near future.
I then looked at the total shares outstanding trendline. I am looking for a trendline that is trending downwards. Share buybacks when done for the right reasons will boost the equity value of the shareholders and as we can see through the graph above, JNJ is trending in the right direction here.
Finally, I compared JNJ to the overall S&P 500 performance. While capital appreciation is not the central goal of my portfolio, it does matter when it comes to gauging the overall performance of the stock. I have this data thanks to Dividend channel for a period of 1995-present starting with an initial capital of $10,000 and with and without dividends re-invested.
JNJ has clearly outperformed the broader market here, with an average total return of roughly 12% with dividends re-invested. To illustrate the point of why dividends matters, the total return without dividends reinvested comes up to about 10%. It is, therefore, very clear that dividends play a massive role in total returns obtained by the investor.
Management and Other Company details
While the engineer in me likes to breakdown the numbers, analyze data and evaluate business in a quantitative manner, that alone is not enough to understand the inner workings of a business. After all, numbers can only tell you so much. There are real people between those numbers and sometimes it is important to analyze business qualitatively as well.
So in that pursuit, I closely look at the management that runs the business. After all, these people are the face of the company. I listen to them speak during the conference calls and earnings presentations. Furthermore, this team provides the necessary leadership to the organization, motivates employees to perform their day-to-day roles efficiently. If a company has a fantastic balance sheet, but a clown as a CEO, it does not exude a lot of confidence in me as an investor about the long-term prospects of the business.
JNJ has this area pretty well covered though. Their current CEO, Alex Gorsky, has been with JNJ since 1988 rising up the ranks from a sales representative for Janseen Pharmaceutica to marketing, to management and finally the CEO and the chairman of the board. I really like organizations that hire from within, and where management have a long-standing history with their company.
I looked into the company’s outlook through Glassdoor to see how the employees rate working there:
The ratings are generally positive with around 95% of the employees approving of the current CEO.
Fair Value Estimation
For a fair value estimation, I used the Discounted Cash Flow model. For this estimation, I computed the Free-cash flow for a 5-year preceding period by subtracting capital expenditures from the total cash flow from operating activities. For my future cash flow estimation, I assumed a conservative net margin of 18% and computed FCF/net margin estimates based off that. I assumed a terminal growth rate of 2.5% to be on the conservative side. Furthermore, I estimated the required rate of return by using the weighted average cost of capital model (or WACC). Per my estimation, this came up to about 7%. Putting all the numbers together, the fair value of equity today, less debt and adding some margin of safety, is about $162.
At the time of writing this (EOD 8/2/2021), JNJ is trading at a share price of $172.27, so slightly above my estimated fair value above.
Any deep analysis is not complete without a discussion of risks associated with a stock pick. Even a solid business like JNJ has risks associated with it. With JNJ, as is typical with other companies in the healthcare sector, there are always risks associated with lawsuits due to consumer healthcare products or pharmaceuticals.
A few that come to mind with JNJ, is the lawsuit associated with their baby powder product, where it is alleged that the powder was contaminated with asbestos leading to ovarian cancer. More recently, there were reports of JNJ’s COVID-19 vaccine being linked to blood clots in women. At the time of writing this, JNJ is recalling their Neutrogena line of products related to sun-screens due to the presence of benzene which is considered to be carcinogenic.
Even in the presence of such risks, I am fairly confident that JNJ still has a solid foothold with its business to weather any storm.
JNJ is one of my “sleep-well at night” stock picks and I am fairly confident that this business will remain relevant in my lifetime at-least. It is for this reason that I have put it in the “Core” category of my dividend portfolio. However, as with all things in life, even a solid company like JNJ will cease to exist one fine day. It is for this reason that I manage a diversified portfolio with stock picks from different sectors.