JOHNSON & JOHNSON, INC. (NYSE: JNJ)
Johnson & Johnson, Inc. focuses
on the research and development,
manufacture
and
sale
of
pharmaceutical,
medical,
and
consumer
related
healthcare
products. Johnson & Johnson is an
international diversified health care
company that operates as 3
separate
business
segments:
Consumer, Pharmaceutical, and
Medical Devices & Diagnostics.
For the full year 2010, these
segments contributed 24%, 36%
and 40% respectively to the
company’s top line revenue.
March 8, 2011
Current Recommendation
Price
Target Price
Projected Return
SIM Position
Sector
Industry
Analyst
HOLD
$60.40
$68.00
12.6%
3.9%
Health Care
Pharmaceutical
Todd D. Yaross
Yaross_1@fisher.osu.edu
614.499.4340
Summary Financial
52-Week High
52-Week Low
Shares Outstanding (mil)
Market Capitalization ($mil)
Dividend Yield (%)
Beta
Trailing P/E
Forward P/E
$66.20
$56.86
2,788.8B
$163.8B
3.6%
.58
12.7
12.8
Investment Thesis
Johnson & Johnson appears slightly undervalued based on fundamentals and multiple valuations. The uncertainty
surrounding the implementation or modification of “health care reform” warrants a cautious approach to the sector
and Johnson & Johnson, however. We believe a HOLD rating is justified given Johnson & Johnson’s global
diversification of sales, late stage drug pipeline, current demographics and current dividend yield.
Investment Summary




Growth Catalysts
Deep Pharmaceutical Pipeline
Aging Demographics
Strategic Acquisitions/Partnerships
Emerging Markets




Risk Factors
Unfavorable FDA Rulings
Health Care Reform Uncertainty
Patent Expirations
Pricing Pressures
EPS/Revenue Data and Projections
2010
2011(e)
Revenue 61,587
64,122
EPS
4.78
4.97
Estimate
High
Low
1 YR Chart
-
4.90
4.80
2012(e)
65,847
5.25
5.29
4.93
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Table of Contents
Company Analysis ........................................................................................................................................ 3
Corporate Strategy........................................................................................................................... 3
Segment Analysis ......................................................................................................................................... 5
Consumer ......................................................................................................................................... 5
Medical Devices ............................................................................................................................... 5
Pharmaceutical ................................................................................................................................ 7
Sector Outlook ................................................................................................................................... 7
Regulatory Risk ................................................................................................................................ 7
Demographics .................................................................................................................................. 8
Financial Analysis ......................................................................................................................................... 9
Profitability Analysis......................................................................................................................... 9
Liquidity Analysis.............................................................................................................................. 9
Income Statement Projections ...................................................................................................... 10
Valuation Analysis ...................................................................................................................................... 10
Equity Valuation: Absolute Ratio Valuation Model ....................................................................... 10
Equity Valuation: Discounted Cash Flow Model ............................................................................ 11
Sum of Parts Analysis ..................................................................................................................... 12
Investment Thesis ...................................................................................................................................... 12
Catalysts ......................................................................................................................................... 12
Risks ............................................................................................................................................... 12
Summary..................................................................................................................................................... 13
Recommendation........................................................................................................................... 13
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Company Overview
Johnson & Johnson, Inc. (sometimes referred to as Johnson & Johnson or the company) is a diversified
health care company engaged in the research, development, manufacture and sale of a diverse array of
medical, pharmaceutical and consumer related products internationally. Johnson & Johnson employs
approximately 114,000 employees through its holding company as well as its 250 operating subsidiaries.
Johnson & Johnson operates internationally through three distinct business segments: Consumer,
Pharmaceutical and Medical Devices and Diagnostics (MD&D). A detailed analysis of each business
segment is presented below.
Corporate Strategy
Johnson & Johnson is a rare breed of companies that can be considered a defensive growth company.
The company follows a 4-pronged growth strategy: it places a significant emphasis on maintaining brand
equity in the Consumer segment; it invests substantial resources in research and development (R&D)
activities in the Pharmaceutical and MD&D segments; it participates in strategic partnerships and
acquisitions; and, it penetrates emerging growth markets. The company’s iconic brands in the Consumer
segment serve as an anchor and position the company for success in declining and expanding economic
cycles. On the other end of the spectrum, however, is the company’s tremendous innovation in the
Pharmaceutical and MD&D segments. Johnson & Johnson invests a significant amount of capital on
R&D, which has resulted in a promising pipeline of drugs and medical devices and will serve as a catalyst
for growth. Another key element of the company’s growth strategy is international expansion.
