Thursday, April 16, 2015

Johnson and Johnson: A Great Company In a Great Sector

This is not an invitation to buy or sell this security.  Do your own research and come to your own conclusions.  Heck, you might learn something in the process.
     Johnson and Johnson (JNJ) is just barely the second largest company in the health care sector.  With a market cap of $279.72, it is just below Novartis’ $272.81 total.  Pfizer and Merck come in 3rd and 4th, respectively.  JNJ recently announced an earnings beat, but also warned on growth thanks to a strong dollar.  Despite this warning, JNJ is a buy at current levels.  It has a strong balance sheet, growing revenue, positive cash flow and an attractive dividend yield (2.78%).  With an aging population, the US, Europe and Asia will provide an increasing number of customers for the company's products.   Finally, the health care sector is in the middle of a three year rally. 
The Health Care Sector
     Global health care spending is buoyed by two key factors: aging world demographics and broad insurance coverage.  In the US, 10,000 baby boomers will retire/day through 2029.  And with the uninsured level dropping, a larger percentage of the US will have access to the health care market.   Europe has universal coverage and an aging population , as does Asia.  JNJ has  international reach, allowing them to take advantage of these developments.
JNJ’s Charts
     The above factors explain why the health care ETF has been in a three-year rally:
The weekly XLV chart has more than doubled over the last three years, rising from a low of 33.65 in 2012 to a high of 76.01 earlier this year.  JNJ has been a strong participant in this rally:
The weekly chart shows a rally form 2012-2014, when the stock rose from ~56 to 1~08.  There was a period of consolidation that lasted about 6 months in 2013, when prices moved between 78-83 on the low end and 89-92 on the top end.  Prices broke the longer-term uptrend at the end of last year and have since been consolidating in a triangle pattern.  Pay particular attention to the MACD, which is nearing a buy signal. 
     JNJ’s daily chart shows the company is trading right around the 200 day EMA, near yearly lows.  But with a 2.78% yield and solid earnings history, this price level looks very attractive, which is supported by this table from Morningstar:
The company’s PE is 27% lower than the industry average, despite having better revenue and net income growth.  And their ROA is 12.4 compared to the industry’s 7.3.  Despite being one of the largest companies in their industry, JNJ is undervalued.
JNJ the Company 
    JNJ is a multi-national health care company with three divisions: consumer products (~19% of sales), pharmaceuticals (~43% of sales) and medical devices (~38% of sales).  Each segment has international exposures.  All financial information will be analyzed at the consolidated level.
     It doesn’t get much better than JNJ’s balance sheet.  With a current ratio of 2.36 and quick ratio of 1.76, they have ample liquidity.  Accounts receivable decreased from 9.5% of assets in 2010 (which is still a very low number) to 8.3% in 2014.  Inventory has increased, but that statement is deceptive: it rose from 5.2% of assets in 2010 to 6.2% in 2014.  LTD only comprises 11.53% of liabilities.  And to be on the safe side, they have 99 days of cash on hand.  While the word “bulletproof” is a bit cliché, it clearly applies here.
     Solid financials don’t end at the balance sheet.  Top line revenue has grown between 3%-6% for the last four years.  While not a gangbusters pace, it’s impressive for one of the largest health care companies in the world.  Additionally, expenses are contained.  COGs has been very stable at 30%-31% since 2011.  Operating income has been a bit more variable, coming in between 23%-28% over the same period.  And net margin has fluctuated between 14% and 21% for the last four years.  Moreover, the dividend payout ratio is a solid 47.5% while the interest coverage ratio is 39, meaning the company has more than adequate resources to pay its obligations.
     And finally, we turn to the cash flow statement, where the company has free cash flow levels between $11.4-$14.7 billion for the last four years.  This is more than adequate to fund the $7.4 billion dollar dividend from current operations. It also means they have ample financial room to maneuver should they experience any problems.
     JNJ is a well-managed company with solid overall financials, growing earnings and strong cash flow.  Thanks to the global aging of various populations, the company's customer base will grow over the next decade.  And at current levels, the company is undervalued relative to its peers.  What's not to like?