Johnson & Johnson (JNJ, Financial) is one of those stocks that rarely produces a lot of excitement for investors; what you see is what you get. The healthcare and consumer products company produced yet another solid quarter (it seems to always beat analysts’ estimates at least slightly), but the market sent shares a little bit lower on Tuesday morning after the company lowered full year earnings guidance. However, we think that investors will find JNJ very appealing if they take a long term look at the company and their steady yet growing fundamentals.
In the first quarter, JNJ reported EPS of $1.62 which incorporates an after tax gain of $910 million awarded through litigation. For comparison sake, ex-items EPS of $1.29 is a more suitable picture of the company’s profitability, and that result was 2 cents better than Wall Street expected. Revenue of $15.63 billion matched expectations, as international operations carried the day. Domestic sales slumped 5% but the company was buoyed by 14.4% growth overseas. When adjusting for foreign exchange rates, revenue was just about even compared to last year. In terms of business segments, consumer products were stronger than pharmaceuticals with growth of 1.5% versus a decline of 2.5%. Generic competition to Topamax and Risperdal cut into sales, but strong growth from inflammatory disease treatment Remicade helped moderate the damage. Still, on a constant currency basis, drug sales would have posted declines of 5.7%, and remain the most glaring weakness in JNJ’s recent performance. Over the last four quarters, the medical devices and diagnostics devices has actually grown to be a larger division that drugs in terms of sales. That division posted impressive growth of 12.5% in the quarter.
Looking forward, the company revised their full year earnings guidance to $4.80 to $4.90, which compares to prior guidance of $4.85 to $4.95. On the surface this is a disappointment, but the company gave reasoning for the downward revision of $.05 related to negative currency movements and $.10 related to health-care reforms. So, after adjusting for these two external factors, Johnson & Johnson believes operations will claim $.10 greater profit than they had originally projected.
At Ockham, we continue to believe JNJ is Undervalued at the current price level, and this quarterly report only serves to back up our opinion of the stock’s valuation. The company does have weaknesses and it is not a huge growth machine, but there is certainly something to be said for consistency. When looking at how the market has historically valued the stock, the current valuation should appeal to investors looking for a buy and hold candidate. For example, over the last ten years the market has been willing to pay 13.4x to 17.4x multiple of cash earnings per share, but the current price-to-cash earnings is only 11.9x. Similarly, the current price-to-sales of 2.80x is not expensive when compared to the historically normal range of 3.16x to 4.09x. Given the current fundamentals, for the stock to trade at the low end of these historically normal range would imply a price of about $73 per share.
That kind of margin of safety is difficult to find in the currently overheated market; also consider that Johnson & Johnson pays a respectable dividend of about 3% if it takes time for the market to recognize that value. Being defensive in nature, this stock has woefully underperformed the red hot market over the last year. However, if you are interested in a safe place to stash some cash and not worry about it, you could do far worse than JNJ with its nice dividend and real potential for price appreciation.
Ockham Research Staff
http://www.ockhamresearchstaff.com
