Ticker: JNJ
Sector: Health Care
Industry: Drug Manufacturers
Recommendation: HOLD
Pricing
Closing Price $61.55 (9/17/10)
52-wk High $66.20 (4/20/10)
52-wk Low $56.86 (6/22/10)
Market Data
Market Cap $166.148B
Total assets $94,682M
Trading vol 13.06M
Valuation
EPS (ttm) $4.84
P/E (ttm) 12.66
Div Yield 3.60%
Profitability & Effectiveness
(ttm)
ROA 14.70%
ROE 25.60%
Profit Margin 21.60%
Oper Margin 26.90%
Gross Margin 74.40%
Brittany Weissman
Bewq58@mizzou.edu
September 19, 2010
RECOMMENDATION: HOLD
Johnson & Johnson is well positioned within the global health
care market. The company uses innovative products, robust
pipelines and its talented people to capture a global presence in
the health care industry. Johnson & Johnson is committed to the
future research and development of new products. When
necessary, the company is committed to expansion through
acquisitions to improve its product development and global
expansion. This will help sustain long-term growth, and improve
company revenue, which is already projected to increase by 5% in
2010. Johnson & Johnson’s diverse selection of products, in all
three of its segments, gives the company flexibility, and reduces
risk for investors.
Based on my evaluation of Johnson & Johnson and the healthcare
industry, it is my recommendation that we HOLD our 600 shares
of Johnson & Johnson. However, I do recommend that we keep a
close watch on the company and the healthcare industry as a
whole to ensure we do not miss the appropriate time to sell some
of our shares.
COMPANY PROFILE
Johnson & Johnson is one of the largest and most diversified
health care firms in the world, with 250 operating companies in
over 60 countries. Johnson & Johnson, along with its family of
companies, is the largest medical device and diagnostic company,
the fourth largest biologics company, and the eighth largest
pharmaceutical company in the world. The firm is divided into
three major segments: Medical Devices and Diagnostics,
Pharmaceuticals, and Consumer Health Care.
Johnson & Johnson continuously seeks to expand its global
presence in the health care industry, while paving the way for
new product development. This past year, Johnson & Johnson
invested $7 billion (or 11.3% of sales) in research and
development. This commitment to research is one internal method that Johnson & Johnson uses to
grow its pipeline of new and innovative products. Johnson & Johnson also utilizes company acquisitions
to expand its market share and generate new growth. It is this method of combining innovative
products, robust pipelines, and talented employees, along with a strong global presence, that shapes
Johnson & Johnson’s business.
In 2009, worldwide sales decreased 2.9% to $61.9 billion, compared to increases in 2007 and 2008 of
14.6% and 4.3% respectively. Cash and equivalents at the end of 2009 were $15.8 billion, up from $10.8
billion at the end of 2008. Total borrowings increased to $14.5 billion at the end of 2009, up from $11.9
billion at the end of 2008.1
Percentage of Sales by Segment
Medical Devices and
Diagnostics
26%
38%
36%
Pharmaceuticals
Consumer Products
MEDICAL DEVICES AND DIAGNOSTICS
Johnson & Johnson’s medical devices and diagnostics segment incorporates a wide range of family
companies, each producing a multitude of products. These products are primarily used in the health
care industry by doctors, nurses, therapists, hospitals, laboratories and clinics. Product distribution in
the segment is done by direct sales and through surgical supply.
Sales in the medical devices and diagnostics segment accounted for 38% of Johnson & Johnson’s total
sales in 2009. The segment experienced growth of 1.9%, (consisting of a 4.2% operational increase and a
2.3% decline due to currency fluctuations), with 2009 sales totaling $23.6 billion. Additionally, U.S. sales
were $11.0 billion, up 4.5% from 2008 and international sales were $12.6 billion, decreasing by 0.2%
from 2008.
The segment experienced small or no gains in three of the seven major franchises, including Cordis
Corporation, Diabetes and Vision Care. This was due to increased competition for drug-eluting stents
and tighter consumer spending on contact lenses and diabetes test strips. Conversely, the segment
1
Johnson and Johnson 2009 Annual Report
experienced high growth within the DuPuy, Ethicon, Ethicon Endo-Surgery, and Ortho-Clinical
Diagnostics franchises.
