JNJ Stock Is Undervalued, but Not Compelling Given These Headwinds

You can't ignore the bad optics when it comes to JNJ stock

Shares of consumer and pharmaceutical healthcare giant Johnson & Johnson (NYSE:JNJ) have been under pressure since early 2018 amid multiple operational challenges and headwinds. From then to today, JNJ stock has dropped 7%, versus a 12% gain for the S&P 500.

JNJ Stock Is Undervalued, but Not Compelling Given These Headwinds
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Why the relative underperformance? Three big reasons.

First, slowing global economic growth has dragged down Johnson & Johnson’s organic revenue growth rates to multi-year low levels. Second, Washington D.C. has waged a war against drug makers and their sky-high drug prices. Third, Johnson & Johnson has run up against some huge optical issues, including being at the epicenter of the 2019 opioid crisis and having its signature talcum powder products being associated with possible cancer risks.

Net-net, the operating backdrop for Johnson & Johnson has not been favorable over the past 18 months. As such, Johnson & Johnson stock has dropped during that stretch, while most other stocks have rallied.

Will this under-performance persist? I think so, at least for the foreseeable future. JNJ does appear undervalued here, but there are optical risks which should keep the stock range-bound going forward.

The Fundamentals and Johnson & Johnson Stock

The fundamentals underlying JNJ stock actually look pretty good and support the argument for why shares should trade above where they currently trade.

Johnson & Johnson essentially has three major businesses. All of them are steady growth businesses with stable margins. There’s the consumer business, which sells health and wellness products that have steady demand drivers. There’s the pharma business, which sells various medicines that consumers have needed, still need, and will always need. Last, there’s the medical-devices business, which is a necessary component of the non-cyclical healthcare industry.

Sure, demand across all three of these businesses has slowed somewhat over the past few quarters, as the global economy has similarly slowed. But, we are talking a very minor slowdown, and growth is still positive. It will remain positive for the foreseeable future because – regardless of the economic backdrop – consumers will need health and wellness products and medicines.

Broadly, then, Johnson & Johnson projects as a low single digit revenue grower with stable margins going forward. Throw in buybacks, and Johnson & Johnson has a visible runway to grow EPS toward $13 by fiscal 2025.

Based on a historically average 16-times forward multiple and 7% discount rate (3% below my customary 10% discount rate to account for the yield), that equates to a 2019 price target for JNJ of about $150.

The Optics Are Pretty Bad

Although the fundamentals underlying JNJ look good, the optics decidedly do not, and that should keep a lid on shares for the foreseeable future.

There are a few things going on here. First, Washington D.C. has waged a wage against drug makers and their sky high drug prices, promising to push legislation that will permanently end pharmaceutical price gouging. So long as that legal headwind hangs over JNJ stock, investor sentiment will remain depressed.

Second, Johnson & Johnson’s signature talcum powder items have been rumored to increase cancer risks. The verity of this claim remains under question. But, the rumor itself is enough to give customers pause when thinking about buying Johnson & Johnson talcum powder products and to give investors pause when thinking about buying JNJ.

Third, Johnson & Johnson is at the epicenter of what has become a very big and very public opiod crisis. Long story short, the company has provided opioid painkillers into the U.S. market for a long time, which puts it front and center of multiple legal and political attacks against the opioid industry at large.

In the big picture, then, the optics here are bad – bad enough to keep investors at bay for the foreseeable future despite the favorable fundamental backdrop.

Bottom Line on JNJ Stock

Long term, I like JNJ stock. But here and now? I’d stay away. The stock is undervalued. But it’s undervalued for a reason – the optics are bad, and project to remain bad for the foreseeable future.

Until those optics turn a corner, I don’t think JNJ stock will break out of this $120 to $150 trading range.

As of this writing, Luke Lango was long


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/jnj-stock-undervalued-not-compelling-headwinds/.

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