Today we deep dive into Johnson & Johnson, a Dividend King that has been raising the Dividend for no less than 60 consecutive years. Another indication of the quality of this company is being one of the only two companies to hold a AAA rating by Standard & Poor’s, the other one being Microsoft. This is a credit rating even higher than that of some U.S. bonds. Let’s see what this iconic company has in store for us.
In 1880, Robert Johnson separated from his partner George Seabury. Together they had created a company to develop medical utensils according to the theories of the aristocratic and eminent English surgeon Sir Joseph Lister, who pioneered the use of antiseptics for surgical tools.
Sterilization in surgery was new, since the theory had been developed only a few years earlier by Louis Pasteur. However, its efficacy was so evident that Robert Johnson and George Seabury’s business was an immediate success.
The only problem they had was not being able to agree on how to share the company’s profits, and their relationship deteriorated so much that they finally agreed that Seabury would keep the company in exchange for a monthly rent to Robert Johnson, with the commitment that the latter would not engage in any medical-related business for 10 years.
Meanwhile, James Johnson and Edward Mead Johnson, Robert Johnson’s brothers, had already created the firm Johnson & Johnson. But it was a young company that wasn’t able to raise the necessary funds to grow. It was then, by one of those coincidences of fate, that George Seabury informed Robert Johnson that he could no longer pay him the agreed rent, and that he would allow him to return to the medical business. Unbeknownst to him, George Seabury had just cleared the way for the creation of one of the largest business corporations on the planet.
Robert W. Johnson accepted the proposal and joined his brothers in providing the necessary funds. He took half of the company’s shares and assumed the presidency. The year was 1885.
The company’s early days were hectic. Robert W. Johnson worked tirelessly to develop ready-to-use sterilized tools, returning to the obsession that had guided him in his previous company. In this innovative zeal, he met Frederick Barnett Kilmer, a pharmacist from New Brunswick (New Jersey) with a restless character and great gifts as an inventor, with whom he forged a lifelong friendship.
Kilmer was a key player in the creation of the first research laboratories within Johnson & Johnson and helped Robert Johnson in the early years to develop sterile surgical dressings, bandages and other medical tools.
In those years, the United States was in the midst of conquering the Far West, and meanwhile, they were rapidly building a railroad network throughout the American territory, as we saw in our previous article about Union Pacific. Kilmer and Robert Johnson took their ready-to-use sterile surgical dressings one step further: they created the first-aid kits.
In the Wild West, medical care was in short supply, and first-aid kits quickly became a must-have for railroad travelers, employees and builders alike. To sell them better, Kilmer came up with the idea of adding a leaflet inside the kit with explanatory drawings on how to apply the various bandages and dressings. This was immensely useful to railroad employees and builders, who suffered frequent injuries and fractures in remote locations with no access to a doctor.
The United States quickly assumed that every workplace should have a first-aid kit, a habit that would gradually be implemented throughout the world. Nowadays, it is very difficult to find a building anywhere in the world that does not have these basic first-aid kits.
It was also Kilmer who would introduce the development of the very famous Johnson talc powder, when a customer asked him for advice against irritations due to the use of plaster casts.
As for the brothers, James Johnson was the company’s lawyer and Edward Mead Johnson left the company early, in 1888, when his son was born with cardiovascular and feeding problems. He decided then to create on his own another company dedicated to infant nutrition. His efforts to find a solution to his son’s problems also paid off, as he discovered maltodextrin: the first infant nutrition product approved by the medical scientific community as a substitute for breast milk. The Mead Johnson company would grow greatly as well, and Edward Mead Johnson eventually dedicated his life to children’s medicine through research and generous anonymous donations. Most recently in 2017, Mead Johnson became part of the Reckitt Benckiser Group.
After Robert Johnson’s death, he was succeeded as president by his brother James, and then by his son and namesake. It was Robert Johnson II who wrote the Johnson & Johnson Credo in 1943: a code of conduct that is engraved in stone at their New Brunswick headquarters and which serves as a guide for the company to this day. It is a fantastic text, and a very clear letter of introduction to its customers, employees and shareholders. This Credo has been updated several times, but retains its original essence: to maintain a clear and fixed direction for the company. It states that it must provide the best quality service at the lowest possible price to society, take care of its employees and provide a solid and sustainable return to its shareholders.
