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Health is wealth with Johnson & Johnson

The New-York-quoted giant is the largest and most diverse medical company on earth
March 11, 2021

 

  • Evolved over 135 years into a leader in pharma, consumer health and medical devices
  • Over a tenth of revenues invested in R&D every year
IC TIP: Buy at $153.07
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Diversified growth across three distinct businesses
  • Strong sales and earnings track record
  • Good cash generation underpinning ‘Dividend Aristocrat’ status
  • Focus on innovation borne out in R&D spending and new product launches
Bear points
  • Potential drug pricing pressures 
  • Ongoing litigation challenges

Painkillers. Cancer drugs. Contact lenses. Mouthwash. These four very different healthcare products have two things in common. First, they are relied on by millions of people around the world every day. Second, they are all manufactured and sold by Johnson & Johnson (US:JNJ), and contribute to making it the largest and most diverse medical company on earth.

Founded in 1886, J&J has evolved over the past 135 years into a New-York-quoted giant with 134,500 employees serving more than 1bn patients every day. Operating across three distinct businesses – pharmaceuticals, medical devices and consumer health – the group boasts solid footholds in a wide range of countries and specialist areas. About 70 per cent of its sales come from markets in which it is either the number one or number two player.

Cementing those positions, 16 of the products and platforms owned by J&J make more than $1bn in sales each year. A further 12 products make more than $2bn in sales. But despite its maturity and already extensive reach, the group still believes it can generate further value for shareholders, fuelled by investment and sales-enhancing acquisitions.

And, on balance, investors appear to agree. Shares in J&J have risen 15 per cent over the past 12 months, notwithstanding the small issue of the coronavirus pandemic. They are up almost a half over the past five years, taking the company's total value to more than $400bn (£290bn).

 

Solid foundations

J&J’s sales momentum has been slow and steady rather than ‘shoot the lights out’. The group has averaged a compound annual growth rate of just 3 per cent over the past decade. But to put that pace in context, its revenues last year came in at a huge $82.6bn.

Meanwhile, signalling the quality of its business model, the group has raised its dividend every year for almost six decades – ensconcing it safely on the S&P 500’s ‘Dividend Aristocrat’ register, which only includes companies that have lifted their shareholder payouts consistently for a quarter of a century. (Readers should note that withholding tax applies to US dividends and a W-8BEN form is required to avoid double taxation.)

Those dividend payouts are underpinned by very strong cash generation. J&J’s free cash flow rose from $16.1bn in 2015 to a record $20bn in 2020, of which roughly half was returned to investors.

J&J’s growth over the years has been spread across different geographies and product categories, helping it to hedge its bets. While roughly half of sales stem from the US, in its own words, it “conducts business in virtually all countries of the world”.  

 

And while J&J’s pharmaceuticals division sits ahead of the others – comprising 55 per cent of all sales – medical devices account for 28 per cent of the total, with consumer health goods (such as pain medicine Tylenol) bringing up the rear. Moreover, within pharma, the group’s medicine cabinet is further diversified across six separate therapeutic areas and multiple drugs.

 

J&J’s main pharma specialism by sales is immunology: the treatment of autoimmune illnesses such as rheumatoid arthritis and psoriasis. These conditions typically stem from the body overreacting to infection or attacking its own cells and organs by mistake, giving rise to a medical sector worth $80bn, according to one industry estimate. The group reported $15bn in immunology sales last year alone, bolstered by a $7.7bn contribution from Stelara – a drug used to help patients with various immune-mediated inflammatory conditions.

But, at the same time, oncology revenues came in at $12.4bn, propelled by a contribution from the drug Darzalex for the treatment of multiple myeloma. And beyond immunology and cancer-related ailments, J&J’s pharmaceutical expertise extends to neuroscience, infectious diseases such as Aids, cardiovascular and metabolic illnesses, and pulmonary hypertension.

 

Breaching the moat

Such scale and diversification have helped to establish a protective moat around J&J to keep competitors at bay. However, those defences are not unassailable, especially given intensifying discussions around the need for affordable healthcare. Questions remain about how far Joe Biden’s administration will tackle drug pricing during his US presidency – a priority that has topped the Washington agenda for years.

J&J does have barriers to entry in the form of patents. But when these expire, rival companies can step into the fray – potentially developing cheaper generic versions of drugs and biting into the group’s revenues and margins.

