For what it might be worth, Johnson & Johnson (JNJ) was the very first position I ever initiated in my Healthcare Portfolio of stocks. To put it simply, this is one of the most stunning companies that I’ve ever researched and is superbly run from both a strategic management and an operations perspective. There are very few companies of this size that fire on all cylinders efficiently without experiencing bumps along the road from time to time.
The company itself was founded in 1886 with a strict focus on the fundamentals of health. Over 120 years later the company operates in over 57 countries with its products sold in over 175. Not only does the company have a reputation and history of corporate responsibility to its consumers, stakeholders & public; but they also employ over 116,000 people across the world and have had little or no labour conflicts over that time. To put it simply…it is tough to find any company that can boast the statistic of having 74 years of consecutive sales increases and 45 years of increases to its dividend. That in itself is an impressive achievement when so many companies struggle on a quarterly basis to simply keep their heads above water and remain profitable. Not only does the company have the ability to grow their business through sale of products, but also have the dedication and focus to consecutively return shareholder value for almost half a century.
The company is organized into three main components: Pharmaceuticals, Medical Devices/Diagnostics & Consumer products (but more on this in a little bit). As of Q2 of 2007, US sales accounted for just 41.6% of total sales in contrast to 54.5% for international sales. In an environment of a weakening USD and concerns over the US consumer being unable to sustain consumption due to rising debt loads; JNJ sits in a position to benefit from the strength of products sold in other currencies and strong demand in expanding global markets.
The company also has an undervalued segment in reference to their pharmaceutical line of products. As of July 17th, 2007 the company had a significant number of products in late stage trials (stage III & IV) seeking approval with both the FDA & European Union. From what I could find through various resources, JNJ spends on a yearly basis about $0.10 per dollar of sales on R&D. In 2002 that was approximately $4.1B and last year (assuming past behaviour) would have worked out to approximately $5.3B. To put that into perspective: Pfizer spent approximately $7.0B last year on R&D and it’s solely a pharmaceutically focused business.
My point? All of this translates into growing sales of over $53B in 2006 alone. To put that into perspective: in 2007 the Ontario government plans to spend a total of $37.5B on healthcare alone in this province – close to 50% of our provincial budget. To be blunt, JNJ sells literally tons of products that are used on a repeat basis (remember that theme). These products aren’t something a consumer buys once in a while or when they feel the need to splurge on a discretionary purchase; the base of their product line is focused on constant demand and continued consumption.
JNJ is selling at the same price as in March of 2002. The company has grown its sales, earnings & raised its dividend each year since. 10-year sales growth (9.6%), EPS growth (14.4%) & $11.6B in FCF in 2006 alone matched with a P/E of 18, dividend yield of 2.5% and debt/equity ratio of 0.15 makes for a compelling valuation. Not only is the company a defensive stock to hold in a portfolio, but the valuation has improved successively since 2002. Essentially, if you invested in JNJ each year through a DRIP or other investing strategy since 2002 you would have received a significant discount in each successive year for your patience. To some investors that might seem like a “NO WIN” situation for their capital with opportunities elsewhere to offer capital appreciation. But for an investor with a long-term view of the market, this may be a once in a lifetime opportunity to “stock up” on a key position in your portfolio.
Warren Buffett often talks about the “predictability” in reference to his preference for quality value investments. JNJ is a great example of how consumer driven demand for a range of products results in that predictability. Sales have increased, earnings have increased and people continue to buy their products not simply because they have the best brand or quality among all competition, but because the company has the unique ability to understand consumer demand & needs for those products. Companies such as FDX, PG, GIS, SBUX & JNJ all hold intimate knowledge of their consumer base and what drives their demand. Money, time and patience is invested into that consumer base in an attempt to not only sustain current sales, but drive demand for increased purchases of those same products.
Now…if you want to talk “Value” then you want to examine all aspects of a business in order to gauge what amount of worth the company can generate. With respect to JNJ, products say it all. The company boasts that over 70% of their products hold the #1 or 2 global market share position against competition and I would tend to agree. That might not seem very significant at first, but looking at the full range of their product line, in all divisions, helps to show you just how important that is from a value perspective. If you take a few moments to browse through that list you’ll quickly recognize both the sheer number of products they sell that people use on a daily basis & how many of those products you take for granted as never attributing to something JNJ might produce.
Products such as:
– Benadryl, Imodium, Rolaids, Rogaine, Sudafed, Motrin & Tylenol for drugs
– Johnson Baby products, Band-Aid brand bandages, Acuvue Contact Lenses & Visine
– Listerine or Reach toothbrush products
– Splenda & Lactaid
– O.B. tampons, Stayfree & Carefree Pads, Clean & Clear, Neutrogena, K-Y brand lubricants (wink wink)
Those are simple consumer products that sell in millions of units across the world; not even including the highly lucrative product lines for medical applications such as diagnostic services, drug therapies or surgical applications.
The simple realization once you’ve researched this company enough is that it’s not only a mammoth of a global corporation, but a machine for designing, producing and selling to the world’s consumers. Very few companies match the scale & proficiency at which they sell to consumers in any market; it all comes down to brands. The mature product portfolio that JNJ controls is one of the most valuable components of its business. Not only are the products something many use on a daily basis, but the brand loyalty to specific names generates profit margins in the range (and excess) of 18-20% (talk about PRICING POWER). If you were to assess the break-up value of ONLY the consumer products division you would quickly realize the true worth of this company expands well past its P/E and other technical indicators. Predictable cashflow, brand name, brand loyalty, brand value and all other attributes contribute to a stunning realization that if there was one or two consumer product companies to hold in your portfolio – JNJ could be argued as a must have. I’m not an advocate for valuing goodwill at some astounding multiple, but the fact that many of these product names are trademarked, patented or hold a competitive advantage against competing products is worth a nod.
I also realize that I focus excessively on qualitative factors at times with specific companies, but my last point may be the most important of all:
It’s often easy for an investor to look at specific technical indications of a stock and determine whether it’s a buy or not. The major difference with my value approach is the simplicity it offers in assessing a company from a product or service view. I’ve learnt extensively from reading WB that the predictable nature of a business can often lead you to judge very accurately where the company will be in the future regardless of short-term complications. At the end of March of 2002, JNJ traded for $64.95 with a dividend of $0.72/share. If you had bought back then and held to now, the stock would only be up 0.90%, but the dividend would have increased 133% (original yield of 1.11% vs. current yield of 2.59%). That means if your original investment contained 500 shares your capital appreciation would only be $295 – but your dividends each year would have grown to $840 currently, in contrast with the original $360.
Another key point is the strategic focus that the company has with reference to emerging markets. It’s my strong opinion any current or prospective shareholder of JNJ pay attention to this point:
China & India in the next 20 years will provide one of the rarest opportunities for companies such as JNJ to penetrate, capture and mature consumers with their arsenal of products. To put it simply the word “arsenal” is the best descriptor for the potency of these products if & when they are exposed to this target market. Although I never advocate competing on price, the simple fact is that JNJ can afford to enter these new markets with attractive price-points of their products and create the brand loyalty & demand that they enjoy in many other markets. The margins may be slimmer to start, but once consumers have adopted the products and sales begin to grow, as in any product cycle, the company can then afford to begin driving margins higher as demand matures.
My simple conclusion is that this conglomerate is a machine. They continue to operate efficiently, are led by superb management, continue to product substantial results and the market for some time has given them little or no respect. This stock will be one of 5-7 core holdings that my new RSP strategy will be constructed around with an emphasis on quality US corporations for a long-term dividend strategy.