The first generations of the company were followed by several discoveries that had a profound impact on society, such as a cream toothpaste, less abrasive than the powders used at the time (Zonweiss, 1889); band-aids for wounds (Band Aid, 1921), discovered by an employee to treat the cuts his wife used to suffer when she cooked.
After the company’s first successful decades, Johnson & Johnson would adopt a strategy of inorganic expansion through the purchase of a multitude of companies to form the immense corporation it has become today.
It would take too long to go through them all, but let’s take a look at the main ones:
- 1947: Ethicon: production of sterile suture elements for surgery.
- 1959: McNeil Consumer Healthcare: owner of the patents for the drugs Tylenol and Motrin IB (ibuprofen). These were the first drugs to be sold in the USA over the counter.
- 1959: Cilag (Chemical Industry Laboratory AG): research laboratory.
- 1961: Janssen: pharmaceutical laboratory. We all know its recent vaccine against COVID.
- 1998: DePuy: orthopedic material.
- 1998: Centocor ($4.9 billion): biopharmaceutical company specializing in monoclonal antibodies.
- 2010: Crucell ($2.4 billion): biopharmaceutical company specializing in infectious diseases.
- 2012: Synthes ($19.7 billion): orthopedic material.
- 2014: Alios BioPharma ($1,750M): specializing in infectious diseases.
- 2016: Abbott Medical Optics ($4.325M) ophthalmic.
- 2017: Actelion ($30.000M) biopharmaceutical specializing in Immunology and Oncology.
- 2020: Momenta ($6.5 billion): biopharmaceutical company specialized in Immunology.
- 2022: Abiomed ($17.1 billion): cardiovascular medical technology manufacturer.
Through its Belgian subsidiary Janssen, Johnson & Johnson has played a leading role in the fight against Covid-19, producing one of the main vaccines against the pandemic. It is a single-dose vaccine, easier to transport and with simpler
maintenance conditions than other vaccines. However, its efficacy is somewhat lower than that of its competitors from Pfizer and Moderna and it has registered some infrequent but more relevant side effects, causing blood clots that have resulted in the death of some patients. The frequency of these side effects is very low (4 per million), but enough for the USA to stop its commercialization for some time. This reputational blow to Johnson & Johnson’s vaccine has caused the company to de-prioritize its production, especially in the USA, where sales of this vaccine are still much lower than abroad in 2022. Last year, the COVID-19 vaccine accounted for just 4.1% of the company’s sales.
Today Johnson & Johnson is divided into three major divisions: Consumer Healthcare (nutrition, soaps, dressings, over-the-counter drugs), Pharmaceuticals (prescription drugs) and MedTech (all types of surgical supplies, implants and devices from contact lenses for myopia to knee prostheses). The company’s best-known brands are structured as follows:
Consumer Health: Neutrogena, Listerine, Band Aid, Care Free, Clean&Clear, Johnson’s Baby, Tylenol, Motrin, Fortasec, Frenadol, Nicorette, Oraldine, Vispring, Zyrtec…
Pharmaceutical: Darzalex and Imbruvica (oncology), Stelara (immunology), Opsumit and Uptravi (pulmonary hypertension), Invega (neurology)…
MedTech: Acuvue, Ethicon (surgical tools), Biosense Webster (cardiovascular and neurovascular solutions), DePuy Synthes (orthopedics) …
Its sales are quite diversified, although the largest market is the USA, which continues to account for 51% of sales. Interestingly, Consumer Health products are the least important in terms of sales, even being the most popular.
Johnson & Johnson is one of the largest and most diversified companies in the world, and one of the leaders in all the sectors in which it operates. Its large size and diversification allow it to be a company resistant to economic cycles, and this has been reflected in its profits, which have increased steadily even since the beginning of the pandemic. Its size also allows to have on important moats such as its distribution network and its scale. Also, to maintain its leadership Johnson & Johnson needs to invest in research and acquire other companies.