New and innovative products within the medical devices and diagnostics segment have helped to shape
the landscape of the health care industry. CARTO 3, from Biosense Webster, Inc. gives doctors a detailed
three-dimensional view of the heart to help treat cardiac arrhythmias (irregular heart rhythms). The
SURGIFLO Hemostatic Matrix Kit is an advanced flow hemostat to be used in surgical procedures. Finally,
in June, the Vision Care franchise continued to launched sales of the new 1 Day ACUVUE TruEye, the
world’s first daily disposable silicone hydrogel contact lens
The segment continues to grow, and has recently expanded its product mix through several recent
acquisitions. Acclarent, Inc., specializing in designing and developing devices for the ear, nose and throat
surgical space, was acquired in the first quarter of 2010. Finsbury Orthopedics, Ltd., specializing in hip
implants, and Gloster Europe, a developer of innovative disinfection technologies, were also acquired in
2010. Johnson and Johnson also recently acquired Ethicon, a leading company in the area of surgery
innovation.
Future growth will also be seen in the segment’s continued dedication to strengthening its pipeline of
products. This includes products such as the SEDASYS System, the first computer-assisted personalized
sedation system, which received positive recommendations from the U.S. Food and Drug Administration
in 2009.2
2
Summer 2010 IFM JNJ Analyst Report
PHARMACEUTICALS
This segment of Johnson & Johnson consists of a family of companies that offer medicines to help treat
numerous diseases worldwide. Pharmaceutical products are centered on five major therapeutic areas:
cardiovascular and metabolic diseases, immunology, infectious diseases, neuroscience, and oncology.
Overall, the pharmaceutical segment represented 36% of Johnson & Johnson’s total 2009 sales.
Pharmaceuticals accounted for sales of $22.5 billion in 2009, a decrease of 8.3% from 2008, with an
operational decline of 6.1% and the remaining 2.2% due to the negative impact of currency fluctuations.
Domestic sales totaled $13.0 billion, a decrease of 12.1%, while international sales totaled $9.5 billion, a
decrease of 2.6%.
One major reason for the 2009 decline in sales was the loss of exclusivity for RISPERDAL and TOPAMAX,
representing a loss of nearly $3 billion in sales. Competition from generic drug producers will continue
to put pressure on this segment, and increase demand for future innovation. In response, Johnson &
Johnson invested $4.6 billion in pharmaceutical research in 2009.
Conversely, Johnson & Johnson’s broad spectrum of products, treating a wide range of diseases, will
give the segment flexibility and growth opportunities in the future. The largest 2009 revenues came
from products treating diseases such as inflammatory diseases (REMICADE), attention deficit
hyperactivity disorder (CONCERTA), schizophrenia (CONSTA), and HIV (PREZISTA).
The pharmaceutical pipeline of new and developing products is seen as a major strength of Johnson &
Johnson. The segment launched five new drugs in 2009, including SIMPONI and STELARA (immunology),
NUCYNTA (immediate release tablets for pain relief), INVEGA SUSTENNA (schizophrenia), and PRILIGY
(sexual health). Up and coming products in Phase III clinical trials include treatments for diabetes,
prostate cancer, and Alzheimer’s disease. The segment has historically devoted research into
broadening drugs individually, as seen in REMICADE, which now has 15 FDA-approved indications for
use in various immune system disorders.
Johnson & Johnson has also expanded its pharmaceutical segment outward, acquiring or signing
innovative agreements with companies in various medical arenas. Elan Corporation, plc works in slowing
the progression of Alzheimer’s disease. Crucell NV works with a monoclonal antibody product for the
treatment and prevention of influenza. Gilead Sciences, Inc. developed an HIV therapy with a single
combination pill. Finally, Cougar Biotechnology, Inc. works in the treatment of prostate cancer.
