Johnson & Johnson (JNJ, Financial) sits at the top of the healthcare sector with nearly $338 billion in market capitalization. That is more than a $100 billion higher valuation than pharma giant Pfizer. With more than $18 billion in operating income, JNJ is a cash flow generating machine that has withstood the test of time, increasing its dividends for the last 54 years. If you are a dividend hunter, you would have researched this company well before adding them to your portfolio.
Although I do not like Johnson & Johnson's increasing focus on the pharmaceutical segment, while its medical devices and consumer health unit edge lower and lower, I do not think that affects the ability of the company to keep growing. It does, however, change the risk/reward profile of the company, since the pharmaceutical industry has become extremely competitive. I have explained my reasoning in detail in my article Why Berkshire Hathaway Dumped Johnson & Johnson.
Revenue Growth
Johnson & Johnson's sales declined from $74.33 billion in 2014 to $70.07 in 2015, mainly due to the sales drop for the hepatitis C drug Olysio, that went from $2.3 billion in sales in 2014 to $621 million in 2015. Currency headwinds did the rest of the damage.
The company has reversed the slowdown this year, reporting a 2.3% sales growth during the first six months of the current fiscal year as sales reached $35.964 billion, from $35.151 billion in the year ago period - a period that saw consumer unit sales decline by 3.8%, medical devices decline by 0.8% and pharma sales grow by 7.4%.
The company is very obviously focusing on the pharma segment, which is the segment that has been growing for them in terms of sales growth, as well as contribution to overall sales. At the end of second quarter, their pharmaceutical unit accounted for nearly 47% of overall revenues and I expect this segment to contribute even more in the next few years.
Operating Margin and Operating Cash Flow
JNJ has been extremely consistent with its operating margins, keeping them well above 20% for the last ten years. That is a great achievement by any standards and one that highlights the care management takes to achieve bottom line results.
Though sales did decline during the 2014-2015 period, operating cash flow increased and, as you can see from the chart below, has been steadily increasing since 2006. Operating cash flow as a percentage of sales has also moved up, from 26.7% in 2006 to 27.5% in 2015. The increase might look small, but the key thing to note here is that they have improved both their operating margin as well as cash flow, while increasing sales - not an easy feat when you are trying to balance declining segments with growing ones.
Payout Ratio and Balance Sheet Strength
JNJ’s payout ratio has steadily increased in the last ten years, from below 40% to the current above-50% level. The company paid $8.173 billion in dividends in 2015, while their free cash flow stood at $15.816 billion - a free cash flow payout ratio of 51.6%.
At the end of second quarter, Johnson & Johnson had nearly $39.7 billion in cash on hand with long-term debt of $20.23 billion. Although most of that money is currently being saved for acquisition purposes, the balance strength is good enough for JNJ to keep paying and increasing dividends  for at least the next five years.
Disclosure: I have no position in any of the stocks mentioned and no intention to initiate any position in the next 72 hours.
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