The sectors in which it operates are very defensive and have good future prospects, although based on its recent acquisitions, Johnson & Johnson is expecting higher growth in the pharmaceutical sector.
Pharmaceutical companies make a living from their “Blockbusters”: new and very demanded drugs that have a patent, so they represent a monopolistic business for a period of time. This is why the expiration date of these patents must be carefully analyzed.
It is also important to know the status of the “Pipeline”, which indicates the stage of research of drugs in development. That’s why large pharmaceutical companies need to acquire other laboratories with drugs in advanced stages not only to expand their business, but also to maintain their position and make up for the lack of success in the development of “Blockbusters”.
Johnson & Johnson has many competitors. They include Procter & Gamble in the Consumer Health sector and Stryker Corporation in the MedTech sector. In the pharmaceutical sector, the most important are Roche, Novartis, Pfizer, Merck and Bristol Myers Squibb. But what is interesting is that none of these companies covers all the sectors in which Johnson & Johnson operates. They are only partial competitors.
However, this very year 2023 Johnson&Johnson is going to spin-off its Consumer Health segment. In recent years, we have already seen other pharmaceutical companies such as Pfizer or Merck divest their OTC segments. This is because these types of drugs have a lower margin, and therefore weigh on the overall margins of the company as a whole.
Therefore, in November 2023 Johnson&Johnson will split in two, leaving the original company with only the Pharmaceutical and MedTech segments. The Consumer Health segment will be separated into a new company called “Kenvue”. Johnson&Johnson shareholders will receive shares of this new company, and the opration should not affect them too much, unless the combined dividends of the two companies are reduced. Or if either company changes substantially its shareholder remuneration policy. Johnson&Johnson has not yet provided details on these matters.
In addition, Johnson&Johnson has a serious problem related to its famous Johnson’s Baby Powder. Let’s remember that, although Johnson&Johnson’s talc powder is an iconic and historic product of the company, it represents a tiny part of its turnover. However, in recent years, the company has been sued by more than 40,000 people who claim that the company’s talc powder has caused them cancer. They apparently argue that the company has known for some time that the powders contained traces of asbestos, which is a carcinogenic substance. The company has strongly denied these allegations, and maintains that its products do not contain asbestos and have been scientifically tested for decades to ensure their safe use. However, due to the volume and potential risk of the allegations, Johnson&Johnson has decided to change the base component of its powders: from 2023 they will be composed of cornstarch instead of talc.
In addition, Johnson&Johnson has created a new company called LTL Management and transferred all talc powder assets to it, with the intention of declaring this company bankrupt and stopping the blow. This strategy to avoid the brutal impact of massive whistleblowing is known as the “Texas Two Step”. However, it seems that the courts have rejected the bankruptcy declaration of this company, claiming that it is a subsidiary of a very solvent company.
According to the documents issued by Johnson&Johnson on its Spin-Off, the new Kenvue company will only be responsible for claims outside the US and Canada, while Johnson&Johnson will remain responsible for North American claims, which are the majority of them. Therefore, although the new company will own the talc powder segment, it will not be entirely responsible for past claims, which will remain the responsibility of Johnson&Johnson.
Finally, US President Joe Biden has just passed the Inflation Reduction Act, which penalizes pharmaceutical companies that have increased the price of 27 drugs above inflation. Johnson & Johnson has only one drug on this list (Reybrevant), for which it will have to pay a proportional fine to Medicare, the US social security system, for the price increased above inflation. For the moment, this law does not affect any Johnson&Johnson blockbuster, but President Biden has assured that they will extend the list very soon, while repeating “We beat Pharma!” in his speeches. We will have to keep an eye on the impact of these new policies.
Johnson & Johnson’s main shareholders are currently the major American funds Vanguard, State Street Corporation and Blackrock, with stakes of around 9.0%, 5.4% and 2.2%, respectively.
Let’s take a closer look at its financial statements.
