Johnson and Johnson (NYSE:JNJ) stock is down by 13.6% for 2019 and the primary reason for the downside has been headwinds related to multiple litigation. As the markets talk about the potential cost of litigation, the company has increased full-year sales and earnings-per-share guidance.
I believe that Johnson and Johnson will continue to deliver steady growth. Further, the stock’s downside for year-to-date 2019 is a good accumulation opportunity. This coverage will discuss why investors should look beyond the litigation headwind and consider JNJ stock for long-term exposure.
Johnson and Johnson Has Robust Financial Flexibility
It is important to discuss the company’s financial muscles since the focus has been on litigation costs.
As of the third quarter of 2019, the company reported cash and equivalents of $17.9 billion. Further, for the first six months of 2019, JNJ reported operating cash flow of $9.5 billion. This implies an annualized operating cash flow of $19 billion.
Johnson and Johnson therefore has a strong cash buffer. Also, I don’t see any balance sheet stress even with the potential payments for litigation.
It is also worth noting that for the first half of 2018, JNJ repurchased shares worth $1.6 billion. However, share repurchase accelerated to $4.7 billion for the first half of 2019. In a scenario of meaningful litigation payments, share repurchase can be scaled back.
The Risperdal Litigation
On Oct. 8, a Philadelphia jury announced an $8 billion verdict against JNJ. This is related to the anti-psychotic drug Risperdal, where plaintiff Nicholas Murray complained that he grew breasts as a result of using the drug. As of June 2019, the company reported 13,400 suits alleging that the antipsychotic medication causes breast growth in boys.
Of course, $8 billion is significant even for JNJ with robust cash flows. However, it is unlikely that Johnson and Johnson will eventually have to pay anything close to $8 billion.
According to Stanford Law professor Nora Freeman Engstrom, “The punitive-to-compensatory-damages ratio in Murray’s case is a whopping 11,765-to-1 ($8 billion in punitive damages as against $680,000 that Murray was previously awarded in compensatory damages). Given State Farm’s command, we expect to see a sharp downward shift in the damages determination.”
As the verdict amount is scaled down in the foreseeable future, JNJ stock is likely to trend higher.
The Opioid Litigation
Related to the opioid litigation, JNJ has reached an agreement with two Ohio counties for a $20.4 million settlement. Further, a large drug maker and three drug distributors have agreed to pay $260 million for their role in the U.S. opioid epidemic.
The point I am making is that there is a gradual move toward settlement of the opioid litigation. JNJ has also offered to pay $4 billion to resolve the more than 2,000 opioid lawsuits pending against the company. Therefore, there are hopes of significant litigation clearance in the coming quarters.
Importantly, even if JNJ has to shell out $4 billion to $6 billion for these litigations, I don’t see a big impact on fundamentals. The amount would be roughly equivalent to one quarter of operating cash flows.
A more important factor is the company’s intent to resolve these litigations with bulk settlement. This will help the market focus on core business developments than legacy litigation issues.
High Investment in Research and Development
One of the key highlights for Johnson and Johnson for Q3 2019 was 5.1% sales growth in the pharmaceuticals segment. Sales growth was driven by healthy performance in the immunology, oncology and neuroscience segments.
One of the key growth drivers for the pharmaceutical segment is the company’s investment in research and development. For Q3 2019, investment in research and development was 12.5% of sales.
My point on pharmaceutical revenue growth is backed by the fact that the company reported six regulatory drug approvals in Q3 2019. In addition, the company had several filings with regulatory authorities. With a strong drug pipeline, there is visibility for growth.
Final Thoughts on JNJ Stock
I believe that the decline in Johnson and Johnson stock is overdone and the current stock price is an attractive long-term buying opportunity.
The company has shown a clear intent to resolve all pending litigations. Importantly. the company’s financial flexibility will allow swift settlements.
The focus of the market should therefore shift to growth. JNJ has ample opportunities in the global market to ensure steady top-line and EPS growth.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