Research & Development: Johnson & Johnson invests a significant portion of its resources in R&D
activities. These R&D expenditures relate to the development of new products, the improvement of
existing products, technical support of existing products and compliance with governmental regulations
for the protection of consumers and patients. The company has demonstrated a commitment to
investing in R&D with the aim of delivering high quality and innovative products. Johnson & Johnson
invested $6.8 billion, or 11.1% of sales, on R&D
Rank
Company
Sales
i
in 2010.
1
Johnson & Johnson
844.5m
2
Pfizer
762.7m
Johnson & Johnson’s emphasis on R&D has
3
Sanofi‐Aventis
345.9m
enabled it to capture a leadership position
4
Novartis
322.0m
5
Takeda
307.3m
relative to its competitors.
New products
Cephalon
296.9m
6
introduced within the past five years accounted
Galderma Labs
249.8m
7
for approximately 25% of 2010 sales.ii Further,
Novo Nordisk
226.8m
8
Johnson & Johnson leads the pharmaceutical
Genzyme Corp
179.7m
9
industry in U.S. sales generated from 2009-10
GlaxoSmithKline
179.4m
10
product launches. Figure 1 shows sales from Source: IMS Health, National Sales Perspectives, Dec 2010
Figure 1
2009 and 2010 product launches through
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
December 2010. Continued investment in R&D will solidify the company’s position as a market leader
and will assist in the development of new and additional products, which will enable the company to
sustain continued growth.
Strategic Acquisitions and Partnerships: In addition to its organic growth generated from brand equity
and innovation, Johnson & Johnson continues to pursue strategic acquisitions and partnerships. Such
strategic ventures increase the company’s revenue, diversify its product lines and enhance its existing
drug portfolio and pipeline. In 2010, Johnson & Johnson acquired certain businesses for approximately
$1,269 million.iii Figure 2 presents a summary of the company’s key strategic acquisitions and
partnerships it entered into during 2009 and 2010. Such transactions boosted the company’s
substantive capabilities and product offerings and will assist with future growth.
Figure 2
Company
Acquired Business Summary
Acclarent, Inc.
Dedicated to designing, developing and commercializing devices that
address conditions affecting the ear, nose and throat.
Global biopharmaceutical company focused on the research &
development, production and marketing of vaccines and antibodies
against infectious disease worldwide.
Global developer and manufacturer of minimally invasive devices for
hemorrhagic and ischemic stroke.
Focused on developing small-molecule, inhaled therapies for the
treatment of pulmonary diseases.
Leading supplier of medical products for the global aesthetics market.
Development stage biopharmaceutical company with a specific focus on
oncology.
Manufacturer and global distributor of orthopaedic implants.
Developer of innovative disinfection processes and technologies to
prevent healthcare-acquired infections.
Joint venture with Elan to develop treatments for alzheimers.
Crucell N.V.
Micrus Endovascular
Corporation
RespiVert Ltd.
Mentor Corporation
Cougar Biotechnology, Inc.
Finsbury Ortohpaedics Limited
Gloster Europe
Elan’s Alzehimer’s Immunotherapy
Program
Source: Johnson & Johnson 2010 10-K
International Exposure: Consolidated worldwide sales in 2010 were $61.6 billion, a decrease of .5%.
Interestingly, Johnson & Johnson’s U.S. sales were $29.5 billion in 2010, a decrease of 4.7% while
international sales increased 3.6% to $32.1 billion.
The company recently made significant attempts
to penetrate certain international markets.
Figure 3 shows the increasing proportion of
international sales to Johnson & Johnson’s total
sales. In 2010, international sales accounted for
52% of total sales. International
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
expansion and the penetration of emerging markets such as Brazil, India and China offer an important
growth opportunity for Johnson & Johnson. Countries across the globe are facing the same issues that
the U.S. is facing relative to an uninsured population. Such factors are actually favorable for the
company internationally. Sales in Brazil, India, Russia and China increased 14% in 2010.iv In Brazil, over
the last 5 years, private medical insurance has increased by 60%, covering approximately 30% of the
populationv. In India, private insurance coverage is expected to increase from 35 million in 2010 to 220
million by 2015.vi In China, about 90% of the Chinese population (over 1.2 billion) is now covered by
some form of the country’s medical insurance system.vii These particular emerging markets hold huge
potential for Johnson & Johnson because they are all subject to the same demographic trends and each
trying to bring more of their respective populations into its respective healthcare coverage. As the
emerging markets evolve and the population covered by medical insurance increases in such markets,
Johnson & Johnson will be well positioned to capture a significant share of the expanding markets.
