Ticker: JNJ
Sector:
Health Care
Industry: Drug Manufacturers
Major
Recommendation: HOLD
Recommendation: HOLD
Pricing
Closing Price
52-wk High
52-wk Low
$60.72 (09/25/09)
$69.97 (09/25/08)
$46.25 (03/09/09)
Market Data
Market Cap
Total Assets
Trading Vol.
$167.5B
$84.91B
11.3M (3mon avg.)
Valuation
EPS (ttm)
P/E (ttm)
Div Yield
$4.55
13.34
3.20%
Profitability & Effectiveness (ttm)
ROA
15.98%
ROE
30.32%
Profit Margin 20.31%
Oper Margin 26.29%
Gross Margin 70.80%
Daniel Parmar
hdpt3c@mail.missouri.edu
We currently have 600 shares of JNJ, and I recommend we hold
them. Johnson and Johnson has a diverse revenue base, a robust
research pipeline and exceptional cash-flow generation that
together create a wide economic moat. Its diverse health care
segments insulate the company from downturns in the economy
and provide stability to the portfolio. The company also has
good growth potential as their entire spectrum of products
should benefit from the growing percentage of the aging
population.
Based on my analysis, I believe that Johnson & Johnson are a bit
undervalued right now. The stock is currently trading at $60, and
as per my analysis, the intrinsic value per share is around
$66.79. Though the company faces patent losses upto 10% of its
sales in 2009, growth from its remaining product lines will help
offset these. In addition, recent acquisitions like Omrix
Biopharmaceuticals (Dec. 2008) and Mentor (Jan. 2009) will
help broaden and strengthen JNJ's presence in the global
biosurgical and esthetic product markets. These new acquisitions
are part of JNJ's strategy to diversify into new long-term
opportunities in the face of challenging prospects in drugs.
Ongoing cost restructurings within the company augur well for
the future.
I believe that the investment risk is low because JNJ has
products that are largely immune from economic cycles, has
modest reliance on any single product category or customer for
sustained growth, and enjoys competitive advantages owning to
its large financial resources, business scale and global
capabilities. In addition, it is only of 5 U.S companies to hold a
Triple-A ranking from Standard & Poor's Ratings Service.
COMPANY PROFILE
Johnson & Johnson ranks as one of the world’s largest and most diversified health care firms.
The company is also a major participant in the global consumer products business, and, in
December 2006, purchased the consumer products unit of Pfizer for $16.6 billion. Johnson &
Johnson has over 250 operating companies selling products across the globe. Despite its size,
JNJ is highly innovative and seeks to maintain leadership positions by aggressively funding new
product development. R&D spending in 2008 totaled $7.6 billion, representing 11.9% of sales.
Due to its size and diversification, JNJ divides its business into three segments: Pharmaceuticals,
Consumer Health Care, and Medical Devices and Diagnostics.
PHARMACEUTICAL:
This segment includes products in the therapeutic areas, such as anti-infective, antipsychotic,
cardiovascular, contraceptive, dermatology, gastrointestinal, hematology, immunology,
neurology, oncology, pain management, urology and virology. These products are distributed
directly to retailers, wholesalers and health care professionals for prescription use by the general
public. Contributing 38.5% of total revenue, the pharmaceutical division boasts several industryleading drugs.
In addition to the existing product lines, R&D efforts are resulting in next-generation products.
The pharmaceutical group has a robust late-stage product pipeline with more than 10 potential
blockbusters in late-stage development.
During the financial year 2008, the pharmaceutical segment recorded revenues of $24,567
million, a decrease of 1.2% over FY2007. Pharmaceutical segment sales in 2008 were $24.6
billion, a decrease of 1.2% over 2007. U.S. Pharmaceutical segment sales were $14.9 billion, a
decrease of 4.9%. International Pharma segment sales were $9.7 billion, an increase of 5.1%.
In addition to the existing product lines, R&D efforts are resulting in next-generation products.
The pharmaceutical group has a robust late-stage product pipeline with more than 10 potential
blockbusters in late-stage development.
CONSUMER HEALTH CARE:
The consumer segment primarily sells personal care products, including nonprescription drugs,
adult skin and hair care products, baby care products, oral care products, first aid products,
women's health products, and nutritional products. Major brands include Band-Aid Brand
Adhesive Bandages, Imodium A-D antidiarrheal, Johnson's Baby line of products, Neutrogena
skin and hair care products, and Tylenol pain reliever.
The consumer health care segment contributed 25.5% of total revenue in 2008.