In addition to domestic research and product launch, the segment has expanded internationally,
focusing on emerging markets. The segment has now expanded its sales reach in China, its
manufacturing in China, Mexico and Brazil, and its R&D presence in India and China.3
3
Summer 2010 IFM JNJ Analyst Report
CONSUMER PRODUCTS
Most of Johnson & Johnson’s Consumer products are well known throughout the United States, and are
used by over a billion people worldwide. This segment includes products located within baby care, skin
care, oral care, wound care, and women’s healthcare areas. Johnson & Johnson’s consumer segment
distribution brings products to both healthcare professionals and consumers in a direct approach. The
consumer segment of Johnson & Johnson accounted for 26% of the company’s 2009 sales.
Consumer segment sales in 2009 were $15.8 billion, a decrease from 2008 by 1.6%, with 2.0% growth
operationally and a negative currency impact of 3.6%. The U.S. consumer segment accounted for $6.8
billion, a decrease of 1.4%. International sales were $9.0 billion, a decrease of 1.7% (this includes 4.7%
operational growth and a negative currency impact of 6.4%).
Over-the-Counter (OTC) Pharmaceuticals and Nutritionals franchise sales were $5.6 billion, a decrease of
4.5% from 2008. Major brands within this sub-category include ZYRTEC, SPLENDA, TYLENOL, SUDAFED,
and PEPCID AC. In 2009, SPLENDA experienced strong growth, while inventory buildup negatively
affected sales of ZYRTEC.
In their annual report, Johnson & Johnson acknowledged the U.S. FDA looking into the potential for
overdose with acetaminophen, the active ingredient in TYLENOL brand products. In December 2009, the
company announced a voluntary recall of all lots of TYLENOL Arthritis Pain 100 due to an
uncharacteristic smell. In January 2010, the company undertook a broader recall of TYLENOL as a
precautionary action. The recall was further extended in May 2010 to include many versions of popular
infant and children’s medicines. The recall accounts for almost 70% of the United States over-thecounter infant and child medicines. Johnson and Johnson suspended production at its Fort Washington,
PA plant after a poor inspection by the U.S. Food and Drug Administration after the product recall.4 On
June 15, 2010, Johnson & Johnson announced another expansion of the January recall. This included
four lots of Benadryl Allergy Ultra tablets and one lot of Extra Strength Tylenol. The products under a
recall were distributed in the U.S., Puerto Rico, Bermuda and Tobago. It is now known that odor
associated with the recall came from a chemical used to treat wooden pallets that transport and store
medication packaging materials.
The Skin Care franchise sales grew by 2.5% to $3.5 billion in 2009. This growth was primarily associated
with strong sales in the AVEENO, NUTROGENA, and DABAO skin care lines. The Baby Care franchise
reported sales of $2.1 billion, a decrease of 4.5% from 2008 primarily attributed to the exiting of the
online retail business, Babycenter.com. The Women’s Health franchise sales were $1.9 billion, a
decrease of 0.8% from last year. The Oral Care franchise saw sales of $1.6 billion, a decrease of 3.4%
from 2008. Finally, the Wound Care/Other franchise sales grew by 9.4% to $1.1 billion due to the
acquisitions of the Wellness and Prevention platform and strong sales of PURELL hand sanitizer.
Johnson & Johnson acknowledges that more than half of Consumer sales come from markets outside
the United States. The company has attempted to capture this expansion in emerging markets such as
Mumbai, India, where Johnson & Johnson opened its first NEUTROGENA store. They have expanded Skin
iD, an online personalized acne solution sold direct to consumers, as well as home shopping networks.5
4
http://www.dailyfinance.com/story/company-news/no-new-childrens-tylenol-medicationson-shelves-this-year/19530952/
5 Summer 2010 IFM JNJ Analyst Report
REASONS TO BE BULLISH
Global Presence
Part of Johnson & Johnson’s global reach includes expansion in high-growth and emerging markets such
as the BRIC counties. Johnson & Johnson is fully committed to the expansion of health care across the
world, and as an industry leader, remains flexible to incorporate different strategies in different
markets.
In February 2008, Johnson & Johnson partnered with the Russian government to build and establish the
Russian Center for Professional Education. Since its opening, 3,000 physicians have been trained at the
center, and the number of high technology interventions in the past two years has increased from 8,000
to 19,000. Not only does this set the foundation for Johnson & Johnson in an emerging market, but it
also helps to streamline patient care and reduce invasive surgeries. Johnson & Johnson has more than
25 professional education centers around the world. For the Medical Devices and Diagnostics business,
the centers also create innovative partnerships with governments across the world. Other locations
include Brazil, Germany, India, France, China and Japan.
