Johnson & Johnson (JNJ) is the 10th largest publicly listed company in the United States by market cap. Not only is it in America’s top ten, it is also the nation’s single biggest health care company. While there’s plenty of things in the company’s favor, there’s also a few concerns to consider before rushing into JNJ stock.
Stock Pros
31 Consecutive Years Of Adjusted Earnings Growth: Johnson & Johnson is one of the most consistent companies in the Dow Jones Index. The company has a track record of growing earnings for more than 30 years in a row. Admittedly, this is an adjusted number, rather than GAAP earnings that conform to arcane accounting standards.
Still, it has been a pretty remarkable run. Not many companies made it through the 2000-02 or 2008-09 periods without seeing their earnings fall. Similarly, JNJ stock has paid a bigger dividend each of the past 52 years. That’s a pretty reliable record.
Powerful Research Division: There are plenty of large healthcare companies in the United States. JNJ manages to stay on top, however, due to its exemplary commitment to research. More than 11% of the company’s revenues are plowed back into lab research. Roughly three quarters of that goes into new drug development, ensuring that the company has a deep biotech pipeline.
In addition, the company also fosters research to keep its consumer products and its medical devices division up to speed with the competition. The company’s R&D focus has been a big driver in allowing the company to steadily increase income so many years in a row.
Positive Demographics For Health Care: North America accounts for half of JNJ’s sales, and Europe accounts for a sizable chunk of the remainder. This is great news for companies such as Johnson & Johnson which make the majority of their revenue selling products to retirement-age folks. Over the coming decade, a huge portion of the Baby Boomer generation will enter retirement, offering a natural catalyst for serious earnings growth for healthcare companies such as JNJ.
Looking a couple years out into the future, an additional subtrend will help even more. Per capita health care spending in the United States more than doubles for an 85 year old compared with a 72 year old, eclipsing $40,000 per year. A much larger portion of this new Baby Boomer retiring wave will reach this previously unlikely threshold, triggering a large surge in spending for these very elderly folks. This should give JNJ stock a strong boost in the future.
Stock Cons
Reliance On Pharma Income: When people think of JNJ, they are likely to think of the company’s consumer products such as Tylenol. However, in truth, the company’s pharma division produces slightly more than half of the company’s profits. One drug alone, Remicade, is currently responsible for around 10% of the company’s profits. Pharma profits are tied to patents, and JNJ has several drugs coming up that will go off patent soon.
The company has a robust pipeline to replace the drugs that will be going off patent, however earnings volatility from a changing lineup of drugs adds some uncertainty to the company’s year-to-year profit growth rate.
Stalling Earnings Growth: Earnings per share over the past 12 months are at $5.23, down a bit from the $5.70 figure recorded for fiscal year 2014. After EPS tripled between 2000 and 2008, it’s been a more difficult road since then. 2008 EPS was $4.57, earnings were choppy and generally flat from 2008 until 2011 following the recession. Note that adjusted income continued to grow, however currency translation and one-time events caused the GAAP approved earnings figure to fall slightly in some years.
From 2011 to 2014 earnings grew again robustly, but 2015 has been another slow year. The strong US dollar is at fault, with revenues coming in from overseas now devalued by the falling Euro and Japanese Yen, among other currencies. Between 2008 and the most recent 12 months earnings have only grown from $4.57 to $5.23, which isn’t an electrifying rate of growth. A return to a more normal foreign exchange environment would give earnings a big boost and get the company on a more normal growth trajectory. But until then, earnings may continue to flounder a bit.
Pharma Prices Are Under Scrutiny: Pharmaceutical drugs, which as we discussed account for more than 50% of JNJ stock’s profits, are under government watch at the moment. A squabble broke out late last year following a small pharma company’s efforts to try to boost one of its drug’s prices by 5,000%, from $13 to $750 per treatment.
Following that brazen effort, politicians started attacking the drug companies for boosting prices so egregiously. Hillary Clinton in particular has been on the warpath against pharmaceutical companies. Regulation to limit drug price increases now seems increasingly possible.
Valeant Pharmaceuticals (VRX) shares fell by two thirds in late 2015. The company came under fire for its policy of aggressive price hikes, the usage of undisclosed pharmacies that appeared to have been set up to promote Valeant’s drugs, along with aggressive refill practices that some suggest may amount to insurance fraud. Valeant, which has a massive market cap, was a major black eye for drug companies, and led to more scrutiny for the industry. This distrust may come home to roost in 2016, hurting profit margins for companies such as JNJ.
Verdict
JNJ stock faces some real challenges in 2016. Earnings have been slow to grow, and troubled international economic conditions will ensure that this doesn’t change quickly in 2016. Politicians are threatening to further regulate profits for the drug companies. With 2016 being an election year, it’s a bad time to be a under scrutiny.
However, the company’s strong track record more than outweighs this. The company is a true American giant, and has unparalleled research capability to stay ahead of its competition. While earnings may be a bit slow at the moment, the coming demographic wave will raise JNJ stock dramatically over the next 10 to 15 years. The stock is a good buy under $100/share.
Disclaimer: As of this writing, Ian Bezek owns shares of Johnson & Johnson. You can follow him on Twitter at @irbezek.
