Will This Healthcare Company Continue to Rally in 2012?
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Despite the bad rap Johnson & Johnson (NYSE: JNJ) had received due its product recall, the company's stock seem to have recovered in recent months. Further, this recovery was despite the decline in the company's sales compared to the parallel quarter in 2011. On the other hand, the rise in operating profits, mainly due to a drop in the company's G&A, contributed to the rise in the company's profits margins. Will the company continue to grow in the months to follow? Let's examine the recent changes in the company's financial reports.
The company has three main segments of operations: Consumer, Pharmaceutical and Medical Devices, Diagnostics. Based on the recent financial reports of the companies during the second quarter there was only a rise in sales in the Pharmaceutical segment. But the rise was only 0.9% in the second quarter of 2012 compared to the parallel quarter of 2011. Other segments' sales fell mainly due to the unfavorable changes in currencies. The table below summarizes these recent developments for these three segments. Nonetheless, the operating profit of the company rose by 11.6% from the parallel quarter of 2011. This figure may have helped rally the company's stock.
This means that one of the main factors that pulled down JNJ's performance in recent quarter were the changes in the forex market, mainly the depreciation of the US dollar against major currencies. The recent developments in Europe, including the ECB bond purchase plan that is likely to further restore confidence in the Euro, and the recent announcement of the FOMC to issue QE3, in which it will buy mortgage backed securities at $40 billion per month, are likely to further depreciate the USD in the months to follow. Assuming all things equal, this could suggest that the developments in the forex market could continue to adversely affect the sales growth of JNJ.
Another factor that could affect the company's growth is its investment in research and development: during the second quarter the provision for R&D rose by only 7.3% but was 6.1% lower than the parallel quarter of 2011. If the company won't raise its budget on R&D it could impede its future growth and the developments of new products.
Let's examine how is JNJ doing compared to its top competitors in terms of profitability and dividends: as seen in the chart below are the operational profitability of JNJ, Eli Lilly & Co. (NYSE: LLY) and Pfizer Inc. (NYSE: PFE). As indicated, JNJ is in the middle of the pack with an operational profitability of 25% in the second quarter of 2012 compared with Eli Lilly's operational profitability of 21% and Pfizer's 35%. In the previous two quarters, however the profitability of JNJ was higher than the two other above-mentioned companies. Further, the profitability of JNJ declined from Q1 2012 to Q2 2012. This decline did seem to curb the rally of JNJ's stock in recent months.
In terms of dividends, JNJ is currently offering the lowest yield of the three companies: the dividend yield of JNJ is 3.6%, Eli Lilly offers 4.2% and Pfizer offers 3.7%. This is another factor that should make JNJ less appealing as an investment than the other above-mentioned companies.
Shares of Johnson & Johnson have increased in recent months, since June JNJ's stock rose by nearly 11%, but they are still only slightly higher than their starting point from the beginning of the year. Further, JNJ has still under-performed S&P500 index during the year as indicated in the chart below of the normalized prices of S&P500 and JNJ as January 3rd, 2012. During 2012, the linear correlation between JNJ and S&P500 reached 0.63, which means that under certain assumptions nearly 40% of JNJ's stock volatility could be explained by the shifts in the S&P500. The strong correlation between the S&P500 index and JNJ's stock suggests that part of the rally of JNJ's stock in recent months may have been due to the recent recovery of the stock market.
The bottom line:
The decline in profitability may continue in the months to follow especially if the recent changes in the forex market will progress in the same direction, in which the USD is depreciating against the major currencies. The company's decline in R&D could also impede the company's developments in the years to come. This could suggest that if the company's stock will further rise in the months to come, it could be more likely due to the general rise in the stock market, e.g. S&P500 index, than the changes in the company.
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