Segment Analysis
Johnson & Johnson’s total sales in 2010 were
$61.6 billion. 2010 sales by segment are
presented in Figure 4.
Sales by Segment
Figure 4
Consumer Segment
40% 24%
Consumer
Pharmaceutical
The Consumer segment sells a broad range of
36%
personal care products used for baby care, skin
Medical Devices
care, oral care, wound care and the women’s
health care fields, as well as nutritional and
over-the-counter pharmaceutical products. These products are marketed and sold to the general public
through retailers and distributors. A key advantage Johnson & Johnson enjoys in its Consumer segment
is brand equity due to its iconic brands. Major brands include Aveeno, Clean & Clear, Neutrogena,
Tylenol, Band Aid and Johnson’s Baby line of products, to name a few.
The Consumer segment sales decreased overall 7.7% from 2009 to $14.6 billion. Segment sales in the
U.S. decreased 19.3% year over year, whereas International segment sales increased 1.2% year over
year. The Consumer segment was hurt by several significant over the counter (OTC) product recalls in
the U.S. and the prolonged shutdown of a major manufacturing plant. Product recalls impacted the total
year sales by approximately $900 million.
Pharmaceutical Segment
The Pharmaceutical segment offers a diverse range of products covering a wide array of therapeutic
areas including anti-infective, antipsychotic, cardiovascular, contraceptive, dermatology,
gastrointestinal, hematology, immunology, neurology, oncology, pain management, urology and
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
virology. The pharmaceutical products are distributed directly to retailers, wholesalers and health care
professionals for prescription use.
Pharmaceutical segment sales in 2010 were $22.4 billion, a decrease of .6% from 2009. U.S.
pharmaceutical sales decreased 4.0% year over year while International sales increased 4.2% year over
year. The decrease in U.S sales is largely attributed to two factors: the erosion of market share due to
generic competition for certain drugs and the implementation of certain aspects of the health care
reform laws passed in March (sales were reduced by approximately $400 million as a result of
U.S. health care reform legislation).viii Additional pressure on the pharmaceutical segment is expected
in 2011 as market exclusivity for Levaquin (6% of pharmaceutical sales) expires in 2011 and a generic
version of Concerta (5.8% of pharmaceutical sales) is set to come to market beginning May 1, 2011. By
way of example, in March of 2009, Topamax lost basic patent protection and market exclusivity and
became subject to generic competition in the United States and later in the year in international
markets. Sales of Topamax declined by 53.3% and 57.9% in 2010 and 2009, respectively.
Although patent expirations and the attendant generic competition will erode market share for certain
products, Johnson & Johnson’s Pharmaceutical segment is poised for growth based on a few strategic
advantages: the company continues to see significant advancements in its deep pipeline of drugs;
double digit growth in emerging markets; and continued momentum in recently launched products.
Figure 5 presents selected pharmaceuticals in late stage (Phase III and final approval) U.S. and E.U.
development or registration and potential filings. Successful approval and commercialization of any of
the drugs should provide a top line boost to revenues.
Figure 5: Late Stage Pipeline
Approved 2009
In Registration
Planned Filings 2011‐201
INVEGA® SUSTENNA™
(Neuroscience)
PRILIGY™ (E.U.)
(Sexual health)
Abiraterone Acetate
(Oncology)
Rivaroxaban
(Cardiovascular & Metabolism)
SIMPONI™
(Immunology)
STELARA™
(Immunology)
Telaprevir (E.U.)
(Infectious Disease)
TMC 278
(Infectious Disease)
Bapineuzumab IV
(Neuroscience)
Canagliflozin
(Cardiovascular &
Metabolism)
CNTO 136
(Immunology)
DACOGEN™ (E.U.)
(Oncology)
Fulranumab
(Neuroscience)
Siltuximab (CNTO 328)
(Oncology)
TMC 207
(Infectious Disease)
TMC 435
(Infectious Disease)
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Medical Devices and Diagnostics Segment
Johnson & Johnson is the world’s largest medical devices and diagnostics business. The MD&D segment
sells a broad range of wound care and minimally invasive surgical products, including orthopaedics and
diagnostics which are distributed to wholesalers, hospitals and retailers to be used principally in the
professional medical fields. MD&D products include Biosense Webster’s electrophysiology products;
Cordis’ circulatory disease management products; DePuy’s orthopaedic joint reconstruction, spinal care,
neurological and sports medicine products; Ethicon’s surgical care products; Ethicon Endo-Surgery’s
minimally invasive surgical products and advanced sterilization products; LifeScan’s blood glucose
monitoring and insulin delivery products; Ortho-Clinical Diagnostics’ professional diagnostic products
and Vistakon’s disposable contact lenses.
