August 8, 2009

Investment idea - Johnson & Johnson (JNJ)

Johnson and Johnson (JNJ) is a US based pharma and healthcare company. The company has three primary business segments – consumer products, pharmaceuticals and medical devices.

The company had a revenue of 63 billion USD in 2008. The Consumer segment includes a broad range of products used in the baby care, skin care, oral care, wound care and women’s health care fields, as well as nutritional and over-the-counter pharmaceutical products. The Pharmaceutical segment includes products in the following therapeutic areas: anti-infective, antipsychotic, cardiovascular, contraceptive, dermatology, gastrointestinal,hematology, immunology, neurology, oncology etc . The Medical Devices and Diagnostics segment includes a broad range of products such as Cordis’ circulatory disease management products; DePuy’s orthopaedic products; Ethicon’s surgical care products ; Ortho-Clinical Diagnostics’ professional diagnostic products and Vistakon’s disposable contact lenses.

The company operates globaly in a predominantly decentralised structure with over 118000 employees.

The consumer segment had a global sale of 16 Billion in 2008 with a 10.8% growth. The company also acquired the consumer healthcare business of pfizer in 2007. The consumer segment had an operating profit of 16.7%, an increase of 1% over 2007.

The pharma segment had a sale of 24.6 billion in 2008, a decrease of around 1.2% over 2007. This business saw an increase in operating profit from 26.3% to 31% mainly due to writedowns in 2007.

The medical devices segment had sales of 23.1 billion with an increase of 6.4% over 2007. The operating profit increased from 22.3% to 31.2% in 2008 partly due to some litigation settlements in 2008 and some restructuring charges in 2007.

The company has maintained a high level of R&D investment (around 10% of sales or higher) during this period. This efficiency of this investment is evident from the drug pipeline of the company which consists of around 18 drugs filed or approved and almost 25 in the stage III trails.

On an aggregate basis, the company has has a very steady performance in the last 10 years and more. The ROE has ranged between 26-30% during this period. This improvement has been driven by an improvement in net margins from around 15% to 20%. The various asset ratios such as working capital turns has improved from low teens to around 30. The fixed asset turns has improved during this period too.

The company has maintained a healthy cash flow during this period and has had a dividend payout of almost 40% during this period. The balance cash has been used to pay off the small amounts of debt, invest in assets and make targeted accquisitions.The company is a zero (net basis) debt company and has a cash flow rate in excess of 10 billion per annum.

JNJ has several key positives as a business and over other pharma companies
- The company derieves around 30-32% of its revenue and around 40-45% of operating profits from the pharma business segment. Although the company faces the risk of its top performing drugs going off patent, the company has a healthy pipeline to manage this risk
- The company has a medical devices division which does not face the generic or patent risk of the pharma division and is fairly profitable.
- The company has a consumer products division with strong brands and an extensive distribution network which act as a hedge to the other segments.
- The company has a deep moat in all its business segments and sustaniable competitive advantage.
- The company has a decentralised operating structure with 250 operating companies across 57 countries across the the globe.
- The company has strong balance sheet and consistent cash flows. The net profit and cash flow has grown at around 16% per annum for the last 10 years. In addition the company has improved its ROE and other asset rations

The company faces the following key risks
- Several key pharma brands (in excess of 1 bn sales) such as risperdal and Topamax have lost patent protection in the recent and will face drop in sales and profits due to generics. Success of new drugs is not a given and only a few drugs in the pipeline may replace these blockbusters. In addition, there may be short to medium term dip before the new drugs replace the loss in sales.
- The global slowdown is likely to impact the topline and bottom line growth for the next 2-3 years
- The US market accounts for almost 14 bn in sales for the pharma division and 10Bn in sales for the medical devices division. Although I have not been able to find the numbers. the profitability of these divisions in the US is fairly high. This may be at risk due to the health care reforms in the US.
- The recession in the developed markets which account for major part of the sales and profit could keep the topline and bottom line subdued for the next few years.
- The company faces litigation risks related to product marketing, pricing, product side effects and patent issues. These risks are detailed over 3 pages of the annual report and are not easily quantifiable. The company has accrued liabilities against these risk and has stated that these risks in aggregate will not have a material effect on the financials.

next post : competitive analysis, management quality, valuation and conclusion


Daniel M. Ryan said...

Of course, health-care reform could engender baseless fears for the company's profits. The stock could be driven down to bargain levels as a result.

Anonymous said...

Hi Rohit,
I am one of the regular visitors of ur blog. Great stuff. I have this serious problem. Thought of getting your valuable opinion. In my opinion,these days, investing is more of a trading. I know one will get benefits in the long term. But when markets rise/fall like this, long term can get longer. So i am thinking of trading too. But only blue chips or mid caps that are proven. But i find it a little difficult to do this. Take BHEL for example. I want keep accumulating for long term and forget it. At the same time, i want to sell some off periodically. That makes things complicated. So how to go about solving this? Do you think having 2 separate demat account helps?
Please throw some light on this

Aseem Kapoor said...

I love your style and indepth analysis. I am a big fan, cant wait for the next post.

Rohit Chauhan said...

Hi daniel
yes, health reforms are a valid risk for the company.To a certain extent the market is pricing that risk.

Rohit Chauhan said...

Hi anonymous
it is tempting to trade especially with the kind of volatility we are seeing. however i have personally not been able to figure out how to be a long term investor and trade in and out of the market.
being a long term fundamental investor requires a specific mindset which somehow does not work for a trader. my solution has been to buy below intrinsic value and sell at or above this value irrespective of market levels. I am not by default a long term investor ..but base my buy and sell on fundamental value than price.
having 2 demat account may not change much ..the spilt in thinking has to happen in the head :)

Anonymous said...

Alright. Thanks a lot Rohit for ur inputs. Makes sense.
Thanks, Aditya.(Ano at August 08, 2009)

Vic said...

Thanks for great analysis Rohit..look forward to your next post.


Rohit Chauhan said...

hi vic
the next post will be charged ..bait and switch :)

just joking ..otherwise i may get an email (which has happened in the past) that i have turned to the dark side like darth vader or something :)