Published by Bob Ciura on October 31st, 2017
Every year, we review each of the 51 Dividend Aristocrats, a group of companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
This time, it is Johnson & Johnson (JNJ) in the spotlight.
J&J has been in operation for 130 years, and has raised its dividend for 55 years in a row. Not only is J&J a Dividend Aristocrat, it is a Dividend King as well.
The Dividend Kings are an even more exclusive group of stocks, with 50+ years of consecutive dividend increases. J&J is one of only 22 Dividend Kings. You can see all 22 Dividend Kings here.
J&J has virtually everything a dividend growth investor should look for. It has a dividend yield above the S&P 500 average, backed by a strong brand and highly profitable business model, with potential for long-term growth.
This article will discuss the quintessential Dividend Aristocrat that is J&J.
J&J is a global healthcare giant. It has a market capitalization of $376 billion, and generates annual revenue of approximately $71 billion.
Today, J&J operates in more than 60 countries across the world and employs 131,000 people. It is a massive company, with more than 250 subsidiary companies.
In all, it manufactures and sells health care products through three main segments:
- Pharmaceuticals (49% of sales)
- Medical Devices (33% of sales)
- Consumer Health Products (18% of sales)
It has a diversified business model, with strong brands across its three core operating segments.
Source: Q3 Earnings Presentation, page 1
J&J is one of the largest companies in the world, but it started from very humble beginnings. It was founded all the way back in 1886 by three brothers, Robert, James, and Edward Johnson. The company was incorporated the following year.
In 1888, the three brothers published a healthcare manuscript titled “Modern Methods of Antiseptic Wound Treatment”, which would quickly become the leading standard for antiseptic surgery techniques.
The same year, the three brothers began selling first aid kits, which also became the standard-bearer at the time.
Over the following decades, the company steadily brought new products to market. Soon, the company was the leading manufacturer across several healthcare categories, including baby powder, sanitary napkins, dental floss, and more.
In many cases, the Johnson brothers created products that were the first of their kind. J&J is still a leading manufacturer of consumer healthcare products.
Source: 2017 CAGNY Presentation, page 8
The consumer franchise is broken up into six broad categories. Its most popular consumer brands include Band-Aid, Tylenol, Listerine, Johnson’s, and Neutrogena.
Johnson’s, Neutrogena, and Listerine each generate more than $1 billion in annual sales. The consumer products business is highly profitable, and is a source of stability for J&J.
J&J’s pharmaceutical segment is its strongest area of growth. This segment has generated much higher growth rates than medical devices or consumer products, in recent periods.
For example, J&J had adjusted earnings-per-share of $6.73 in 2016, which represented 8% growth from the previous year. Organic revenue increased 7% for 2016.
Source: Q3 Earnings Presentation, page 10
J&J’s pharmaceutical revenue increased 11% for the year, while the medical devices and consumer products segments grew revenue by 4% each.
Within the pharmaceutical segment, two of the company’s best-performing areas were oncology and immunology. Oncology sales rose by 24% last year, while the immunology segment grew by 15% in 2016.
The results are solid to begin 2017 as well. Revenue, excluding currency impacts, rose 4.8% through the first three quarters. Adjusted earnings-per-share increased 8% in the same time.
J&J’s pharmaceutical pipeline is a positive growth catalyst.
Source: 2017 Pharmaceutical Business Review Day, page 10
By 2021, J&J expects to file 10 new products, each with annual sales potential of $1 billion or more.
It also sees the potential for 40 line extensions to existing products by then. Of these 40 extensions, 10 of which have the potential for more than $500 million in annual revenue.
J&J is no stranger to acquisitions, big or small. In 2016, the company completed 14 acquisitions or licensing deals. Moving forward, the $30 billion acquisition of Actelion is the most important individual acquisition.
Actelion is a standalone R&D company, and will help J&J continue its long history of innovation.
Source: 2017 Pharmaceutical Business Review Day, page 16
Actelion’s R&D focuses on rare conditions with significant unmet need, such as pulmonary arterial hypertension.
J&J expects the deal to be immediately accretive to adjusted earnings. Management forecasts a 1% annual revenue bump from the acquisition, with earnings growth of 2%-3% thanks to cost synergies.
Competitive Advantages & Recession Performance
J&J’s most important competitive advantage is innovation, which have fueled its amazing growth over the past 130 years.
J&J’s strong cash flow allows it to spend heavily on research and development. R&D is critical for a health care company, because it provides product innovation. J&J’s R&D spending over the past few years is as follows:
- 2014 research-and-development expense of $8.5 billion
- 2015 research-and-development expense of $9.0 billion
- 2016 research-and-development expense of $9.1 billion
R&D is also necessary to stay ahead of the dreaded “patent cliff”. Patent expirations can cause blockbuster drugs to deteriorate rapidly, once a flood of competition enters the market.
J&J’s aggressive R&D investments have resulted in product innovation and a robust pharmaceutical pipeline, which will help produce growth for years to come.
And, J&J’s excellent balance sheet provides a competitive advantage. J&J ended last quarter with $12.6 billion in cash and marketable securities. It is one of only two U.S. companies with a ‘AAA’ credit rating from Standard & Poor’s, along with Microsoft (MSFT).
J&J’s brand leadership and consistent profitability allowed the company to navigate the Great Recession very well. Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $4.15
- 2008 earnings-per-share of $4.57 (10% increase)
- 2009 earnings-per-share of $4.63 (1% increase)
- 2010 earnings-per-share of $4.76 (3% increase)
As you can see, the company increased earnings in each year of the recession. This helped it continue raising its dividend each year, even though the U.S. was going through a steep economic downturn.
Investors can be reasonably confident that the company will increase its dividend each year moving forward.
Valuation & Expected Returns
There is no shortage of accolades that can be heaped on J&J. If there were one issue investors could be critical of today, it would be J&J’s valuation.
J&J stock has appreciated significantly over the past several years. This has elevated its valuation as well, which means today the stock does not appear to be significantly undervalued.
In the past four quarters, J&J reported adjusted earnings-per-share of $7.14. The stock has a trailing price-to-earnings ratio of 19.6. This is well above its average price-to-earnings ratio of 15.2 over the past 10 years.
Source: Value Line
J&J’s price-to-earnings ratio got down as low as 12 during the recession. The valuation multiple has expanded considerably since then.
According to ValueLine data, J&J’s earnings increased by approximately 4% each year, over the past 10 years.
Based on J&J’s earnings growth rate, a price-to-earnings ratio near 20 does not seem to have much room for further expansion.
As a result, future returns will be generated by earnings growth and dividends. Given J&J’s historical growth rates, a potential breakdown of future returns is as follows:
- 4%-6% revenue growth
- 1% margin expansion
- 1%-2% share repurchases
- 2.4% dividend yield
Combining 6%-9% annual earnings growth with a 2.4% current dividend yield, would result in total returns of approximately 8%-12% per year.
J&J has more than 50 years of consecutive dividend increases under its belt. There are very few certainties in the stock market, but one of them is that J&J will increase its dividend each year.
The company has plenty of future growth, thanks to a strong pipeline and its recent acquisitions.
The one blemish on J&J is that the stock is not significantly undervalued right now. That said, the stock remains a high-quality hold for dividend growth.