1) FINANCIAL HEALTH: BALANCE SHEET
Johnson and Johnson’s Balance Sheet seems well structured as it presents a good current ratio and Financial Autonomy, but it also stands out for high Intangibles and Goodwill, something typical of pharmaceutical companies. Let’s take a closer look.
Short-Term Assets and Liabilities
Johnson&Johnson usually has a very comfortable Liquidity Ratio. However, this past year it had a low ratio of 0.99 due to an unusual and pronounced increase in short-term debt. This is due to the recent purchase of Abiomed coupled with the generalized rise in interest rates. The average interest rate of this short-term debt is 4.23%, so we understand that this is a one-off need in which the company has preferred to take on short-term debt in order to pay less interest in a very high interest rates environment.
Moreover, the Cash Ratio stands at a comfortable 0.42. Therefore, we are not at all concerned about the company’s short-term liquidity. However, it should be noted that a large part of Johnson&Johnson’s cash (around 40%) is invested in fixed income securities, mostly U.S. government bonds.
Long-Term Assets and Liabilities
If we look at its Long-Term Assets, Intangibles are quite high: 50% of Total Assets. It is logical, knowing that a large portion of Johnson&Johnson’s assets are patents, customer portfolios and IP resulting from its R&D.
However, approximately half of its Intangible Assets are Goodwill, due to all the acquisitions of companies that Johnson&Johnson has been making over the years. The increase in Goodwill in 2022 is notorious, after the acquisition of the pacemaker manufacturer Abiomed. Currently almost 60% of Goodwill is attributable to the MedTech segment. We’ll see if next year Johnson&Johnson manages to capitalize on this newly acquired company, which in 2022 made around $1.03 billion in sales. Integrated into Johnson&Johnson’s network, it should be able to boost its sales.
On the other hand, with the Spin-Off, Johnson&Johnson will divest the Goodwill corresponding to the Consumer Health segment, so that next year we should see a 20% reduction of the current Goodwill.
Johnson&Johnson’s Net Debt presents a value of just 0.56 times EBITDA, despite the many acquisitions of companies in recent years. Moreover, during the last decade this ratio has never exceeded 1.0 and in some years it has even been negative. In addition to this excellent figure, Johnson&Johnson pays an average interest rate of just 3.04%, and 60% of the Debt has maturities beyond 2030. For all these reasons, we are not at all concerned about this company’s debt.
Despite a large Goodwill, the Financial Autonomy presents quite a high value: 41%. If we were to remove Goodwill from the Balance Sheet, we would still have a Financial Autonomy of 17%. A reduced value, but still positive and reasonable.
In any case, we have here a very robust Balance Sheet, more solid than most companies in the sector, and with nothing to worry about.
2) PROFITABILITY: INCOME STATEMENT 2022
Over the past 10 years, sales have grown at an average annual rate of 3.5%. A moderate but very steady growth.
The largest and fastest growing segment is Pharmaceutical, where the most important sub-segments are Immunology and Oncology. Within Immunology we can find its flagship drug STELARA (for the treatment of plaque psoriasis), which accounted for around 18% of Pharmaceutical segment Sales and 10% of Total Sales in 2022. However, the US patents for this drug expire in September 2023, and the European patents in 2024. Therefore, the company expects a sharp drop in sales of this drug due to biosimilar competitors.
However, Johnson&Johnson is one of the pharmaceutical companies with the most diversified sales we can find. Although sales of Stelara will be reduced starting this year, it does not seem difficult for a company of Johnson&Johnson’s stature to make up for it with the development of other drugs. This year it already has several drugs for approval in its pipeline, some important ones such as the drug “nipocalimab”, a monoclonal antibody acquired in the development phase thanks to the purchase of Momenta in 2020. It is also developing new versions of Stelara for more specific applications, such as a version for pediatric use.
As for its most important Blockbusters apart from Stelara, we find patents with a more distant and staggered maturity.
- IMBRUVICA (4% Total Sales) — 2027 — Leukemia
- INVEGA/XEPLION/TREVICTA (4% Total Sales) — 2031— Schizophrenia
- DARZALEX (8% Total Sales) — 2035 — Multiple Myeloma
As a curiosity, the drug Imbruvica is developed in cooperation with Abbvie.
