Pat McKeough responds to many personal questions on buying stocks and other investment topics from the members of his Inner Circle. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week, we offer you one of the highlights from these Q&A sessions. While we reserve our buy-hold-sell advice for Inner Circle members, these excerpts provide a great deal of information and analysis on stocks we’ve covered for the Inner Circle.
This week we received a question from an Inner Circle member about an American stock that is literally a household name. Like many large U.S. consumer stocks it now generates more sales internationally than at home. While it has moved forward with a new acquisition, it is also recovering from a number of product recalls.
Q: Pat: Can I have your recommendation on Johnson & Johnson? Thanks as always for your advice.
A: Johnson & Johnson (symbol JNJ on New York; www.jnj.com) has three divisions: Consumer (including products for babies, skin care, oral care and wound care), Pharmaceutical (which makes anti-infective, antipsychotic, contraceptive, dermatological and gastrointestinal drugs) and Medical Devices & Diagnostics (which sells equipment for circulatory disease management and orthopedic joint reconstruction).
In June 2012, Johnson & Johnson paid $20.2 billion—$19.7 billion in cash plus $500 million in stock—for Synthes, Inc. However, this company held cash of $2.7 billion, so the actual cost was $17.5 billion.
Switzerland-based Synthes looks like a good fit with Johnson & Johnson: the company makes a wide variety of medical devices and surgical tools, including implants that help bones heal. To win regulatory approval for the purchase, Johnson & Johnson agreed to sell Synthes’s trauma division, which makes plates and screws for broken bones.
The purchase had little impact on Johnson & Johnson’s sales in the three months ended July 1, 2012: the company’s sales declined by 0.7% in the quarter, to $16.5 billion from $16.6 billion a year earlier. That’s mainly because the higher U.S. dollar hurt the contribution of its overseas operations; Johnson & Johnson gets roughly 60% of its sales from outside the U.S.
If you exclude unusual items, such as costs related to the Synthes purchase, earnings rose 2.7%, to $3.6 billion from $3.5 billion. Because of more shares outstanding, earnings per share rose just 1.6%, to $1.30 from $1.28.
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Johnson & Johnson works on strengthening its drug pipeline
Because Johnson & Johnson mostly paid cash for Synthes, its long-term debt of $17.6 billion remains low, at 9.2% of its market cap. Even after the purchase, the company holds cash of $16.9 billion, or $6.14 a share. However, the acquisition pushed up its goodwill by $5.4 billion, to a total of $21.4 billion, or 11.2% of market cap.
The company’s Consumer division is the most stable part of its business, but it is still suffering from the effects of a number of product recalls.
In addition, the company continues to work on strengthening its drug pipeline, which has been a weak point. It’s now working on several promising new drugs, including Preszista for HIV, Xarelto for stroke prevention, Invega for schizophrenia and Zytiga for prostate cancer. Johnson & Johnson spends around 11% of its sales on research.
The stock trades at 13.4 times the $5.07 a share that the company will probably earn in 2012. The $2.44-a-share dividend yields 3.6%.
In the most recent Inner Circle Q&A, Pat looks at whether Johnson & Johnson can counter sluggish growth in the U.S. with improving international sales. He also examines whether the company has yet regained consumers’ trust after its product recalls. He concludes with his clear buy-hold-sell advice on this stock.
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