Percentage of Sales by Location
8%
United States
16%
50%
26%
Europe
Asia/Pacific & Africa
Western Hemisphere
In 2009, approximately 50% of Johnson & Johnson’s sales were international. In the second quarter
2010, international sales rose 1.8% compared to decreasing domestic sales. International sales in 2009
were $31.0 billion, following sales of $31.4 billion and $28.7 billion in 2008 and 2007 respectively. .
Johnson & Johnson expects the global health care market to grow by 5% over the next five years.6
Research & Development/Strong Pipelines
Staying flexible within a changing domestic and international business climate is essential for Johnson &
Johnson, whose products mirror the needs of the global community. Johnson & Johnson uses a
commitment to R&D, as well as robust pipelines of new products to stay ahead of competition. New
products that were introduced over the past five years accounted for 25% of the company’s 2009 sales.
Last year, Johnson & Johnson continued the trend by spending $7 billion in R&D. Currently the company
is focusing on product innovations for the effective treatments for diabetes, cardiovascular disease,
6
Johnson & Johnson 2009 Annual Report
central nervous system disorders and pain. Specifically, Johnson and Johnson won approval by the FDA
for an HIV drug that should be coming to market in the near future. This product development will help
Johnson & Johnson stay ahead of generic drug makers who could gain market share as drug patents
begin to expire. This flexibility will also play well in dealing with any industry changes that come of the
new healthcare reform.
Diverse Product Mix/Acquisitions
Johnson & Johnson’s product diversification helps capture a larger market share, and tailor products to
consumer’s needs. The company is split into three major segments including drugs, medical devices &
diagnostics and consumer goods. With expiring patents and the financial downturn, Johnson & Johnson
is relying on their diversity to help them grow. More specifically, the medical devices & diagnostics
segment has been the company’s main source of growth.
Company growth and diversification come in the form of internal innovation, as mentioned earlier, and
also external acquisitions when necessary. Since early 2008, Johnson & Johnson has made at least eight
major acquisitions and invested in several strategic transitions. This allows Johnson & Johnson to reduce
costs and focus on the customer, allowing for sustained growth. Recently, Johnson & Johnson acquired
Micrus Endovascular, a company that develops minimally invasive devices used in stroke treatment. This
is large growth opportunity for Johnson & Johnson. Last week, Johnson and Johnson announced
negotiations for a public offer for all outstanding shares of Crucell, a global biopharmaceutical company
that focuses on the research & development, production and marketing of vaccines and antibodies
against infectious diseases. Currently, a Johnson and Johnson affiliate holds 17.9% of Crucell’s shares.7
In all, acquisitions and diversification hedge a lot of risk in the company’s stock and help decrease the
stock’s volatility during tough economic times.
REASONS TO BE BEARISH
Recalls/Lawsuits
Any major company will face adversity in the form of legal action; however, Johnson & Johnson has
faced recent recalls that have raised questions. Beginning in December 2009, Johnson & Johnson began
to initiate voluntary recalls of TYLENOL brand products due to an uncharacteristic smell. This recall has
carried over into the current year, and in June 2010, Johnson & Johnson announced further recalls.
Many experts are questioning the recall delay and the length of time it took to identify all the problem
areas. The U.S. FDA is still involved, and time will tell if consumer sentiment will be affected by the
recalls.
Patent Expiration/Intellectual Property Rights
Johnson & Johnson operates in an environment that has become increasingly hostile to patent
competition and intellectual property rights. Generic drug makers are now poised to expand on expiring
product patents for many healthcare leaders. In some cases, generic drug firms have filed Abbreviated
7
http://online.wsj.com/article/SB10001424052748703904304575497053542363616.html
New Drug Applications (ANDAs), seeking to market generic forms of Johnson & Johnson’s products prior
to patent expiration. Johnson & Johnson is continually fighting legal battles over these property rights. If
unsuccessful, Johnson & Johnson could stand to lose substantial market share and revenue. Johnson &
Johnson currently has eight product lawsuits pending against generic drug makers. On June 21, 2010,
Business Wire announced a $1.67 billion verdict won by Jonson & Johnson in the dispute against drug
maker Abbott Laboratories over Abbott’s arthritis drug Humira.
