In March, the current bull market will have reached the age of 11. This is already one of the longest bull markets in U.S. history. At some point, a recession will occur and stocks will decline 20%, 30% or even 40%.
While even the best companies won’t be spared from investors rushing to the exits, those companies that are best of breed, meaning they have businesses and characteristics that separate them from competitors, will continue to thrive. These types of companies are more likely to see growth in earnings per share even as the rest of the economy around them falters.
More importantly to dividend growth investors, these companies will continue to increase dividends. When a recession does happen, income investors who have a portfolio of stocks that can raise dividends will likely perform better than those that don’t.
This combination of earnings per share and dividend growth qualifies these types of companies as recession proof. One such company that I feel is the very definition of the term “recession proof” is Johnson & Johnson (JNJ, Financial).
Company background and recent earnings results
Johnson & Johnson was founded in the late 1880s. Over time, the company has become a worldwide leader in the health care sector. Today, the company trades with a market capitalization of $391 billion. Johnson & Johnson operates a diversified business made up of three reportable segments: pharmaceuticals, medical devices and consumer products.
The company is not without controversy. Johnson & Johnson’s baby powder has been the source of numerous lawsuits as plaintiffs allege that talc used in the product has caused cancer. Numerous verdicts have already been rendered, though some have been overturned on lack of standing on the part of plaintiffs. Still, there are 12,000 other lawsuits related to this issue still pending.
Even with this overhang, Johnson & Johnson had a very successful fourth quarter and full year. Earnings for the 2019 fourth quarter totaled $1.88 per share. This was 5% below the results for the previous year, but 1 cent above what analysts had expected. Revenue was up 2% to $20.8 billion, though this missed estimates by $80 million.
Earnings per share for full year 2019 increased 6% to $8.68, which was slightly above the company’s midpoint guidance. Revenue inched up 0.6% to $82.1 billion. Currency translation negatively impacted results by 2.6%.
As has been the case all year, pharmaceutical sales were the key contributor to growth. Sales for this segment were up 3.5%. Oncology (up 9.1%) and immunology (up 5.4%) continued to show gains during the quarter. Stelara grew 18% as more patients suffering with Crohn’s disease were prescribed the medication. Stelara was just given approval in Canada for treatment of adult patients with moderate to severe ulcerative colitis. Simponi/Simponi Aria, which is used in treatment for rheumatoid arthritis, was up 7% year over year as the number of indications was increased in the U.S. Darzalex, which is used to treat bone cancer, had sales growth of more than 40% as the product has taken market share in the U.S. and EU. Imbruvica, which the company shares with AbbVie (ABBV, Financial), had a 25% uptick in sales (Imbruvica treats lymphoma).
The consumer segment grew 0.9%. Over-the-counter sales were up 4.1% as Tylenol Rapid Release Gels increased its market share. Pepcid products also aided growth. Beauty sales improved 3.5%, led by strength in Neutrogena and Aveeno. Growth in this area was offset by an 11% decline in Baby Care, due to a combination of weakness in baby powder and tough year-over-year comparisons.
Sales for medical devices were down 0.5% in the fourth quarter as surgery was lower by 5.6%. This is this segment’s largest business. Partially offsetting this was a 12.8% improvement in interventional solutions, which had double-digit growth in Atrial Fibrillation and higher catheter sales. Orthopedics grew 0.5%, marking two consecutive quarters of higher sales for this business. International growth in knee procedures was the main driver of growth.
Johnson & Johnson has guided towards a midpoint for 2020 earnings of $9.03 per share and a midpoint for revenue of $85.8 billion. Each midpoint represents 4% growth from results for 2019.
However, while the company’s recent performance was solid, it is Johnson & Johnson’s performance during the last recession that really stands out.
