This Healthcare Giant Needs to Focus on Organic Growth

Dr. Osman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Johnson & Johnson (NYSE: JNJ) is a research-and-development-led company that has been providing health care and consumer products for the past 126 years. In the company’s third-quarter earnings report, Johnson & Johnson surpassed analysts’ estimates and boosted its full-year forecasts on the back of solid sales.

The approval of prostate cancer drug Zytiga, stroke prevention drug Xarelto, and psoriasis drug Stelara have helped the company to gather more than $17.1 billion in revenue during the third quarter. Johnson & Johnson purchased Synthes, a multi-national device manufacturer earlier in the year, which was the single largest acquisition in its 126-year history. The benefit of the buyout has been instantly visible, as JNJ reported a 12.5% third-quarter increase in medical device sales due largely to its newly integrated orthopedics segment.

Future Prospects

With a 3.41% dividend yield, Johnson and Johnson has been a great dividend stock for a long time. In April, it increased its dividend by 7% – the fiftieth consecutive annual increase. Furthermore, it is one of the few companies with an AAA credit rating, thanks to its strong cash flow and balance sheet. The company can afford to spend big to streamline product development for the future, as is shown by the Synthes purchase. Over the next three years, plans are in place to file for more than ten new drugs and over thirty line extensions for the marketed drugs. More importantly, the company’s research and development is bearing fruit, as sales for its newly introduced prescription drugs increased by 7%. With the acquisition of Synthes, the world's largest manufacturer of implants to mend bone fractures and producer of surgical power tools and advanced biomaterials, expect a positive addition to JNJ’s earnings.


The company has lost revenue capacity due to the expiration of the Concerta, Levaquin, and Invega patents in 2011. Aciphex will lose its patent exclusivity in 2013, and the company’s biological drug treatment for Crohn’s disease will lose patent protection in 2014. JNJ was forced to recall 157,000 surgical staplers used in hemorrhoid treatment after the Food and Drug Administration issued severe safety warnings on the products. Furthermore, 845 Luevaqin lawsuits have also been settled based on the customer not being informed about the risks of tendon damage after consumption of the drug.

Johnson & Johnson Vs. the Rest

In the pharmaceutical industry, Novartis (NYSE: NVS) and Merck (NYSE: MRK) provide stiff competition to Johnson & Johnson’s operations and market presence. The table below lists key statistics regarding the trio’s performance.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Johnson & Johnson</strong></p> </td> <td> <p><strong>Novartis</strong></p> </td> <td> <p><strong>Merck</strong></p> </td> </tr> <tr> <td> <p>Market Cap</p> </td> <td> <p>$192.1 B.</p> </td> <td> <p>$142.8 B.</p> </td> <td> <p>$131.8 B.</p> </td> </tr> <tr> <td> <p>Trailing P/E</p> </td> <td> <p>22.7</p> </td> <td> <p>16.7</p> </td> <td> <p>19.6</p> </td> </tr> <tr> <td> <p>P/B Ratio</p> </td> <td> <p>3.0</p> </td> <td> <p>2.1</p> </td> <td> <p>2.4</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>3.41</p> </td> <td> <p>4.21</p> </td> <td> <p>3.90</p> </td> </tr> <tr> <td> <p>Debt/Equity</p> </td> <td> <p>0.2</p> </td> <td> <p>0.2</p> </td> <td> <p>0.3</p> </td> </tr> <tr> <td> <p>Return on Equity</p> </td> <td> <p>13.6</p> </td> <td> <p>13</p> </td> <td> <p>12.2</p> </td> </tr> </tbody> </table>

The three competing giants are very closely matched in most measures. They share the same philosophy of taking on as little debt as possible. The trio is very conservative in this regard, and thus their growth fortunes should also be kept in check. Over the past three years, the earnings growth shown by Johnson & Johnson has been overshadowed by that of Novartis, which had a meager growth percentage of only 2%. However, compared to Johnson & Johnson’s (8.6%) and Merck’s (17.8%), Novartis is the clear-cut choice.

The deciding factor between the three companies is the dividend yield being offered on their stocks, and Novartis also leads the way in this regard. From an investor viewpoint, Johnson & Johnson is not the best option from a purely dividend perspective. Its yield is overshadowed by Novartis, which offers a better dividend yield. However, Johnson & Johnson has a long history of dividend hikes, which makes it a perfect dividend growth stock.

Foolish Summary

Recent quality hiccups for the pharmaceutical giant are alarming in their extent, but still have dented neither the company’s financials nor its stock performance. Perhaps Johnson & Johnson is too big to be brought down by such failures, but at the same time it seems to be too big to launch itself forward. The trend of spin-offs being followed by its competitors such as Abbott (NYSE: ABT) might be a plausible strategy for the company to consider. Abbott has decided to unleash more investor value by dividing itself into two companies. We have yet to see the benefits from an investor's point, but the long term prospects look good for both Abbott and its spin-off.  Such moves are likely to be beneficial for the long-term outlook of Johnson & Johnson. I think it is better to get focused on organic growth and eliminate reliance on acquisitions and mergers.

ecofinstat has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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