MD&D sales were $24.6 billion in 2010, representing an increase of 4.4% over the prior year. U.S. sales
were $11.4 billion, an increase of 3.6% over the prior year. International sales were $13.2 billion, an
increase of 5.0% over the prior year.ix
Sector Outlook
Regulatory Risk: Health Care Reform and the FDA The Health Care sector is not as correlated to
economic indicators or data points as the other S&P Sectors. That said, the sector is not immune to
external factors. 2010 was an historic year in the U.S. from a regulatory perspective. The Patient
Protection and Affordable Care Act passed in March 2010. The sector experienced volatility following
the Act’s passage and will continue to see investor sentiment fluctuate as the market attempts to
predict whether the Act will be implemented in its current form or whether it will be repealed or
modified. Consequently, the sector will likely continue to experience volatility over the near-term.
The Patient Protection and Affordable Care Act (more commonly referred to as health care reform)
included an increase in the minimum Medicare rebate rate from 15.1% to 23.1%. Johnson & Johnson
saw a fully year impact to sales as a result of the increased Medicare rebate rate of approximately $400
million.x The 2011 full year impact to sales is estimated to be between $400 and $500 million.xi
Additionally, in 2011, companies that sell branded prescription drugs to certain U.S. government
programs will pay an annual fee based on an allocation of the company’s market share of total branded
prescription drug sales from the prior year. The company estimates that the annual fee from the sales
related to branded prescription drugs will be approximately $150 - $200 million in 2011. Commencing in
2013, a 2.3% excise tax will be imposed on the sale of certain medical devices. A complete analysis of
the health care reform law is beyond the scope of this equity report. This summary is intended to
demonstrate that the law will have an adverse effect, at least initially, on the Pharmaceutical and MD&D
segments. Gradually, however, the reform could have a benefit on the sector resulting from the
expansion of the market, with new coverage to an estimated 40 million Americans.
Hidden behind the well-publicized regulatory wrangling in the U.S. legislature related to health care
reform, the FDA has quietly increased its regulatory strain on the sector generally and the
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
pharmaceutical industry specifically. The FDA approved only 21 new drugs in 2010, down from 25 in
2009 and 24 in 2008.xii Although it is not entirely clear what is underlying the FDA’s reluctance to issue
patents, the new normal appears to be a reticence to grant patent protection – this is not all that
surprising given a tenet of the health care reform law is to bring down the cost of prescriptions. This
trend is troubling alone. When coupled with the discretion shown to generics, however, the outlook
appears much more ominous for established pharmaceutical firms. The FDA has recently encouraged
generic drug firms to file Abbreviated New Drug Applications seeking to market generic forms of
patented pharmaceutical products prior to expiration of the applicable patents covering those products.
Such an application requires the patent holder to defend the viability of the applicable patent in court.
If the patent holder is not successful in defending the resulting lawsuits, generic versions of the product
at issue will be introduced, resulting in very substantial market share and revenue losses. These issues
will be amplified in the coming years because the pharmaceutical industry is facing a patent cliff with
estimated losses of $80 billion of sales attributed to expiring patents through 2014.
Demographics
Although I anticipate near-term volatility due to
the aforementioned risks the sector faces, the
long-term view of the sector remains positive
supported by aging demographics and upward
trends in discretionary spending. The aging
global population is more likely to use medical
coverage/products and is expected to support
sustained sector growth. Figure 6 shows the
global population growth over the past 50 years
and the projected growth over the next 50 years:
the number of older persons (over 60) globally is
expected to triple over the next 50 years.
Figure6
Another factor supporting the growth of the sector is an increasingly positive economic outlook. The
strengthening economy should result in increased employment and thus boost demand for employersponsored health plans. The corollary is that the improving economy should also trigger a rise in
discretionary spending, resulting in industry growth due to an increased number of persons seeking
healthcare coverage and the related benefits that are associated with coverage, such as prescription
pharmaceutical products and medical devices. Underlying the discretionary spending (and incidentally
also underlying health care reform) is the continued growth in health care expenditures as a percentage
of GDP. Growth in National Health Expenditures (NHE) is anticipated to average an annual growth rate
of 6.3% for 2009 through 2019, reaching 19.3%.xiii
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Financial Analysis
Profitability Analysis
Johnson & Johnson’s profitability analysis suggests the firm compares favorably to its competitors.
