(Published by Bob Ciura on July 13)
For investors looking for high-quality dividend stocks, the Dividend Aristocrats is a great place to begin your search.
The Dividend Aristocrats is a group of 51 stocks with at least 25 consecutive years of dividend increases.
Health care giants Johnson & Johnson (JNJ, Financial) and Medtronic PLC (MDT, Financial) are both on the list.
J&J is a member of an even more exclusive club: the Dividend Kings.
It has increased its dividend for 55 years in a row, compared with 40 years for Medtronic.
The Dividend Kings is a group of just 19 stocks, each with at least 50 years of consecutive dividend increases.
We will attempt to determine which of these two Dividend Aristocrats is the better buy right now.
Business overview
Winner: J&J
Both J&J and Medtronic are highly profitable companies, with leadership positions in their respective industries.
Medtronic is a global medical devices giant.
Source: 2017 Bernstein Annual Strategic Decisions Conference, page 4
There is some overlap between them, however. J&J also has a large medical devices business of its own.
The main difference between the two companies is J&J is much more diversified.
In addition to its medical devices segment, it also operates huge pharmaceutical and consumer health care businesses.
Source: 2016 Earnings Presentation, page 1
This gives J&J a structural advantage, which may be more attractive to investors looking for steadier growth. The company's diversification gives it more consistent growth.
Medtronic performed well in fiscal 2017, with 5% organic revenue growth for the full fiscal year. Adjusted earnings per share increased 11% to $4.60.
All four of Medtronic’s businesses generated growth, led by 4% organic growth in the minimally invasive therapies group and diabetes group.
Last year’s performance was highly impressive, although in fiscal 2016 the company's adjusted EPS increased just 2%.
While J&J did not quite match Medtronic in its most recent full fiscal year, it performed very well itself.
In 2016, J&J’s adjusted EPS increased 9% to $6.73.
Pharmaceuticals were its best segment last year, with operational sales growth of 12% followed by medical devices and consumer growth of 4% each.
Over the past five full fiscal years, J&J increased diluted EPS by 9% compounded annually. Medtronic’s GAAP EPS declined 14% over the past five years due to significant restructuring and amortization charges.
As a result, Medtronic’s earnings have been much more volatile over the past several years. J&J has a large consumer franchise, which gives it more consistent results from year to year.
J&J’s consumer business is loaded with popular household brands, including Johnson’s, Tylenol, Neutrogena, Listerine and Band-Aid.
Source: 2017 CAGNY Presentation, page 7
J&J has three individual consumer brands—Johnson’s, Neutrogena and Listerine—that each generate $1 billion or more in annual sales.
This helps the company be more resistant to recessions than it would be if it operated in a single-product market.
Separately, J&J enjoys unrivaled financial strength.
It is one of just two U.S. companies with the AAA credit rating from Standard & Poor’s. Medtronic has an A rating, which is strong but several notches below J&J.
Considering, according to S&P, J&J has a higher credit rating than the U.S. government, it is provided with a tremendous advantage.
Possessing the highest possible credit rating allows J&J to raise capital at very attractive rates, which it can use to pursue acquisitions or invest in research and development.
This also gives J&J an edge when it comes to future growth potential.
Growth prospects
Winner: J&J
While J&J’s consumer business provides it with great stability, its future growth engine is pharmaceuticals.
This is another advantage J&J has over Medtronic, which does not operate in the space. Pharmaceutical revenue rose at a double-digit pace for the company last year.
Revenue growth is poised to continue going forward thanks to the company’s strong drug pipeline and its $30 billion acquisition of Actelion.
Source: Acquisition Presentation, page 11
Actelion is a standalone R&D company that specializes in pulmonary arterial hypertension. This widens J&J’s pharmaceutical exposure into a focus area of significant unmet need.
J&J expects Actelion will add at least 1% to the company’s overall revenue growth each year. Earnings growth should be at least a point above this due to expected cost synergies.
This makes the acquisition very accretive to shareholders.
Plus, J&J has an excellent organic pipeline. Its two most attractive areas are oncology and immunology, which generated revenue growth of 24% and 15% in 2016.
Medtronic is no stranger to transformational acquisitions. In 2015, Medtronic acquired Covidien in a massive $43 billion deal.
Source: 2017 Bernstein Annual Strategic Decisions Conference, page 20
The acquisition significantly added to Medtronic’s product line.
In addition, the company has reaped significant cost synergies from the takeover, including $600 million in savings in fiscal 2017.
The cost savings are projected to wind down in 2017, however, to between $250 million and $275 million.
Still, J&J is expected to generate stronger growth up ahead.
On average, analysts expect J&J to increase EPS by 9% in 2017 and 12% in 2018. For its part, Medtronic is projected to grow EPS by just 5% in 2017 and 3% next year.
Dividend analysis
Winner: Toss up
When it comes to dividends, J&J and Medtronic are both appealing, for different reasons.
J&J is a stronger dividend stock for retirees or those interested in current income. It has a current dividend yield of 2.6%, roughly 50 basis points above Medtronic’s yield.
Medtronic has a 2.1% dividend yield, which is just on par with the S&P 500 Index average yield.
As a result, Medtronic may be less attractive for investors who want income right now. That said, it is a stronger choice for dividend growth investors because of its high dividend growth rates.
From fiscal 1978 to fiscal 2017, Medtronic grew its dividend by 18% per year on average.
Source: 2017 Bernstein Annual Strategic Decisions Conference, page 24
Over the past 10 years, J&J has increased its dividend by 7% per year on average.
Medtronic’s most recent dividend increase was 7%, which was below its average growth rate. Regardless, it still beats J&J’s most recent dividend raise, which was 5%.
Final thoughts
There is little doubt both Medtronic and J&J are high-quality businesses. Investors will likely do well with either stock.
That said, J&J may be the better Dividend Aristocrat to own. It has a higher dividend yield, a more diversified business model and a stronger growth catalyst in its pharmaceutical business.
For investors considering one or the other, J&J gets the nod.
Disclosure: I am not long any of the stocks mentioned in this article.