Consumer segment sales in 2008 were $16.0 billion, an increase of 10.8% over 2007 with 8.3%
of this change due to operational growth and the remaining 2.5% due to positive currency
fluctuations. U.S. Consumer segment sales were $6.9 billion, an increase of 8.3%. International
sales were $9.1 billion, an increase of 12.8%.
MEDICAL DEVICES AND DIAGNOSTICS:
The medical devices and diagnostics segment sells a wide range of products, including Ethicon's
wound care, surgical sports medicine and women's health care products; Cordis's circulatory
disease management products; Lifescan's blood glucose monitoring products; Ortho-Clinical
Diagnostic's professional diagnostic products; Depuy's orthopaedic joint reconstruction and
spinal products; and Vistakon's disposable contact lenses. This segment contributed 36.3% of
total revenue in FY 2008.
The Medical Devices and Diagnostics segment achieved sales of $23.1 billion in 2008,
representing an increase of 6.4% over the prior year. U.S. sales were $10.5 billion, an increase of
1.0%. International sales were $12.6 billion, an increase of 11.3%.
These multiple business lines generate
substantial cash flow. Johnson &
Johnson's healthy free cash flow is
close to 20% of sales. Strong cash
generation has enabled the firm to
increase its dividend for the past 45
years and take advantage of acquisition
opportunities.
Diverse operating segments, coupled
with expected new products insulate
JNJ from the R&D cycle facing the
pharmaceutical group. While the
company faces more than $6.3 billion
in patent exposure through 2009, strong
growth from the remaining business
lines are expected to offset these losses
and yield slight growth over the next
two years. After 2009, the company's
patent exposure is greatly reduced,
setting JNJ up for steady growth.
The U.S, Johnson & Johnson's largest
geographical market, accounted for
50.7% of the total revenues in FY2008.
Revenues from the US reached $32,309
million in 2008, a decrease of 0.4%
over FY2007.
Europe accounted for 26.3% of the
total revenues in FY2008. Revenues
from Europe reached $16,782 million
in 2008, an increase of 7.3% over
FY2007. Asia-Pacific and Africa
accounted for 14.9% of the total
revenues in FY2008. Revenues from
Asia-Pacific, Africa reached $9,483
million in 2008, an increase of 13.9%
over FY2007.
INDUSTRY OUTLOOK
The pharmaceuticals industry, like the broader health care industry, faces uncertainty in the face
of health care reform. Along with weakness in the overall economy, the sector faces a tough
regulatory environment, including proposed drug price discounting in the Medicare and
Medicaid programs. Despite the outlook not being very positive for the sector overall, companies
with well defined growth prospects and a strong, diversified product base should hold up
relatively well.
In addition, increased M&A activity in the sector has also increased confidence among investors.
Pharmaceuticals also remains one of the widest-margin U.S. industries. Long-term prospects
look to be enhanced by demographic growth in the elderly (which account for about 33% of
industry sales), and new products stemming from discoveries in biotechnology.
COMPETITOR COMPARISON
Ratio
JNJ
Eli Lilly
Novartis
P&G
Industry
Market Cap.
167.47B
37.29B
110.82B
167.11B
123.78B
EPS
4.55
-1.48
3.34
4.26
-
P/E
13.35
14.65
14.7
13.44
14.34
Current Ratio
1.78
1.56
1.77
0.71
3.32
Debt/Equity
29.44
90.19
27.47
58.59
14.6
ROA
15.98
-5.16
9.59
10.24
0.76
ROE
30.22
-21.2
14.39
17.62
1.35
Profit Margin
20.31
-10.17
19.77
17
0.55
Operating Margin
26.29%
30.37%
21.44%
20.40%
9.21%
Revenue
61.37B
20.76B
42.05B
79.03B
198.8M
Net Income
12.94B
(1.62B)
7.57B
11.10B
-
SWOT ANALYSIS
STRENGTHS
Diverse business offering
J&J represents one of the most diverse healthcare companies in terms of its pharmaceutical,
medical devices and consumer healthcare offerings, mainly due to its large Medical Devices &
Diagnostics and Consumer Health divisions. This diversification reduces the company's
dependence upon any one area, and is set to broaden further. Additionally, with a presence in a
wider number of areas, J&J can choose to expand those that offer the greatest growth prospects,
rather than being limited to just one or two areas of expertise.
Growth forecast despite challenges
Prescription pharmaceuticals represent J&J's largest business and across 2009-13, almost all of
its key products face a decline in sales. Despite this significant hurdle, pharma revenue is
forecast to grow overall across the period. This is a result of the impressive number of new
launches forecast to occur. While the ultimate success or failure of these efforts will only become
clear by 2010, with the shortfall in sales expected to be overcome, investment can be directed
more towards longer-term growth strategies, rather than off-setting losses.
