7/15/08

Johnson & Johnson, a Good Defensive Play

Founded in 1886 and traded on the New York Stock Exchange since 1944, Johnson & Johnson (JNJ) is the largest and most diversified health care firm in the world. The company has raised dividends every year for the last 44 years. Its most recent dividend, in June, was 11% higher than its previous quarterly dividend payment.

Just as Procter & Gamble (PG), JNJ seems to be a good stock for those who are looking for safety or have long time horizons.

Johnson & Johnson faces the following headwinds, particularly in its pharmaceutical division, which in 2007 accounted for about 41% of the firm's sales.

1. High margin drug Risperdal had its patent expire at the end of June. Topamax, another high margin drug, will have its patent expire later this year. The two drugs represented nearly 25% of JNJ's drug sales in 2007.

2. JNJ lost its patent on Risperdal recently, sending sales of the antipsychotic drug down around 16%, according to its quarterly report.

3. Procrit, an anemia drug, has slowing sales due to patient side effects, more restrictive labeling, and competition from Amgen's (AMGN) Epogen. In the most recent quarter, sales of the drug fell 14%.

4. Drug coated stents sales declined 6% in the most recent quarter on health and efficacy concerns. Sales are expected to drift lower in the future.

5. In its most recent quarterly report, the company said that drug sales grew 3.1%. The rise is attributed to a weaker dollar. Excluding the declining currency, drug sales fell 1.3%. While its sales rose 17% last quarter, Topamax's patent is set to expire soon, as mentioned. In all, the pharmaceutical division's sales are expected to decline to around a third of JNJ's total sales over the next decade.

6. Higher raw materials and energy costs are putting a strain on margins, as they are with pretty much every other firm.

Despite the above problems, Johnson & Johnson's future looks bright.

1. The FDA recently approved Ustekinumab, a drug that treats plaque psoriasis. Around 37 million people worldwide suffer from plaque psoriasis. While sales are not expected to contribute much to earnings, the drug has potential for treating other ailments. It is currently in phase III for treating Crohn's Disease.

2. The firm has several drugs currently in phase III trials that might become huge sellers.

3. The consumer products division, which accounted for 24% of 2007 sales and has brands such as Band-Aid, Listerine, Neutrogena, Tylenol, and Zyrtec, is growing. In the most recent quarter, sales were up 13%. The consumer products division is expected to continue to grow at a healthy clip.

4. Johnson & Johnson's medical devices division, which accounted for 35% of sales in 2007, is doing well too. Even though drug coated stent sales declined, the division's sales rose 12% in the most recent quarter. The medical devices division is also expected to continue growing.

5. Analysts expect that growth in consumer and medical device sales, as well as new drugs coming on the market, should offset declines from near term patent losses. The firm is expected to post mid single digit sales growth over the next decade. The US's aging baby boomers will need various products, and JNJ holds the leading market position in almost all of them.

6. A stronger dollar could hurt growth, as almost half of JNJ's 2007 sales came from abroad. Nevertheless, the dollar is expected to stay weak against other currencies, at least in the near term. With foreign central banks expected to raise interest rates or keep them steady, the dollar will probably continue its decline.

7. Dividend payments have almost doubled from four years ago. Future dividend increases are likely, as the firm is expected to grow. Its payout ratio is currently under 42% of projected earnings for 2008.