It is relieving to see that Sales are not overly dependent on one drug. For example, sales of REMICADE (used in rheumatoid arthritis treatments) used to account for a large portion of sales, but fell substantially after the patent expired in 2018. This is a recurring problem faced by pharma companies that Johnson&Johnson seems to know how to successfully overcome by developing and acquiring other Blockbusters.
In MedTech, the Surgery and Orthopedics segments are the most important ones. The important acquisition of Abiomed in December 2022 should boost sales in this segment, which, together with Pharmaceutical, is the company’s bet for the future.
In the Consumer Health segment, the sub-segments that contribute the most are Beauty with brands such as Neutrogena, Clean&Clear or Aveeno; and over-the-counter (OTC) drugs with brands such as Tylenol, Motrin, Fortasec or Frenadol.
This is the segment that will be spun-off from Johnson&Johnson in 2023 into a separate company called Kenvue. Johnson&Johnson shareholders will receive Kenvue shares when the Spin Off becomes effective.
Consumer Health is the only segment that has not grown in 2022, while Pharmaceutical and MedTech sales have grown around 6-7% at constant exchange rate, and around 1-2% considering the negative impact of the exchange rate in 2022. This is undoubtedly the main reason for the Consumer Health spin-off, which adds diversification, but weighs on the company’s results.
Profits have grown at an average annual rate slightly higher than Sales: around 5% per year over the last decade. Thanks to its diversification, margins are fairly stable, with Net Margin hovering around 20% (except 2017 due to Donald Trump’s tax reform).
Several conclusions can be drawn from this graph. On the one hand, we see that Pharmaceutical segment is by far the most profitable, accounting for 68% of EBT. In 2022 its competitors obtained the following EBT margins: Merck&Co (27%), Pfizer (35%), Brystol-Myers Squibb (17%), Roche (26%) and Novartis (17%), while Johnson & Johnson’s EBT margin reaches 30%. Pfizer’s case is somewhat distorted due to the success of its COVID-19 vaccine. Johnson & Johnson is therefore in the upper profitability range compared with its Pharmaceutical competitors.
MedTech segment is not nearly as profitable, but still accounts for 20% of EBT and has decent and very stable returns between 13 and 17%. It also achieves somewhat higher margins than its competitors. For example, Stryker achieved an EBT margin of 14.5% in 2022.
Finally, Consumer Health segment is very volatile, mainly due to litigations, which sometimes wins and sometimes loses. It is a segment that has the capacity to have very good margins despite intense market competition for its brands. However, we assume that Johnson&Johnson prefers to split it in order to gain in predictability of results. It should also be noted that this segment competes with other brands that achieve higher margins, such as Procter&Gamble.
In any case, it should be noted that Johnson&Johnson is a leader in all the segments in which it operates, something quite remarkable and within the reach of very few multi-sector companies.
ROA: 10% (Net Income/Total Assets)
ROE: 23% (Net Income/Equity)
ROCE: 24% (EBIT/(Equity + Net Debt))
Johnson & Johnson’s profitability ratios are very high. We are positively surprised by the ROA, which is very high despite the large amount of Goodwill on the Balance Sheet.
Both ROE and ROCE are excellent and all this with a high Financial Autonomy. And best of all, they remain constant over time.
Earnings per Share (EPS)
Earnings per share have grown at an average annual rate of 5.7% over the last decade. However, it is worth noting that until the pandemic it had been stagnant for a number of years. Fortunately, the company’s guidance for the next few years is optimistic, and the spin-off of the Consumer Health segment should help to restore growth in the coming years.
Dividend per Share (DPS)
Johnson&Johnson has been paying dividends since 1972, and has surpassed the 60-year mark of uninterrupted and growing dividends. It is one of the most notorious companies in the Dividend Kings list. Over the last decade, it has increased its dividend at an average rate of 6.4% per year, in a tremendously consistent manner.
Those shareholders who purchased shares in 2016 at $115 earn today an annual Dividend Yield of 3.9%.
