Stock of the week: Johnson & Johnson

Summary:

• Despite latest sell-off on the stock market Johnson & Johnson (JNJ.US) trades near all-time-high

• The company has been rising dividend payout each year for over four decades

• Strong cash flow stream may support company at times of economic downturn

• The company had superior performance to S&P 500 at times of turmoil on stock markets

• The latest pullback found support at 23.6% Fibo level

As we saw in the past couple of days sentiment on the stock markets is not to be taken for granted. Just as it seemed that a rebound may be on the way major equity market indices took another dive. As uncertainty lingers over whether we are experiencing just a longer correction or a true trend reversal, investors may want to look for companies that perform well regardless of the economic cycle stage. One of such examples could be Johnson & Johnson (JNJ.US), the US pharmaceutical and packaged goods company. In this analysis we will take a look at company’s earnings, sources of revenue as well as how it coped at times of an economic downturn in the past.

Johnson & Johnson enjoyed strong and rising operating cash flow during the past three decades. The company was quick to recover from any pullbacks in operations. Source: Bloomberg, XTB Research

As concerns over the slowdown in global growth intensify, investors may find a need to increase exposure to non-cyclical, defensive companies. Such companies tend to be the least impacted by deteriorating macroeconomic conditions and a drop in the aggregate level of demand in the economy. Established pharmaceutical companies with a diverse drug portfolio, like Johnson & Johnson, are examples of such companies. Such statement is in line with common sense as it seems highly improbable that people suffering from sickness will decide to stop buying their medicines due to drop in consumer expectations and underperformance of the whole economy. Having said that, drug sales tend to be less volatile than sales of other goods at times of an economic downturn ensuring more predictable levels of operating cash flows. Moreover, at those times companies are also more reluctant to expand investment projects and in turn often experience decent free cash flows allowing them to keep sharing profits with investors via dividends. Sustainability of business operations as well as continuity of dividend payouts are one of the most desired features of companies during periods of long and broad declines on the stock markets.

Pharmaceutical segment is not only the biggest in terms of revenue but also the one with highest pretax margin. Source: Bloomberg, XTB Research

Johnson & Johnson’s business is divided into three major segments: Pharmaceutical, Medical Devices and Diagnostics and Consumer. The Pharmaceutical segment is the biggest source of company’s revenue since 2014 when it surpassed Medical Devices and Diagnostics segment. This is also the best performing segment of the company as it holds the longest streak of YoY revenue increases out of all three. During the third quarter of 2018 the company’s drug division managed to boost revenue by 6.7% YoY thanks to strong sales of oncological drugs. Moreover, this segment is facing bright future as it is expected that Johnson & Johnson will file in for 10 new patents by 2021 with each having potential to boost sales by at least $1 billion. On top of that, another pleasing fact is that this segment holds the highest pretax margin. When it comes to other segments, outlook for the Consumer business looks promising. This is due to the fact that the company decided to revamp its Johnson Baby products. The company decided to focus more on millennial parents and in turn lowered the amount of chemicals in its Baby products. Efforts seem to have paid off as the Baby&Kids Care subsegment of Consumer division managed to improve sales by 3.5% QoQ after a period of declines.

While Johnson & Johnson’s gross margin saw a drop recently, it managed to hold in 63-73% range during the past three decades. Operating and profit margin managed to move substantially higher in the period. Source: Bloomberg, XTB Research

Returning to margins’ topic, let’s take a look at figures for the whole company. As one can see on the chart above Johnson’s gross profit margin moved lower during the past year. According to company’s 2017 annual report the reason behind the drop were higher marketing and research expenses as well as higher amortization expenses (mostly related to acquisition of Swiss biotech company, Actelion). An interesting feature visible on the chart is that while company’s gross margin dropped during financial crisis, its operating and profit margins actually increased. Last but not least, while the chart may at first glance show a significant drop in the gross margin figures since peak in 2005 it should be noted that during the past three decades it held relatively steady in the 63-73% range. In the whole period depicted on the chart (1987-2017) operating and profit margins kept rising with the latter more than doubling

Johnson & Johnson has been rising dividend payout each year for over four decades now. Moreover, dividend growth rate exceeded price growth rate significantly. Source: Bloomberg, XTB Research

Johnson & Johnson seems to be a good addition to portfolios of investors with a longer time horizon. The company is known for its steady dividend policy as it did not missed a single dividend payout since 1973 and managed to pay higher dividend per share in each consecutive year in the period. Moreover, when we take a look at the chart above we can see that those increases were not just nominal ones. The company’s rate of dividend growth was constantly above the US CPI inflation with year 1980 being the only exception (dividend growth - 11.27%, CPI - 12.5%). Additionally, company’s stock looks more resistant to periods of economic downturn than a broad market. Taking a look at weekly rates of return between peak of dot-com bubble and subsequent trough in late 2002 one could see that average weekly return for S&P 500 index in that period was -0.55% with a standard deviation of 2.86%. When it comes to Johnson & Johnson the mean weekly return was 0.26% with a standard deviation of 3.85%. However, one may argue that dot-com bubble was not about pharmaceutical companies. Then let’s take a look at figures for financial crisis of 2007-2009 that was marked with even broader declines. Taking peak of the bubble in late-2007 as starting point and trough in early-2009 as ending point results also point to superior performance of Johnson & Johnson. While S&P 500 index had a mean weekly return of -1.03% with a standard deviation of 4.36%, the company had mean return of -0.38% with a standard deviation of 3.35%. As one can see, rates of return from investment in Johnson & Johnson stock in the period of financial crisis were not only higher but also less volatile. To complement the analysis it should be said that smaller volatility is seen mostly at times of financial turmoil. Analyzing weekly rates of return since the turn of millenia (2000 - present) one can see that S&P 500 had a mean weekly return of 0.09% with 2.4% standard deviation while Johnson & Johnson had mean return of 0.15% with a standard deviation of 2.55%. In the same period correlation coefficient between the two turned out to be 0.48 pointing to moderate correlation and potential benefits from diversification.

Johnson & Johnson (JNJ.US) stock managed to resist downward pressure seen lately on the US stock market. However, the price pulled back recently from the all-time-high at 148.70 USD. Nevertheless, the decline was halted at the 23.6% Fibo level of the upward impulse started in late-May. Source: xStation5