What is Holding Back JNJ from Pulling Up?
Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The recent financial reports of Johnson & Johnson (NYSE: JNJ) for Q2 2012 showed the company came very close to Wall Street's expectations. JNJ's Sales reached $16.5 billion – a decline of 0.7% compared to the parallel quarter in 2011. But is JNJ doing well? The company’s response to this decline was mostly due to the negative currency impact. I think there is a much deeper fundamental problem the company is facing besides currency changes and economic slowdown: its the consumer industry. Let’s further explore these issues.
The company has three main lines of operations: Consumer, Pharmaceutical and Medical Devices, Diagnostics. No surprise, the consumer segment is the least profitable: in 2011 this segment's operational profitability was 14.1% (percent out of sales); each other segment's operational profitability was in the 20s. On the other hand, all three segments have demonstrated a decline in profitability. This is mainly because Research and Developments costs continue to rise at a higher rate than sales do.
During last year, Consumer's sales increased the least among the three segments. Further, this segment is also the smallest (in terms of sales, for 2011): Consumer sales reached $14.8 billion; Pharmaceutical sales, $24.3 billion; Medical Devices sales, $25.8 billion. The consumer segment represents 22.8% of the company’s sales.
One of the contributing factors for the modest growth rate in sales was the economic slowdown worldwide; further, as long as the U.S. and Europe will continue to dwindle, JNJ along with other consumer product companies may suffer. One indicator for the progress of the U.S. economy is the S&P500 index. During 2012 the correlation between thee S&P500 and JNJ is mid-strong at 0.64. During July the relation has gotten even tighter and reached 0.81. During the year (UTD) the company's stock didn’t outperform the S&P500 index: the stock price rose by 6.1%; the S&P500, by 6.7%.
If the S&P500 won't rally, it may suggest JNJ's stock won't trade up.
As seen above, the chart shows the strong relation between JNJ and the S&P500. It also shows the recent rally of JNJ's stock.
The forex markets are affecting not only the company's performance, but also the company's stock price: during June-July the linear correlation between JNJ's stock price and the Euro/USD (daily percent change) reached 0.65. This is a mid-strong correlation. If the USD will continue to appreciate, it could adversely affect the company's sales as it already did in the second quarter of 2012; this appreciation will reflect in the company's stock price.
Another factor to consider that could adversely affect JNJ is competition in the company's Consumer segment.
One of the properties of this market is a high level of competition, i.e. perfect competition. In such a case, there is little added value for branding especially when big competitors such as Kimberly-Clark Corporation (NYSE: KMB) also have high quality brand names that can compete with JNJ's branded products. This means, in such a market there aren't hedonic prices. In other words, people are less loyal to the brand and more attune to prices changes. This could explain the ongoing decline in JNJ's prices: the price fall caused sales to drop by 0.3% in 2011 and by 0.8% in 2010.
You don't see such behavior in markets where there are hedonic prices such in the tablets and Smartphones markets: after all when you buy an Apple (NASDAQ: AAPL) iPhone you pay an extra few hundreds dollars than you would for a less attractive Smartphones because you consider the price reflects the extra value you get in such a high quality product. This isn't the case when you buy baby powder…
If you also consider the rising competition from Asia and the increasing operational and R&D costs of the company, this could lead to a further drop in profitability in this segment.
The Foolish bottom line:
The decline in profitability may continue in all three of JNJ's business segments, but the consumer segment will remain the weakest of the three.
Besides the normal problems this company is facing such as the global economic slowdown and currency shifts, it also has a fundamental problem in one of its core businesses: the consumer segment. There are too many factors pulling down the profitability of this segment: the price battles are likely to continue; the competition from abroad (including Asia) is likely to intensify in the years to come; JNJ's operational costs and R&D will continue to go in one direction – Up. Thus the profitability and sales in the consumer segment are likely to shrink.
I guess there isn't much the company can do since the consumer segment is one of its core businesses. But when you consider this company as an investment you should take this issue into consideration.
For further Reading: Is Exxon Due for a Rally?
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
liorc has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Johnson & Johnson. Motley Fool newsletter services recommend Apple, Johnson & Johnson, and Kimberly-Clark. 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.If you have questions about this post or the Fool’s blog network, click here for information.