Notably, large pharmaceutical companies have recently experienced margin compression because of
market concerns related to patent expirations. Even in light of this fact, Johnson & Johnson boasts the
second highest operating margin and strong gross and net margins. The company also has the highest
return on assets, suggesting a high degree of management effectiveness. A high return on equity is a
good measure of profitability as it reflects the company’s profits from each dollar of company assets.
JNJ
PFE
MRK
NVS
MDT
Gross Margin
73.6
79.9
68.7
78.5
81.1
Operating Margin
25.8
24.7
4.4
23.7
31.4
Net Margin
21.2
26.3
22.9
24.5
23.0
ROE
24.3
23.2
26.8
20.6
25.6
ROA
18.3
5.2
11.3
10.7
15.3
Figure 7: Comparison of Johnson & Johnson peers based on profitability metrics.
GSK
80.6
15.7
10.1
29.6
6.8
ABT
65.8
17.3
18.5
28.7
10.2
Analysis of Segment Operating Profit
Unlike several of its competitors, Johnson &
Johnson is well diversified with 63% in operating
profits coming from its two non-pharmaceutical
segments, Consumer and MD&D. Figure 8 details
operating profits by segment for the prior 3 year
period. Consumer segment operating profit
decreased 5.4% from 2009 as a result of lower
sales and higher costs attributed to product
recalls. Operating profit for the Consumer
segment in 2009 decreased 7.4% from 2008. Both Pharmaceutical and MD&D saw increases in
operating profit in 2010. The Pharmaceutical segment operating profit increased 10.5% in 2010,
recovering from a decrease in 2009 of 15.7%, which was largely attributed to restructuring charges
incurred. MD&D operating profit increased 7.5% in 2010, after an increase in 2009 of 6.5%. The MD&D
increases in operating profit are expected to continue based on manufacturing efficiencies and
diversified product mixes. This is a positive sign for the company given that revenues from the MD&D
segment accounted for 40% of 2010 revenues.
Liquidity Analysis
To determine Johnson & Johnson’s liquidity position relative to its peers, we analyzed four factors: the
Current Ratio; the Quick Ratio; the percentage of long-term debt to total assets, a measurement of a
company’s leverage, calculated as the company's debt divided by its total capital (debt and equity); and,
the ratio of total assets to total equity, a measure of financial leverage and long-term solvency. Figure 9
shows that Johnson and Johnson compares favorably on all metrics. The company’s strong current ratio
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
and quick ratio suggest sufficient liquidity. These metrics also verify the company’s strong cash position
as shown in the discounted cash flow model presented below.
Figure 9.
Current Ratio
Quick Ratio
%LT Debt: Total Assts
Assets: Equity
JNJ
2.5
1.9
13.8
1.8
PFE
2.2
1.6
30.8
2.2
MRK
1.6
1.0
20.2
2.0
NVS
1.1
.7
18.5
1.8
MDT
1.7
1.2
32.5
1.9
GSK
1.3
1.0
62.5
4.5
ABT
1.3
.7
35.9
2.5
Income statement projections
Selected financial data for Johnson & Johnson is presented in Appendix A. We estimate top line
revenue growth of 4% in 2011 versus 5% guidance provided by the company.
Valuation Analysis
We conducted an Absolute Ratio Valuation Model, Discounted Cash Flow Model and a Sum of Parts
Analysis to determine a target price for Johnson & Johnson.
Equity Valuation: Absolute Ratio Valuation Model
We believe the absolute ratio valuation model using multiples for Johnson & Johnson is an appropriate
metric using target multiples just under the historic means. The Absolute Ratio Valuation Model
presented in Figure 9 implies a target price of $68.83, representing a 14% upside to the share price as of
March 7, 2011. Figure 10 shows Johnson & Johnson’s current equity multiples compared against certain
of its competitors. Based on the multiples comparison, Johnson & Johnson is trading on average slightly
higher than its peers suggesting the stock is overvalued relative to its competitors.
Figure 9: Absolute multiples valuation over 10 years.