Health Care Reform/Reductions
For Johnson & Johnson, the new health care reform bill brings uncertainty to business operations and
the overall industry. Medicare and Medicaid tax credits and discounts will financially affect health care
firms such as Johnson & Johnson in the future. Although Johnson & Johnson acknowledge this future
industry change, industry experts have adjusted earnings per share estimates due to the reform.
Standard & Poor’s expect a projected $0.10 a share hit from the reform. Perhaps a secondary effect of
the reform is seen in the form of cost cutting. Johnson & Johnson announced in November 2009 a
restructuring of the company, including the elimination of 7,500 positions.
Reduced Expected Earnings
Only July 20, 2010, Johnson and Johnson slashed forecasts for the 2010 fiscal for the second time this
year. The coming now expects adjusted earnings to be between $4.65 - $4.75 per a share compared to
$4.80 - $4.90 per a share. The announcement came after 2nd quarter earning fell short. This mostly due
to the year’s second round of product recalls during the quarter.8
INDUSTRY OUTLOOK
Significant uncertainty lies within the Healthcare industry. This is primarily due to the recent passing of
President Obama’s healthcare reform bill in early 2010. Industry experts see potential problems within
the industry over the short term, due to new tax laws and reform stemming from the healthcare bill.
Medicare and Medicaid changes might also hurt health care companies in the short run due to increased
rebates and discounts on pharmaceuticals. However, some analysts point to potential long-term growth
coming from the bill due to increased sales and use of medical equipment. The aging population of
“Baby Boomers” could also have a positive effect, as that generation could require more medical
procedures in the future. In addition, new drugs stemming from discoveries in genomics and
biotechnology could also stimulate growth within the industry.
Johnson & Johnson is clearly aware of the changing landscape, and addresses this point in their 2010
Annual Report. William C. Weldon, Chairman and CEO, notes that Johnson & Johnson “supports reform
that expands access to care, improves the long-term sustainability of the U.S. health care system and
builds on the best aspects, including incentives for medical progress.” The company also is confident
that a proper mix between increased patient care and growth opportunities for health care companies
8
http://www.marketwatch.com/story/jj-reports-higher-earnings-but-lowers-forecast-2010-0720
can exist. Mr. Weldon goes further, saying Johnson & Johnson “is well positioned for a changing
landscape.”9
FINANCIAL ANALYSIS
Johnson and Johnson is known for being a financially strong company. They produce a large net income
and have wide operating margins. In addition, the company boasts a solid return on equity. Compared
to its competitors, Johnson and Johnson out performs in areas of financial stability, yet under performs
in areas of growth. However, this signals that Johnson and Johnson is a less risky investment compared
to its competitor.
While Johnson and Johnson is in a league of its own based on market cap and diversification, the chart
below depicts Johnson and Johnson’s performance versus its competitors. 10
JNJ
ABT
LLY
NVS
Market Cap:
168.82B 79.69B 39.37B 126.59B
Employees:
115,500 73,000 40,360 102,000
Qtrly Rev Growth (yoy):
0.60% 17.80% 8.60% 11.00%
Revenue (ttm):
62.59B 33.08B 22.73B 48.68B
Gross Margin (ttm):
69.98% 57.60% 79.63% 72.85%
EBITDA (ttm):
19.70B 9.35B 7.84B 14.54B
Operating Margin (ttm):
26.90% 21.25% 28.64% 24.62%
Net Income (ttm):
13.53B 5.31B 4.45B 9.75B
EPS (ttm):
4.84
3.41
4.04
4.27
P/E (ttm):
12.66 15.12 8.82
12.95
PEG (5 yr expected):
1.99
1.23 -1.39
2.94
P/S (ttm):
2.69
2.41
1.73
2.62
ROE
27.30% 26.71% 47.37% 18.35%
Outperforming
Underperforming
JNJ = Johnson & Johnson
ABT = Abbott Laboratories
LLY = Eli Lily and Company
NVS = Novartis
PG = Procter and Gamble
9
Johnson and Johnson 2009 Annual Report
http://finance.yahoo.com
10
PG
Industry
173.46B 74.48M
127,000
67
4.70% 15.30%
78.94B 64.38M
51.96% 73.57%
19.13B -555.00K
20.30% 27.58%
10.73B
N/A
4.11
N/A
14.87
10.76
N/A
2.94
2.2
2.88
17.62%
N/A
Neutral
STOCK PERFORMANCE 11
1 Year Stock Performance vs. S&P 500 and Competitors
The past year has been rough for Johnson and Johnson. The company was performing comparable to
the S&P 500, in some instances outperforming it up until mid May 2010. This is when Johnson and
Johnson issued a massive recall for many of their children’s medications. In addition, this event caused
the company’s stock to perform far worse than its competitors within the past year.
