Friday, May 1, 2015

Johnson & Johnson (JNJ): A Quality Dividend King At An Attractive Valuation

Johnson & Johnson (NYSE:JNJ), together with its subsidiaries, is engaged in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments: Consumer, Pharmaceutical, and Medical Devices & Diagnostics. This dividend king has paid dividends since 1944 and has managed to increase them for 53 years in a row.

The company's latest dividend increase was announced in April 2015 when the Board of Directors approved a 7.10% increase in the quarterly dividend to 75 cents /share. The company's peer group includes Novartis (NYSE:NVS), Pfizer (NYSE:PFE) and Roche Holdings (RHHBY).

Over the past decade this dividend growth stock has delivered an annualized total return of 7.20% to its shareholders.

The company has managed to deliver 7.20% average increase in annual EPS over the past decade. Johnson & Johnson is expected to earn $6.14 per share in 2015 and $6.42 per share in 2016. In comparison, the company earned $5.70/share in 2014.

Johnson & Johnson also has managed to reduce number of shares outstanding. Between 2004 and 2015, the number of shares declined from 2,996 million to 2,826 million.

Johnson & Johnson has a diversified product line across medical devices, consumer products and drugs, which should serve it well in the future. This makes the company largely immune from economic cycles. In addition, the company has strong competitive advantages due to its scale, leadership role in various diverse healthcare segments, breadth of product offerings in its global distributions channels, continued investment in R&D, switching costs to users of its medical devices, as well as its stable financial position. The company generates 70% of revenues from products where it is number one or number two in the respective field. The ability to generate strong cash flows, have enabled Johnson & Johnson to reward shareholders with a higher dividends for 53 consecutive years.

Future profits growth could come from new product offerings, which are the result of continued investment in research and development, and through strategic acquisitions. The company spends approximately 11% on R&D, and generates a quarter of its revenue from products launched in the past five years. In the Pharmaceuticals segment, the company expects 10 major filings and 25 line extensions expected between 2013 and 2017. Approximately thirty major filings are expected between 2014-2016 in the Devices segment.

Johnson & Johnson is also expanding its business through strategic acquisitions. For example, the acquisition of Synthes, is expected to generate significant synergies for Johnson & Johnson and make it a leader in fast growing trauma market. This also allowed the company to use its overseas cash without having to pay the steep repatriation taxes. Emerging market growth and opportunities for cost restructurings should further help the company in squeezing out extra profits in the long run.

Sales in drugs like Simponi, Stelara, Zytiga, Xaralto and Olysio should more than offset the generic erosion from older drugs which are losing their patent protection. The fact that the company has exposure to other healthcare segments besides pharmaceuticals makes it a much safer play on the healthcare sector than pure pharma companies. I like the fact that there is diversity in the revenue generating behind each of the large segments. The three segments include Pharmaceutical with 43% of sales, Medical Devices & diagnostics with 37% of sales and the Consumer segment with approximately 20% of sales.

The annual dividend payment has increased by 9.60% per year over the past decade, which is higher than the growth in EPS.

A 10% growth in distributions translates into the dividend payment doubling every seven years on average. If we check the dividend history, going as far back as 1977, we could see that Johnson & Johnson has actually managed to double dividends every five and a half years on average.

In the past decade, the dividend payout ratio increased from 38.70% in 2004 to a high of 64.50% in 2011, before decreasing to 48.40%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The return on equity has decreased from 29% in 2004 to 22.70% in 2014. This is still a very high return on equity however. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time. Given the fact that the amounts in this indicator are still high these days, I do not view this decline as a major warning sign.

Currently, the stock is attractively valued at 17.80 times forward earnings and a current yield of 2.70%. The only reason I am hesitating to add more shares is because the company is one my five largest holdings.

Full Disclosure: Long JNJ

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