Significant sales and marketing capabilities
J&J is strengthened by its large, global sales force. The company consists of a diverse range of
subsidiaries, which together possess expertise across a number of therapy areas. With significant
sales and marketing capabilities, J&J represents an attractive marketing partner. As such, this
will facilitate further in-licensing deals, and also ensure that the company maximizes returns
from existing agreements.
Robust financial position
J&J has maintained a healthy balance sheet by funding significant acquisitions primarily through
cash rather than stock issue or burdensome levels of debt. It is highly cash generative and is
currently one of the few US companies to have a Triple-A credit rating. As such, despite having
invested heavily in recent acquisitions, J&J will still be in a position to take advantage of any
additional opportunities
WEAKNESSES
High reliance upon small molecule drugs, increasing exposure to generic erosion
J&J has a high reliance upon small molecule drugs. Compared to biologics, small molecules are
notably more impacted by generic competition. As such, although the company may generate
new 'blockbuster' small molecule products, when coming off-patent these products face sharp
declines. This is particularly the case in the US, where generic erosion rates are most aggressive.
Until 2003-13, J&J's small molecule drug sales are forecast to maintain growth. This concern is
reflected across the pharmaceutical industry. Finding replacements for billion dollar products as
they mature represents an increasingly difficult task.
OPPORTUNITIES
Leverage coverage of Medical Devices & Diagnostics and Consumer Health divisions
In terms of total revenue, J&J's business is relatively equally split between its Pharmaceutical,
Medical Devices & Diagnostics and Consumer Health divisions. Through new products and
services or by bringing together existing ones, J&J could provide a more efficient coverage of
certain diseases. The CV, oncology, diabetes, and I&I therapy areas were given as examples
where the company could potentially become involved along the entire life-cycle of disease. This
would result in closer links with both patients and caregivers, giving rise to cross-selling
opportunities.
Expand experience in biologics
J&J is experienced in the development and commercialization of biologics including the
therapeutic proteins, Procrit Natrecor, Remicade, etc. The sharp decline facing the company's
key small molecule drugs highlights its exposure to generic erosion. Looking forward, the
addition of further biologics to its portfolio would potentially buffer subsequent small molecule
patent expiries. Moreover, with traditional sources of finance becoming scarcer and the market
capitalization of many biotech companies at relative lows, J&J could use this opportunity to gain
key IP or strengthen its discovery capabilities.
THREATS
Failure of launch portfolio to deliver
Against the significant decline of its aging expiry portfolio, J&J will be primarily dependent
upon launch products for growth. The company has an impressive pipeline, with at least 15 new
launches forecast, lifting 2013 sales by $6.7 billion. Since launch products are typically
associated with the uncertainty of regulatory review and uptake in the market may ultimately
differ from forecast, this reliance upon launch products potentially represents a threat to J&J's
outlook. With launches largely set to occur in the near-term, by 2010 the fate of the launch
portfolio and thus, the company as a whole, should have been significantly de-risked. By this
time, regulatory decisions will have been made and initial prescription trends will have become
apparent.
FINANCIAL TRENDS
Johnson & Johnson's commitment to innovative health care products has resulted in consistent
financial performance.

J&J has a strong financial track record including:
- 75 consecutive years of Sales increases
- 46 consecutive years of Dividend increases, and
- 25 consecutive years of Adjusted Earnings increases.





J&J is one of only five U.S corporations to have a Triple-A rating. This helps them
borrow money at a lower cost than competitors, especially at a time when borrowing is
more expensive.
J&J’s healthy free cash flow is close to 20% of sales. During 2008, the company
generated some $12.2 billion in cash flow after capital expenditures. $15 billion of cash
was generated from operating activities. The company anticipates that operating cash
flows and existing credit facilities will provide sufficient resources to fund operating
needs in 2009.
Johnson & Johnson is in a strong financial position. The company recorded revenues of
$63.7 billion during the FY2008, an increase of 4.3% over FY2007. The increase was
primarily due to higher sales of OTC pharmaceuticals, nutritional, and skin care products.
The operating profit of the company was $15.9 billion during FY2008, an increase of
17% over FY2007. The net profit was $12.9 billion in FY2008, an increase of 22.4%
over FY2007.
The company is implementing a $10 billion share-repurchase program, signaling
management's confidence in the stock.
Pretax savings from cost cutting and restructuring operations totaled $1.6 billion in 2008.

Sales and net income have been
consistently growing too, as the graph
shows. Even through the recent recession,
J&J was able to achieve growth in Sales and
Net Income. Though U.S sales were a bit
sluggish, percentage increases in other parts
of the globe helped the company's sales and
net income grow. This illustrates how the
company's diversification and global reach
are great competitive advantages.