P/Forward Earnings
P/S
P/B
P/EBITDA
P/CF
High
Low
Median
Current
29.3
6.1
8.6
20.39
27.0
11.1
2.2
2.9
6.94
9.0
16.8
3.8
5.1
12.19
15.8
12.8
2.7
2.9
8.45
10.5
Source: Thompson Baseline
Target
Multiple
13.5
3
3.5
11
13
Target
Metric
4.90
23.6
20.09
6.39
5.11
Target
Target
Price
$66.15
$70.8
$70.35
$70.29
$66.55
$68.83
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Figure 10: Comparative multiples against competitors.
P/Forward Earnings
P/S
P/B
EV/Sales
EV/EBITDA
JNJ
12.8
2.7
2.9
2.6
7.9
PFE
8.8
2.3
1.8
2.6
6.9
MRK
9.0
2.2
1.8
2.4
5.1
NVS
10.7
3.0
2.0
3.3
9.0
MDT
11.1
2.7
2.5
3.1
8.5
GSK
10.3
2.3
6.5
2.6
10.0
ABT
10.6
2.1
3.5
2.5
7.9
Source: Thompson Baseline
Equity Valuation: Discounted Cash Flow Model
A discounted cash flow (DCF) valuation is presented in detail as Appendix B. The DCF analysis suggests
that Johnson & Johnson is currently trading at a discount relative to its intrinsic enterprise value. The
DCF model implies an intrinsic value of $68.09 per share. This implied value represents an upside of
12.6% over the closing price on March 7, 2011 and, perhaps more importantly, an upside of 13% relative
to SIM’s cost basis in its shares of Johnson & Johnson ($60.33 as estimated from the 3/5/11 Daily
Performance Analysis).
The DCF model is extremely sensitive to modifications to the terminal growth rate and the discount rate.
In conducting our DCF analysis, we applied a discount rate of 10.5% and a terminal growth rate of 4%.
We applied a discount rate of 10.5% for two primary reasons: the uncertainty within the pharmaceutical
segment relative to the FDA approval process (or lack thereof) and the uncertainty surrounding health
care reform. Although we see Johnson & Johnson as a defensive stock that could trend below the 10%
discount rate applied to the general market, after careful evaluation of the foregoing factors, we believe
it is prudent to assign a slightly higher discount rate to Johnson & Johnson’s expected future cash flows.
We also considered several factors in selecting the appropriate terminal growth rate to apply. With
respect to the terminal growth rate, we considered inflation projections for fiscal year 2011 as a
baseline inflation indicator, aging demographics and the increasing global population. Based on the
foregoing factors, we believe the demand for Johnson & Johnson’s products imply a terminal growth
rate of 4%.
As discussed above, altering either the discount rate or terminal growth rate will provide a range of
implied share prices. The sensitivity analysis presented as Figure 11 demonstrates the range of share
values based on the differing combinations, which also provides a second level of expectations based on
external factors.
10
10.5
3.5
$70.08
$65.10
4
$73.70
$68.09
4.5
$79.63
$73.06
Figure 11: Sensitivity Analysis
11
$60.79
$63.28
$67.50
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Sum of parts analysis
Johnson & Johnson’s operating structure lends itself to a sum of parts analysis. As seen in Figure 12, the
target price under this analysis is $66.65, which represents 10% upside from the share price as of March
7, 2011.
Segments
Pharmaceutical
Consumer
MD&D
TOTAL
Sales per
Segment
P/S
Ratio
22396
14590
24601
61587
Date of price
Current Stock Price
3/7/2011
60.4
# of diluted shares
Target Price
% return to target
2788.80
66.25
9.69%
Pfizer
Merck
2.3
2.7
Competitors P/S ratios
Target P/S
Novartis Medtronic Stryker
Abbot
Glaxosmithcline
Multiple
4.7
2.7
2.2
2.2
4.7
2.2
2.7
3.44
2.2
2.2
Target multiple x
Sales/Segment
3
67188
3
43770
3
73803
184761
Equity Valuation: Final Target Price
Our final target price for Johnson & Johnson is $68.00, 12.6% above the closing price of $60.40 on March
7, 2011.
Investment Thesis
Johnson & Johnson appears slightly undervalued based on fundamental and multiples valuations;
however, the uncertainty surrounding the implementation or modification of “health care reform”
warrants a cautious approach to the sector and the stock. Although the positive fundamentals are
offset by the negative factors referenced above, we believe a HOLD rating is justified given Johnson &
Johnson’s diversification of sales worldwide, late stage drug pipeline, current demographics and current
dividend yield.