5 Year Stock Performance vs. S&P 500 and Competitors
11
http://finance.yahoo.com
From a broader perspective, Johnson and Johnson has performed well over the past 5 years. In general,
the company has outperformed the S&P 500. It has also performed similar to its competitors.
DIVIDEND
In April 2010, Johnson & Johnson increased its dividend for the 48th consecutive year. It increased it’s
quarterly dividend 10.2% from $0.49 a share to $0.54 a share, raising its annual dividend to $2.16 per a
share from $1.96 per a share. In 2009, Johnson and Johnson paid a total of $5.3 billion in dividends to
shareholders. The company is known for having one of the strongest dividends on the market delivering
a 3.3% dividend yield to investors. The following chart highlights the history of the annual dividend from
1997 to 2010.
Annual Dividends Issued Per a Share12
VALUATION
To calculate a reasonable estimate of Johnson & Johnson’s intrinsic value, I used a two-staged
discounted free cash flow model. To calculate CAPM, I found an average beta of 0.57. Using the risk free
rate of 2.7% and an expected market return of 11%, the discount rate is calculated as follows:
K = .027+0.57(.11-.027) = 7.43%
Most analyst reports expect a growth rate between 4 and 6 percent over the next few years. In order to
be conservative in my valuation, I used and average growth rate of 4%. I used slower growth rates in the
early years due to product recalls this year, patent expirations in the near future, as well as to factor in
the slow current economic conditions. Once the economy recovers, growth in the emerging markets
takes place and future drugs and product make it through the pipeline to market, I expect Johnson and
12
http://www.investor.jnj.com/divhistory.cfm
Johnson to have higher growth rates. For my second stage growth rate I used a value of 3% to account
for inflation.
Through my valuation I calculated an intrinsic value of $69.28. At the end of the trading day, Friday,
September 17, 2010, Johnson & Johnson was priced at $61.55. This is a disparity in prices, and therefore
shows Johnson & Johnson to be somewhat undervalued at its current price.
In addition, I tested various discount rates and growth rates to come up with a more thorough
evaluation of Johnson and Johnson’s intrinsic value. The chart below indicates the threshold where the
company becomes over or undervalued.
Discount rate
3%
7.43
66.25
8.5
53.83
10
42.85
Green = Undervalued
Growth Rate
4%
5%
6%
71.78
77.77
84.25
58.12
62.77
67.79
46.07
49.55
53.3
Red = Overvalued
OUTLOOK
Johnson and Johnson is a well diversified and financially sound company within the healthcare market.
The company is known for its large increasing dividends and dedication to growth. As the consumers
are taking greater responsibility and interest in their own health, the consumer health market continues
to expand. Johnson and Johnson is at the forefront of the consumer health market’s growth. When it
comes to healthcare, its almost impossible for a consumer to avoid interaction with a Johnson and
Johnson products. Though Johnson and Johnson has had a rocky year in part due to product recalls,
greater generic drug competition with blockbuster drugs and slow economic times, the company is still
poised for growth. Johnson and Johnson has a strong pipeline and continues to expand through
acquisitions. There is also the potential for large growth in the emerging markets. Overall, Johnson and
Johnson is hold for our portfolio due to its financial security and growth potential. However, industry
instability keeps the company on a watch list for a potential sell in the future.
Financial Statements: