August 12, 2009

Johnson & Johnson - part II

Part II of the analysis

Competitive analysis
The main competitors for the company are the other big pharma companies and the generic firms such as Ranbaxy, Sun etc. We can apply Michael porter’s five factor model to evaluate the company
Barrier to entry – All the segments of the company enjoy substantial entry barriers. The pharma and medical devices have formidable barriers in the form of patents and sales and marketing network. In addition any new drug or device requires substantial R&D expenses and infrastructure. The consumer segment has barriers in the form of Brands and distribution network
Supplier power – Moderate to low in this industry. Suppliers are mainly providers of basic chemicals or contract manufacturers. The value is derived from the IPR of the drug and not from the manufacturing.
Buyer power – Low in consumer goods. However in case of Pharma and the devices segments, national programs such as Medicare have a strong leverage and with escalating cost will attempt to drive down prices.
Substitute product – none
Rivalry – There is intense rivalry in the industry from other pharma majors who are attempting to develop a similar drug and especially from the generics where the price and profits drop by as much as 90% over the course of a few years as soon as the drug comes off a patent. In addition, the generic companies are constantly trying to challenge the patents too.

Management quality checklist
- Management compensation: The company has almost 215 Million outstanding options which would result in 2% dilution. The options do not appear to be excessive.
- Capital allocation record: Fairly good. The management has maintained an ROE in excess of 25%, low debt and a dividend payout of almost 40%. In addition, the management has been engaged in acquiring other pharma companies to pull gaps in its drug pipeline and added to it too.
- Shareholder communication: The shareholder disclosure is good with clear explanation of the benefits assumptions and IP R&D (in process R&D) calculations from the acquisitions.
- Accounting practice: The overall accounting seems to be conservative. However there are some areas of concern. For example – the company has assumed long term returns on plan assets of 9%. I think that is aggressive and could result in additional charges over the years. The IP R&D (in process R&D) charges do not appear to be excessive.

Valuation
The company has approximately 12 Bn of cash flow and is selling at around 13 times earnings. The company has shown a profit growth of almost 15% per annum with high degree of consistency. At the same time the company has maintained a high level of ROE during this period too. One cannot assume such a high level of profit growth in the future as some part of this has come from the increase in net margins. However with a conservative assumption of 6-7% growth, discount rate of 8% and CAP period of 10 yrs, intrinsic value can be estimated to be between 80-85 (PE of around 20).

The current valuation assumes a growth of 0 or worse and gives no value to the competitive advantage of the company. The company is currently selling at a 5 year low and appears to undervalued by comparative and absolute standards.

Conclusion
The company has performed well in the past in terms of fundamental performance. The sales and profits have grown at a double digit rate. In addition the company has a healthy drug pipeline at various stages of approval which could help in replacing the blockbuster drugs going off patent. The medical devices and consumer division provide stability to the earnings and help in reducing the risks of the pharma division.
The management has been a rational allocator of capital which is visible via the high dividend payout, above average ROE and sensible acquisitions. The company appears 20-30% undervalued compared to the intrinsic value which in turn can be expected to grow at 7-10% in the future.

A new addition: I have created a
pdf version of the analysis. Please feel free to download and share with others

17 comments:

dripo said...

http://www.valueline.com/dow30/f4979.pdf

If one buys in weak market ( low 50s), you can expect to make 15-20% annual returns based on a 3-4 years hold time. http://www.valueline.com/dow30/f4979.pdf

karthik said...

Hi Rohit,

Good analysis.. Iam not able to locate the stock in ICICI Direct or in Money control. Does it trade in Sensex?

Puneet said...

Dear Rohit,

I am very impressed by your analysis and worksheets. They are very thorough. Regarding johnson Johnson is it a publically traded company. If so on which stockj exchange is it listed NSE or BSE?

wbrgds
Puneet

Anonymous said...

since this is US listed company can i do a overseas investing in tis stock via icicidirect

Rohit Chauhan said...

Hi dripo
thanks for the link. i am not sure if we will get a price in low 50s unless we have a major drop in the marked
regards
rohit

Rohit Chauhan said...

Hi puneet / karthik
this stock does not trade on the nse or BSE. it is a US listed company.

anon - i have not checked the overseas investing via icici direct, but i think one should be able to buy this stock via that option.

regards
rohit

Puneet said...

Dear Rohit

Could you kindly briefly tell me for overseas investment mode. In case of overseas investment how is dividend paid out. What is the taxation of this dividend. Also can we readily sell any overseas stock purchase? Any weblinks which can update us on hot to invest in overseas stocks?


regards
Puneet

Rajiv said...

Rohit,

As a stock moves towards its intrinsic value, there is a temptation to exit a little before the final value is hit, especially if you have waited a long time for Mr. Market to come around.

I feel that as a value investor the sell decision is much tougher than the buy decision, because the buy decision usually comes with a big enough margin of safety. However, during the sale decision the market value may be stuck at Intrinsic Value minus 10%, making the investor quite jittery to sell.

Would be good to hear out your thoughts on this?

- from a fellow Value investor

Rajiv

Anonymous said...

Hi Rohit,
Recently read in news that Buffett has brought 4 million shares of JNJ. Looks like he is also following your blog :)

Sachin

Aniruddha said...

I Wish a Happy Independence day to Rohit & all Readers of Rhohit's blog.

Jai Hind

Rohit Chauhan said...

Hi puneet
i have will have to investigate more the questions you have asked. maybe some reader on this blog maybe able to answer the question more readily

regards
rohit

Rohit Chauhan said...

hi rajiv
let me respond to your question by a post.

sachin
i wish it was the case :)..its the other way round. i found jnj on buffett's portfolio and decided to analyse it

Rohit Chauhan said...

Hi anirudha

happy independence day to you and all the indian readers of the blog

rohit

Anonymous said...

rohit,

Do you mean that jnj is a buy at the current price of $60???\

Or do we need to wait for a certain price?

G

Aniruddha said...

Rohit
Did Buffet visit your blog?
=====
Josh Funk, THE ASSOCIATED PRESS
August 14, 2009
OMAHA, Neb. - Billionaire Warren Buffett's company revealed Friday that it had bought a new stake in medical supply company Becton, Dickinson&Co. and boosted its holdings in Johnson&Johnson during the second quarter.
Berkshire Hathaway Inc. disclosed those investments and several other changes to its roughly $49 billion U.S. stock portfolio in documents filed with the Securities and Exchange Commission. The filing offers a snapshot of the Omaha-based company's holdings as of June 30.
Berkshire reduced its holdings in CarMax Inc., ConocoPhillips, Eaton Corp., Home Depot Inc., and health insurers UnitedHealth Group Inc. and WellPoint Inc.
=====

Rohit Chauhan said...

Hi G
i dont give buy or sell recos. that is upto the reader to decide. what i can say is that the current price is cheaper than my estimate of intrinsic value

hi anirudha
its the other way round - i have been analysing jnj as buffett has a holding

regards
rohit

Rohit Chauhan said...

Hi G
i dont give buy or sell recos. that is upto the reader to decide. what i can say is that the current price is cheaper than my estimate of intrinsic value

hi anirudha
its the other way round - i have been analysing jnj as buffett has a holding

regards
rohit