STOCK PERFORMANCE
As the charts show, J&J has performed well when the S&P was down and not as well when the
broader markets were performing well. The stock provides a defensive growth opportunity
during downturns in the economy. YTD, the stock has lagged behind the S&P, but has performed
better than its close competitor, Novartis.
5 YEAR STOCK PERFORMANCE VS. S&P500 AND NOVARTIS
YTD STOCK PERFORMANCE VS. S&P500 AND NOVARTIS
VALUATION:
I used the Owner Earnings model to find the intrinsic value of Johnson & Johnson.
I calculated the discount rate taking the risk free rate, beta, and the market risk premium. I used
an average beta of .60, a risk-free rate of .198 and a market return of 11%. Using these numbers,
the discount rate works out to be:
K= 0.00198+0.60(0.11-0.00198) = 6.7%
However, this discount rate was too low, so I assumed a rate of 11%. I used a conservative
growth rate of 3% for this year, and a higher growth rate of 4% for the next four years through
2014. I believe that J&J's annual growth will average around 4% from strong expected growth in
new pipeline drugs and a steady expansion in consumer health care, offsetting patent challenges
in the pharma division. Considering the uncertainty surrounding the broader health care industry,
I stuck with a conservative 3% growth rate for the rest of the 10-year period and for the second
stage. Using these numbers, the intrinsic value works out to be $66.79. Since the stock is
currently trading at $60.72 (as on 09/25/09), I believe that J&J is undervalued. Though this might
seem a good stock to buy right now, the uncertainly in the industry and the fact that we are
looking to reduce our exposure to healthcare make me recommend a Hold.
Below is a sensitivity analysis showing the intrinsic value at different discount and growth rates:
Discount Rate
10%
11%
12%
13%
14%
15%
3%
73.25
64.69
58.06
52.76
48.44
44.85
5%
84.7
74.41
66.45
60.11
54.95
50.67
First Stage Growth
7%
98.02
85.69
76.16
68.6
62.45
57.35
9%
113.49
98.75
87.39
78.37
71.06
65.02
11%
131.44
113.87
100.34
89.63
80.96
73.8
INTRINSIC VALUE CALCULATION:
Two-Stage Discounted Free Cash Flow Valuation Model
assuming discount rate (k) of
Free Cash Flow ("owner earnings") in 2009:
Net Income
Depreciation & Amortization
Average Capital Expenditures (subtract)
Free Cash Flow (Owner Earnings)
11.00%
$
$
$
$
FIRST STAGE
Prior Year Free Cash Flow
First Stage Growth Rate
Free Cash Flow
Discounted Value per annum
$
$
Sum of present value of owner earnings
12,949,000,000.00
2,832,000,000.00
(2,696,000,000.00)
13,085,000,000.00
Year:
2010
2011
2012
2013
2014
2015
13,085,000,000.0 $ 13,477,550,000.0 $ 14,016,652,000.0 $ 14,577,318,080.0 $ 15,160,410,803.2 $ 15,766,827,235.3
3.0%
4.0%
4.0%
4.0%
4.0%
3.0%
13,477,550,000.0 $ 14,016,652,000.0 $ 14,577,318,080.0 $ 15,160,410,803.2 $ 15,766,827,235.3 $ 16,239,832,052.4
$13,477,550,000.0
$12,627,614,414.4
$11,831,278,370.3
$11,085,161,716.3
$10,386,097,463.9
$9,637,549,898.9
$101,132,300,848.7
SECOND STAGE
Residual Value
Free Cash Flow in year 10
Second Stage Growth Rate (g) (add)
Free Cash Flow in year 11
Capitalization rate (k-g)
Value at end of year 10
Present Value of Residual
Intrinsic Value of Company
Shares outstanding assuming dilution
Intrinsic Value per share
$
$
$
18,278,074,047.9
3.00%
18,826,416,269.3
8.00%
235,330,203,366.49
$82,879,645,012.52
$184,011,945,861.24
2755000000
$66.79
2016
2017
2018
2019
$ 16,239,832,052.4 $ 16,727,027,014.0 $ 17,228,837,824.4 $ 17,745,702,959.1
3.0%
3.0%
3.0%
3.0%
$ 16,727,027,014.0 $ 17,228,837,824.4 $ 17,745,702,959.1 $ 18,278,074,047.9
$8,942,951,708.0
$8,298,414,648.0
$7,700,330,709.4
$7,145,351,919.5
RESOURCES USED
1.
2.
3.
4.
5.
6.
7.
www.jnj.com
www.wsj.com
www.reuters.com
www.morningstar.com
www.cnbc.com
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