In contrast, those who invested in 2012 at a price of $70 per share have obtained a large appreciation and earn today an annual return of 6.4%.
Johnson&Johnson share is currently offering an initial DPS of around 3%, which is certainly an interesting initial yield. We will see how the spin-off of the Consumer Health segment affects dividends. Johnson&Johnson has not given too many details about it yet.
Payout (Dividends/Net Income)
Due to the stagnation of EPS between 2014 and 2020, the Payout stood at 72% in 2020, a value that was a bit worrying. Thanks to the increase in EPS over the last 2 years, the Payout is now at a value of 66%, certainly much more in line with the nature of this company.
1) Free Cash Flow considering Maintenance CAPEX
Johnson&Johnson’s Cash Flow chart considering only the Maintenance CAPEXis great, which is kind of normal, since we are not considering the necessary Investment CAPEX in the acquisition of other companies, something usual in the pharmaceutical sector.
We see a perfectly growing Operating Cash Flow, except for the last fiscal year. In 2022, the company had a higher tax burden due to the Spin-off of the Consumer Health segment and lower tax benefits in the international segment than in 2021. However, this does not seem to be a problem that will persist in the future.
In addition, Maintenance CAPEX is a horizontal line, which we think is great, since it indicates that Johnson&Johnson does not need to spend more money to maintain its business despite the multiple acquisitions it makes over time.
Dividends are perfectly covered by Free Cash Flow.
2) Free Cash Flow considering CAPEX for Maintenance + Investments
As a pharmaceutical company, we must include investments (acquisitions of other companies) in the Maintenance Cash Flow. Johnson & Johnson needs these investments to remain a leader in such a competitive sector.
In this case, the acquisition of Actelion in 2017 stands out, an investment that helped boost the Immunology and Oncology areas within the Pharmaceutical segment. Also the acquisitions of Momenta in 2020 and Abiomed in 2022.
Even so, we see that FCF is widely sufficient to pay dividends most of the years.
3) Free Cash Flow considering total CAPEX:
If we analyze the Total CAPEX, we see that Johnson&Johnson adjusts large company acquisitions with its financial investments. In years of cash surplus, it takes the opportunity to invest in fixed income securities while it waits to make acquisitions.
Johnson & Johnson does repurchase a small amount every year. Over the past decade the number of shares has declined at an average rate of 0.54% per year.
Johnson & Johnson is a very solid company whose size and diversification make it a company that is resistant to economic cycles. In fact, it is one of only two companies to hold a AAA rating from Standard & Poor’s. This is very remarkable for a pharmaceutical company, which needs to constantly update its patent pipeline, and therefore tends to be more cyclical than other types of companies. We will see if it manages to maintain this credit rating once it divests its Consumer Health segment.
The Balance Sheet structure is very robust: good current ratio, conservative Debt and high Financial Autonomy. Goodwill has an important weight due to its continuous acquisitions, but we see that even so the company manages to make its Assets profitable in an outstanding way.
It is undeniable that Johnson & Johnson has high margins and excellent Profitability Ratios, and is the market share leader in almost all the segments in which it operates, generally achieving margins in the high range compared to its competitors.
Sales are increasing year after year, slowly but steadily. Profits were stagnant for a long time (2014-2020) although they have recently resumed the growth path. It is expected that by divesting its Consumer Health Segment, the company will manage to increase the growth rate more steeply and steadily.
The Dividend has been growing for many years, and its “Dividend King” track record is a guarantee for our investment style.
No doubt Johnson&Johnson is a “must” for a growing Dividend portfolio, but the company’s upcoming developments have cast some dark clouds over its share price in recent times. Will the company manage to minimize the impact of talcum powder litigation? Will the spin-off of Consumer Health segment manage to boost the company’s margins and profits? Will the spin-off positively or negatively impact shareholder remuneration? All these questions explain the approximately 15% drop in Johnson&Johnson’s share price in 2023.
What is your opinion of Johnson & Johnson? Do you have full confidence in it? Do you have it in your portfolio? What do you think about the future spin-off of the Consumer Health segment? How do you think the company will solve the talc powder litigation?
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