Johnson & Johnson: Blue chip stock is a buy for its dividends (NYSE: JNJ)
I love the healthcare industry. I own several sector companies from different industries within the sector in my Dividend Growth Investor. Medical device companies like Abbott (ABT) and Medtronic (MDT) as well as pharmaceutical companies like Pfizer (PFE) and Viatris (VTRS).
In this article, I will analyze Johnson & Johnson (JNJ). Johnson & Johnson is my favorite company along with Disney. The company combines medical devices with pharmaceuticals and also offers a consumer health sector. It is one of the most stable stocks on Wall Street with a low beta of around 0.7 and a long execution history.
I will analyze the company using the chart below, which represents my methodology for analyzing dividend growth stocks. I use the same methodology to facilitate the comparison of the stocks analyzed. I will examine the fundamentals, valuation, growth opportunities and risks of the business. I will then try to determine if it is a good investment.
According to Seeking Alpha’s company overview, Johnson & Johnson researches and develops, manufactures and sells a range of healthcare products worldwide. It operates through three segments: Consumer Healthcare, Pharmaceuticals and Medical Devices. The company markets its products to the general public, retail outlets and distributors, and distributes directly to wholesalers, hospitals and healthcare professionals for prescription use.
The company has seen its revenue grow by 26% over the past five years. This is a CAGR of almost 5%. Johnson & Johnson generates most of its growth through organic growth. In the third quarter, the company posted 10.7% year-over-year growth, and only 0.1% was due to acquisitions. Going forward, according to analyst consensus, as seen on Seeking Alpha, investors should expect mid-single-digit growth. The main event ahead is the spin-off of the company’s consumer care unit, which accounts for nearly 20% of revenue but is growing more slowly than the rest of the business.
EPS is growing faster than revenue due to three factors for Johnson & Johnson. Revenue growth is the main contributor, margin expansion, particularly with Covid vaccines, is also helping, and third is buyouts, which are modest but accretive to EPS. Going forward, according to analyst consensus, as seen on Seeking Alpha, investors should expect mid-single-digit EPS growth. If the spin-off is completed, the growth rate should accelerate.
The dividend is the crown jewel of Johnson & Johnson. The company will announce the 60th consecutive annual dividend increase in April. It’s a unique achievement, even among dividend aristocrats. 60 years later, the dividend is still as good. The implantation rate is safe below 50% and the yield is satisfactory at 2.5%. The company should continue to increase its dividend in line with EPS growth, so 6-7% per year seems like a fair estimate in the medium term.
The number of shares outstanding has decreased by 3% over the past five years. This is the result of one-off buyback programs. Johnson & Johnson does not prioritize buyouts. As he attempts to buy back stock, he first engages in organic growth, dividend, M&A activity, and only then buybacks. Still, the company buys back enough shares to ensure shareholders aren’t diluted.
Johnson & Johnson is trading for a P/E ratio just below 16 taking into account estimates for 2022. This is almost the lowest valuation we have seen for this blue chip in the last twelve months. In my opinion, this assessment is fair and even somewhat attractive for a company with such a long track record of fine execution in its business segments. When volatility is higher, havens like Johnson & Johnson can become more expensive, implying that investors should take advantage of the current valuation.
The chart below from Fastgraphs highlights that Johnson & Johnson is attractively valued. The company’s average growth rate is 8% and the average valuation is 17.8. Currently, before the spin-off, the company is trading for a forward PER of 16.76. Once the spin-off is complete, the new Johnson & Johnson will shed its slower-growing business, and investors will hold a faster-growing business for an attractive valuation.
In conclusion, Johnson & Johnson offers investors an excellent combination of solid fundamentals and fair valuation. We see revenue growth fueling earnings growth, which fuels dividend growth and some buybacks. This great growth machine, which has been growing the same for more than six decades, is trading at a lower valuation than its average valuation.
The first opportunity for Johnson & Johnson is its global reach. The company sells its products worldwide. A significant portion equal to nearly 50% of its sales comes from outside the United States. This diversification ensures that it is not based on a single market. The pharmaceutical industry is highly regulated and a regulator can have a significant impact on the business. Not being tied to a single regulator is an opportunity for future sales and limits the risk profile
The second opportunity for Johnson & Johnson is its commercial diversification. Even after dropping its consumer healthcare segment, the company will still have two business units: medical devices and pharmaceuticals. Each unit has its opportunity to develop and each unit can cover a temporary weakness of the other unit. Investors have access to more innovation and a more stable business that is not dependent on a single product or even a single segment for growth.
The impact on consumer health also represents an excellent short-term opportunity for investors. We have seen Unilever (UL) attempt to acquire the consumer healthcare segment of GlaxoSmithKline (GSK) and fail. Unilever was prepared to pay £50 billion or $68 billion for it. GSK declined the offer which valued the unit at around 5 times sales. Johnson & Johnson is currently trading for a price-to-sales ratio of 4.5.
This P/S ratio includes the faster growing medical device and pharmaceutical segments. Therefore, the split can unlock value for both companies. The consumer healthcare unit can benefit from demand and interest from other players, and the pharmaceutical and medical devices business can trade for a valuation appropriate to its growth rate.
Inflation is a risk for Johnson & Johnson. The company must raise its prices to fight inflation and achieve real growth. However, healthcare companies operate under regulatory scrutiny and every price increase can meet significant resistance and negative public relations, which can even escalate into congressional hearings. The company will need to increase sales while slightly increasing prices, and that may be a short-term challenge.
Competition can also make it harder for Johnson & Johnson to raise prices. The company operates in a highly competitive business environment, where significant capital is invested before any new drug or medical device is approved. Peers who are also huge pharmaceutical companies compete at every level with Johnson & Johnson’s product, making it more difficult to raise prices and forcing the company to consistently excel.
Another short-term risk is Covid fading. While Covid had a negative effect in 2020 on business results, vaccines offered a significant revenue boost. As Covid could go from a pandemic to an endemic, the demand for the vaccine is expected to slowly decrease. Investors should expect the infectious disease segment to post weaker results as demand declines after a 60% year-on-year increase.
Johnson & Johnson is the same winning horse as it was 60 years ago when it started increasing its dividends. The fundamentals are on the upside as earnings rise and drive EPS and dividend growth. The company is trading for what I think is a fair valuation and offers investors decent growth opportunities with limited risk.
Investors are currently facing a difficult environment with the VIX up 50%, and here Johnson & Johnson offers a safe haven. Investors have the opportunity to invest in a company that has an almost unparalleled track record. The company has only seen its EPS drop once in the last 20 years. Dividend growth oriented investors should not ignore the opportunity to buy this fantastic blue-chip.