The immunology therapy Remicade offers a case in point. When patents for the drug (J&J’s second-largest product by sales) expired, America’s medicines regulator greenlighted the first biosimilar – or highly similar – version of the treatment in the US in 2016. Various other iterations of the drug have since launched and, in turn, annual Remicade sales have dropped from $7.0bn five years ago to $3.7bn in 2020.

Patent expiry dates will continue to loom for the group. Indeed, the US patent for Stelara is projected to expire in 2023. The projected European expiry date is 2024.

The risks do not end there. Quite apart from competitive threats, J&J has also suffered from well-documented legal issues. For one thing, it is entangled in the long-running opioid crisis in the US, where it and other pharma companies have been named in thousands of lawsuits referencing alleged opioid marketing practices. For another, within its consumer health business, J&J has endured allegations that its ‘Baby’ talcum powder contained asbestos and could cause cancer.

In its 2020 annual report, the group cited a litigation expense of $3.9bn primarily associated with talc-related reserves and settlements. Last May the group said it would stop selling Baby Powder in the US and Canada amid waning demand.

Litigation issues could feasibly continue to plague J&J, potentially leading to further payments in due course. And that’s before mentioning the challenges posed by Covid-19. J&J’s medical devices business, which supplies products used in the orthopaedic, surgery and eye health fields (including Acuvue contact lenses), was knocked by the postponement of elective procedures during the crisis last year. Sales for the division slipped more than a tenth over the respective 12 months to $23bn.

 

Building new barriers

That said, J&J has shone brightly for other reasons during the global health emergency. In February, America’s drugs regulator granted emergency use authorisation for the group’s Covid-19 vaccine – the first jab to be cleared that only requires a single dose. J&J aims to deliver 100m single-shot vaccines to the US by the end of June.

And while the group is making its doses available on a not-for-profit basis for emergency pandemic use, its vaccine work has arguably highlighted the skill and specialist expertise of its workforce.

Such capabilities have been honed through extensive investment in research and development (R&D), which should help J&J to defend its leading market positions and remain competitive. The group spent a huge $12bn on R&D in 2020, equivalent to 15 per cent of group sales. It has allocated more than 12 per cent of revenue to R&D in each of the last five years.

 

Signalling progress on that investment strategy, a quarter of J&J’s annual sales now stem from products debuted in the last half decade.

At the same time, the group has also directed its resources towards strategic acquisitions to enhance its portfolio. Last summer, it bought biotech group Momenta for $6.5bn – bolstering its autoimmune treatment offering with the addition of the treatment nipocalimab, which should allow it to tackle autoimmune conditions “with substantial unmet medical need”.

But the size of this deal was nothing compared with J&J’s $30bn purchase of Swiss group Actelion in 2017, which gave it its sixth pharmaceutical therapy area – pulmonary arterial hypertension – as Remicade sales started to slide.

With J&J’s vast size and robust historical track record, it is perhaps small wonder that the stock has regularly appeared in our Ideas Farm tables as a favourite holding among top pharma, biotech and healthcare funds. The group’s R&D strategy, illuminated by its vaccine work, should continue to bear fruit, churning out enough money to make generous shareholder returns. In that context, a forward price/earnings multiple of 15 times looks palatable, despite sitting higher than peers AbbVie (US:ABBV) and Pfizer (US:PFE).

Johnson & Johnson (JNJ-US)   
ORD PRICE:15,307ȼMARKET VALUE:$403bn  
TOUCH:15,296-15,318ȼ12-MONTH HIGH:17,365ȼLOW:10,916ȼ
FORWARD DIVIDEND YIELD:2,8%FORWARD PE RATIO:15  
NET ASSET VALUE:2,404ȼ*NET DEBT:18%  
Year to 31 DecTurnover ($m)Pre-tax profit ($m)**Earnings per share (ȼ)**Dividend per share (ȼ) 
201982.128.2870.0370.0 
202082.625.4800.0394.0 
2021**91.730.4950.0418.0 
2022**96.533.31043.0443.0 
 +5+10+10+6 
Beta:0.5    
*Includes intangible assets of $90bn, or 3,411ȼ a share
**JPMorgan forecasts, adjusted PTP and EPS figures