Catalysts
-
Diversified sales base, both internationally and across segment lines
Strategic acquisitions to continue diversification and boost top line revenues
Continued R&D investment has led to a promising late stage pharmaceutical pipeline with many
candidates for approval and commercialization
Continued demographic trends provide for an expanding market in need of health care products
and services
Risks
-
Challenges to existing patents; introductions of generic versions of key pharmaceutical products
Pricing pressures, reduced reimbursement rates and austerity measures related to a prolonged
global economic downturn
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
-
-
March 8, 2011
Health care changes in the U.S. and other countries resulting in the continued consolidation
among health care providers, trends toward managed care and health care cost containment, the
shift towards governments becoming the primary payers of health care expenses
Challenges in securing obtaining regulatory approvals to gain and maintain market approval of
products
Summary
We have established a HOLD rating, with a target price for Johnson & Johnson of $68.00, 12.6% above
the closing price on March 7, 2011. Johnson and Johnson is a classic defensive stock with tremendous
prospects for growth due to its existing platforms in major emerging markets, aging global populations
and ever-increasing expenditures on healthcare as a percentage of gross domestic product. Although
Johnson & Johnson is attractive based on fundamental and multiples valuations, we believe increased
regulation combined with regulatory uncertainty and a stringent FDA approval process may have a
stifling effect domestically. Thus, we believe it is prudent to maintain an established position in Johnson
& Johnson while the affects health care reform work their way through the sector.
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
APPENDIX A: Selected Financial Data
JNJ
(millions)
Sales to customers
Cost of products sold
Gross profit
Selling, marketing and administrative expenses
Research expense
Purchased in-process research and development (Note 20)
Interest income
Interest expense, net of portion capitalized (Note 4)
Other (income) expense, net
Restructuring (Note 22)
Total
FY
FY
2012E
2011E
65847.268 64121.5962
FY
2010
61587
FY
2009
61897
18447
43450
FY
2008
63747
18511
45236
FY
2007
61095
17751
43344
FY
2006
53324
15057
38267
FY
2005
50514
14010
36504
21490
7577
181
-361
435
-1015
0
28307
16929
20451
7680
807
-452
296
534
745
30061
13283
17433
7125
559
-829
63
-671
0
23680
14587
17211
6462
362
-487
54
-214
0
23388
13116
3980
12949
2707
10576
3534
11053
3056
10060
4.78 4.39783443 4.566582
3.63349
3.73
3.35
0
0
Earnings before provision for taxes on income
18345.387 17371.4489
16947
19801
6986
0
-90
451
-526
1073
27695
15755
Provision for taxes on income (Note 8)
Net Earnings
4035.9851 3821.71876
14309.402 13549.7302
3613
13334
3489
12266
Diluted net earnings per share (Notes 1 and 15)
Consensus
Guidance
5.2511565 4.97237804
5.35
4.97
4.80 - 4.90
0
2725
2725
Accounts Receivable
% of sales
Inventories
% of sales
Accounts Payable
% of sales
Change in Working Capital
10403.868
0.158
5399.476
0.082
6584.7268
0.1
-241.5941
10131.2122
0.158
5257.97089
0.082
6412.15962
0.1
-478.017468
Sales Growth
Gross Profit to Sales
Chg YoY
Selling, marketing and administrative to Sales
Chg YoY
Depectiation & Amoritzation
Depreciation & Amortization to Sales
Additions to Property, Plant and Equipment
Additions to Property, Plant and Equipment to Sales
Operating Profit
Operating Profit to Sales
Chg YoY
0.0269125 0.04115473 -0.00500832