Recession performance and growth opportunities
From peak to trough, the S&P 500 fell as much as 54% during the last recession. Shares of Johnson & Johnson fell 21% during this same period of time. The fact that Johnson & Johnson performed much better than the market index shows how well the company managed to hold up during the Great Recession. As to why, consider the company’s adjusted earnings per share results for the period of time covering before, during and after the last recession.
- 2006 adjusted EPS: $3.76
- 2007 adjusted EPS: $4.15 (10.4% increase)
- 2008 adjusted EPS: $4.57 (9.2% increase)
- 2009 adjusted EPS: $4.63 (1.3% increase)
- 2010 adjusted EPS: $4.76 (2.8% increase)
- 2011 adjusted EPS: $5.00 (5% increase)
- 2012 adjusted EPS: $5.10 (2% increase)
- 2013 adjusted EPS: $5.52 (8.2% increase)
Adjusted earnings per share increased every year through the recession. Even better, this growth in profitability wasn’t due to just share repurchases. Johnson & Johnson grew net income each year. This is a sign of an extremely well-run company.
Johnson & Johnson was able to improve its business during the last recession because its products were in high demand. When customers have a headache, they are going to reach for Tylenol. When children need medicine, they likely receive Motrin. When it comes to over-the-counter pharmaceuticals, Johnson & Johnson’s most recent quarter shows that its products are still in high demand, especially in the areas of immunology and oncology.
These traits help separate Johnson & Johnson from its competitors, and they are the primary reason that the company has managed to increase its dividend for so long.
Dividend analysis
Johnson & Johnson has increased its dividend for 57 consecutive years, which means the company has seen six different recessions and still managed to increase its dividend. According to the U.S. Dividend Champions, there are just 10 other companies in the market with at least this many years of dividend growth. No other health care company can match Johnson & Johnson’s track record for dividend growth.
Johnson & Johnson has increased its dividend by an average of:
- 6.3% per year over the past three years.
- 6.4% per year over the past five years.
- 7% per year over the past 10 years.
The company last raised its dividend 5.6% for the payment made on June 11, 2019. The most recent dividend increase is slightly below the averages lifted above, but I am willing to make that trade off given the company’s long history of growing its dividend. Shares yield 2.6% today, above the 1.8% average yield of the S&P 500.
Growing dividends through past recessions doesn’t mean much if a company isn’t able to do so in the next one. For a company’s dividend to grow in the next recession, the payout ratios must be healthy enough to overcome any potential decrease in either earnings per share or cash flow. Johnson & Johnson doesn’t disappoint in this regard.
Johnson & Johnson distributed $3.75 of dividends-per-share in 2019. This represented just 43% of the company’s earnings per share for the year. This compares very favorably to the 10-year average payout ratio of 47%. This is also below the company’s payout range of 44% to 54% over the last decade.
Johnson & Johnson hasn’t yet released figures for the fourth quarter, but the company paid out $9.8 billion in dividends over the past four quarters. The company generated $19.7 billion in free cash flow over the same period of time for a free cash flow payout ratio of 50%.
From 2015 through 2018, the company paid out $27.1 billion in dividends while producing $51.8 billion in free cash flow. The company had an average free cash flow payout ratio of 52% during this period of time.
The earnings per share and free cash flow payout ratios show that Johnson & Johnson is well-positioned to continue growing its dividend in the coming years
Final thoughts
Very few stocks are recession proof, as most decline in value when the economy slumps. There are, however, some companies that have a recession proof business. Johnson & Johnson's earnings per share results before, during and after the last recession are a testament to the company’s strength. Johnson & Johnson also has a very diverse business model, which helps when one segment of the company struggles.
Johnson & Johnson is a Dividend Champion, one of just a handful of U.S. companies that have increased dividends for at least five decades. This ability to raise dividends in the worst of times has made the stock a favorite amongst dividend growth investors.
In my opinion, having a business that grows during a difficult economic period and has a long track record of dividend growth qualifies Johnson & Johnson as the quintessential recession proof company.
Disclosure: I am long Johnson & Johnson and AbbVie.
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