JNJ is a classic blue chip company that has raised dividends for 47 straight years. JNJ currently yields 3.1% with a modest payout ratio and is also averaging a net $5 billion in share repurchases per year. For a company of this size, the balance sheet is remarkably conservative.
Johnson and Johnson has seen steady growth for the last several decades. The economic crisis in 2008 and 2009 has slowed growth, but cash flow remains strong in 2009.
Revenue Growth
Year Net Earnings
2009 $12.266 billion
2008 $12.949 billion
2007 $10.576 billion
2006 $11.053 billion
2005 $10.411 billion
2004 $8.509 billion
Earnings Growth
Year Revenue
2009 $61.897 billion
2008 $63.747 billion
2007 $61.095 billion
2006 $53.324 billion
2005 $50.514 billion
2004 $47.348 billion
Cash Flow Growth
Year Cash Flow
2009 $16.571 billion
2008 $14.972 billion
2007 $15.249 billion
2006 $14.248 billion
2005 $11.877 billion
2004 $11.131 billion
Dividend Growth
Year Dividend Yield
2009 $1.93 3.26%
2008 $1.795 2.88%
2007 $1.62 2.75%
2006 $1.455 2.43%
2005 $1.275 2.03%
2004 $1.095 2.03%
Johnson and Johnson has been a solid dividend payer for decades. With a current dividend yield of 3.09%, JNJ presents one of the highest yields it has had in years.
In 2007, JNJ opened the Emerging Market Innovation Center, a nearly 100,000 square ft facility, in Shanghai, to better address the concerns and needs of the world's developing countries. In 2008, JNJ acquired Beijing Dabao Cosmetics company, and with it China's number 1 brand of skin moisturizer. The company takes in half of their revenues from abroad, and is aggressively seeking out partnerships and top product lines throughout emerging countries. Although JNJ is a solid blue chip with $63 billion in revenue, they certainly have ample room to grow. With JNJ, you get 7.5% five-year earnings growth and a 3.09% yield, which likely will fetch a 10% annual return approximately. Analysts predict a 6.2% EPS increase in 2010 and an 8.7% increase in 2011.
However, there are probability risks that JNJ faces. Ongoing healthcare reform could potentially reduce their profit margins in the US. Ongoing healthcare reform could potentially reduce their profit margins in the US.
Looking ahead, the balance sheet should improve further given the large generation of FCF as well as the incoming payments from Boston Scientific (BSX). Historically, the company has reinvested in the business with capital expenditures and acquisitions, repurchased stocks and paid dividends. Share repurchases dropped last year and account for the build-up in net cash. Applying a 44% payout ratio, which is slightly higher than the current ratio, but in line with the progression over the past several years, a dividend of 2.16 is expected this year.
However, there remains a risk
Although revenue growth should accelerate into 2011 as J&J gets past 2007-10 generic cliffs (Topamax and Risperdal), we see limited upside to 2-4% revenue growth rates over the next several years. Near-term pharma reacceleration is unlikely considering the risks and opportunities in the current pipeline and generic expiry schedule. Medical device markets are becoming universally more challenging due to pressures on utilization and price, and will face additional pressure in 2013 with the introduction of the device excise tax. Consumer growth will be dependent on (i) macroeconomic recovery, and (ii) OTC recall remediation, but in any event looks unlikely to eclipse 5% post reintroduction of OTC products.
J&J has amassed an impressive war chest over the past several years, but we would prefer to see more capital returned to shareholders. Theoretically, capital deployment could drive strong returns given JNJ's 9.5% FCF yield; in practice, we think management will prioritize using M&A to bolster the top line instead of increasing dividends or buybacks. When the growth outlook last slowed in 2006-07 ahead of 2007-09 generic cliffs, J&J maintained EPS growth by announcing a $10BB buyback in July 2007, which added ~200 bps to EPS growth in 2007-09. In contrast, management commentary today indicates that J&J remains more focused on deploying capital through acquisitions than returning capital to shareholders (excluding dividends). In fact, the company has not repurchased any shares under the $1.1 billion remaining repurchase authorization since 3Q09. Coupled with cash balances approaching peak levels last seen ahead of the PCH deal, we believe these dynamics suggest a larger acquisition is likely. At the least, capital deployment strategy demands greater explanation by management as its cash hoard grows.
We would advise investors to more closely evaluate the company's capital deployment policy and its potential to drive shareholder value. In our view, despite attractive yields, capital deployment is unlikely to create a near term catalyst for share price appreciation. We expect the company to maintain its strategy of targeted pipeline deals, but this approach is unlikely to give investors the growth visibility needed to drive multiple expansion. In addition, the risk of a larger acquisition is increasing. Competition for growth assets is escalating, and given investor reaction to recent acquisitions at substantial premiums, we would be concerned over J&J's ability to secure another growth leg at a palatable price for investors.