Diluted average shares outstanding (Notes 1 and 15)
2963.1271
0.045
2765.5853
0.042
18345.387
0.2786051
0.007691
2725
2789.1
2835.6
2910.7
2961 3002.985
9607.572
9646
9719
9444
8712
7010
0.156 0.15583954 0.152462 0.154579 0.163379 0.138773
5050.134
5180
5052
5110
4889
3959
0.082 0.08368742 0.079251 0.08364 0.091685 0.078374
6158.7
5541
7503
6909
5691
4315
0.1 0.08951969
0.1177 0.113086 0.106725 0.085422
785.994
-2017
377
265
-1256
2885.47183
2771.415
0.045
0.045
2693.10704
2463.48
0.042
0.04
17371.4489
16947
0.27091417 0.27517171
-0.00425754 0.02063595
-0.029021
0.70197263
-0.0076451
0.31990242
-0.0172115
2774
0.04481639
2365
0.03820864
15755
0.25453576
-0.0110297
0.043408
0.709618
0.000165
0.337114
0.002373
2832
0.044426
3066
0.048096
16929
0.265565
0.04815
0.145732
0.709452
-0.008179
0.334741
0.007815
2777
0.045454
2942
0.048155
13283
0.217416
-0.056139
0.055628
0.717632
-0.005019
0.326926
-0.013791
2177
0.040826
2666
0.049996
14587
0.273554
0.013903
0.722651
0.340717
2093
0.041434
2632
0.052104
13116
0.259651
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
APPENDIX B: Discounted Cash Flow Model
Terminal Discount Rate =
Terminal FCF Growth =
Year
2010
Revenue
61,587
% Growth
16,947
Operating Margin
27.5%
Taxes
3,613
Tax Rate
21.3%
Net Income
13,334
% Growth
17,371
27.1%
3,822
22.0%
13,550
1.6%
Add Depreciation/Amort
2,938
% of Sales
4.8%
Plus/(minus) Changes WC
786
% of Sales
1.3%
Subtract Additions to PPE
2,383
Additions to PPE % of sales
3.9%
Free Cash Flow
14,674
% Growth
2,874
86,048
103,674
189,721
8.71%
Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
12.6
14.2
8.4
9.5
Shares Outstanding
2,789
$
$
60.40
68.03
12.6%
14,541
15,810
5.67
2012E
65,847
2.7%
18,345
27.9%
4,036
22.0%
14,309
5.6%
2,951
2013E
68,152
3.5%
19,083
28.0%
4,198
22.0%
14,884
4.0%
3,054
2014E
70,537
3.5%
19,750
28.0%
4,345
22.0%
15,405
3.5%
3,161
2015E
73,006
3.5%
20,442
28.0%
4,497
22.0%
15,945
3.5%
3,272
2016E
75,561
3.5%
21,157
28.0%
4,655
22.0%
16,503
3.5%
3,386
2017E
78,584
2018E
81,727
4.0%
21,218
4.0%
22,066
27.0%
4,668
27.0%
4,855
22.0%
16,550
22.0%
17,212
0.3%
3,443
4.0%
3,581
2019E
84,996
4.0%
22,099
26.0%
4,862
22.0%
17,237
0.1%
3,724
2020E
88,396
4.0%
22,983
26.0%
5,056
22.0%
17,927
4.0%
3,873
4.5%
4.5%
4.5%
4.5%
4.5%
4.5%
4.4%
4.4%
4.4%
4.4%
(478)
(242)
(250)
(259)
(268)
(277)
(288)
(300)
(312)
(324)
-0.7%
2,693
4.2%
13,252
-9.7%
NPV of Cash Flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
Debt
Cash
Cash/share
64,122
4.1%
Operating Profit
Current Price
Implied equity value/share
Upside/(Downside) to DCF
2011E
10.5%
4.0%
-0.4%
2,766
4.2%
14,253
7.6%
45%
55%
100%
-0.4%
2,862
4.2%
14,826
4.0%
-0.4%
3,033
4.3%
15,275
3.0%
-0.4%
3,139
4.3%
15,809
3.5%
-0.4%
3,249
4.3%
16,363
3.5%
-0.4%
3,458
-0.4%
3,596
4.4%
16,247
4.4%
16,897
-0.7%
4.0%
-0.4%
3,740
4.4%
16,910
0.1%
4.4%
17,586
4.0%
Terminal Value 281,378
Free Cash Yield
12.4
14.0
8.3
9.3
-0.4%
3,889
11.8
13.3
7.8
8.8
6.25%
Terminal P/E
15.7
Terminal EV/EBITDA
10.4
JOHNSON & JOHNSON, INC. (NYSE: JNJ)
March 8, 2011
Appendix C: Source List
i
Johnson & Johnson 2010 10-K
Johnson & Johnson 2010 10-K
iii
Johnson & Johnson 2010 10-K
iv
Zacks Investment Research
v
“Healthcare Brazil,”UBS March 9, 2009
vi
India Pharma 2015, http://www.mckinsey.com/locations/india/mckinseyonindia/pdf/India_Pharma_2015.pdf
vii
China Ministry of Health public statements
viii
Johnson & Johnson 2010 10-K
ii
ix
Johnson & Johnson 2010 10-K
Johnson & Johnson 2010 10-K
xi
Johnson & Johnson 2010 10-K
xii
http://www.accessdata.fda.gov/scripts/cder/drugsatfda/
xiii
Health Spending Projections Through 2019: The Recession’s Impact Continues, Health Affairs, March 2010
(www.healthaffairs.org)
x