<THE DRIP PORTFOLIO>
The doc says: healthy but must exercise
by Jeff Fischer (TMFJeff@aol.com)
Paris, France (December 29, 1998) -- For the past twelve months (actually the past fifteen months), business has been lackluster for Johnson & Johnson (NYSE: JNJ) compared to industry peers. The stock has performed well anyway because management has been able to grow earnings per share 12.5% annually, on average, since 1995. However, recent events have brought to light some of the weaknesses of management.
Being slow to react to industry changes and slow to innovate, Johnson & Johnson paid a boatload of money for Cordis only to watch its share of the stent market quickly plummet from 70% to 10%. J&J probably overpaid for an aging product line and wasn't quick enough in revamping it. Equally unfortunate, several of the company's drug candidates have hit a wall on their way to reaching the market, either being denied FDA approval or showing weak late-phase trial data and thus being abandoned or setback significantly. As a result, J&J is thought to have one of the weaker drug pipelines in the business.
The beautiful thing is, though -- yes, I did say beautiful -- that the stock has still risen from the low $60s this year (it hit as high as $89 this fall, up 43%), and with dividends reinvested it's on track to return over 33%, beating the S&P 500 and a majority of stocks. Plus, this strong year was just more of the same. Over the last five years, good ol' J&J has averaged an impressive 33% annualized gain including dividends; over the last three years, 28%. These are giant returns for a giant company. Granted, we are in a bull market, blah blah. I know. However, for comparison, J&J has outperformed market leader Coca-Cola (NYSE: KO) the past five years. Coca-Cola's stock has gained 27% annualized versus J&J's 33%.
Why is J&J rock-solid even when many of its business lines are floundering?
Johnson & Johnson is such a large company with so many "lines" in the water that, even when several lines snap and big fish swim away, the company continues to sail and to keep fishing. What we want to see, though, is the company getting more lines in the water more quickly, and actually catching more big fish. Management, far from shipwrecked without a clue, completely agrees. It wants to add another few engines and several more fishing lines to its yacht and get this luxury cruiser moving more quickly. So what's in store for 1999? First, a quick look back at 1998.
Memories... of the way... we were...
Sales growth was anemic in 1998, largely due to weak foreign currency prices. J&J will achieve year-over-year total sales growth in 1998 of only about 2.4%. Revenue should inch ahead to $23.1 billion from $22.6 billion last year. However, almost a whole 5% of what would have been sales growth was eliminated by poor currency prices. In reality, sales volume should increase by some 5% to 7% this year. Not awful. In fact, that tops the performance of many international giants in 1998.
The company's strongest division was its pharmaceuticals, with its $1.4 billion Procrit drug leading the charge. J&J has three billion-dollar drugs on the market and all grew very strongly in the U.S. in 1998. Procrit (a red blood cell stimulant) will grow domestic sales around 26% this year, Propulside (mainly for heartburn) saw sales singe 22% higher, and sales of Risperdal (for schizophrenia) gained 16%. Johnson & Johnson's total pharmaceutical sales should reach $8.37 billion in '98, up 8.7%. They're expected to grow about 12% in 1999 and 12% more in 2000, to top $10 billion. We'll see what's in J&J's drug pipeline (in the works for the future) in a moment.
Professional products had been the company's largest division when measured by sales for years, but this year (not counting the DePuy acquisition) it appears that higher-margin pharmaceutical sales will bypass it. We're not complaining. The professional product division is composed mostly of stents, reconstructive implants, contact lenses (this is a huge untapped market -- no joking), blood glucose monitoring, endoscopy and sutures, among others. Sales should reach $8.2 billion this year, down 1.7%. Oddly, this poor showing isn't completely due to currency translations. International sales should rise 3.4%, but domestic sales will drop nearly 6% this year due to J&J getting hammered in the stent market. Excluding J&J's ugly Cordis division, professional product sales in the U.S. would have climbed about 7.6%, and total professional product sales would have gained over 6%.
Ahh... live and learn.
The largest breadwinners in the company's professional product business are sutures, with $1.5 billion in 1998 sales, and J&J Medical Systems, also above $1 billion in sales, though sales have been flat here since 1995. J&J's Lifescan business is also a one-billion dollar plus division, with 2% sales growth this year and 9% expected in 1999. And then there are contact lenses. Nearly 3 billion people in the world should use them, but only about 70 million people do (a majority of them being in the U.S.). This $2.5 billion market (of which J&J has about $900 million in market share) should grow to $5 billion by 2001.
We barely scratched the surface of that division, but we need to move to the next. We have years to study J&J, thankfully, because it's so large that we could write a 300 page report on it.
Consumer products, the company's smallest division which accounted for 29% of last year's sales, should see 1998 revenue of $6.8 billion, essentially flat. U.S. revenue should turtle-step ahead by 1.2% percent, but negative international sales will negate it. The Big Dogs in this division include Tylenol, with annual revenue of above $1 billion (Tylenol could be considered J&J's fourth billion-dollar drug, though it's an OTC drug), and baby toiletries with $350 million in '98 sales, followed by women's hygiene at $320 million. The company has several new products arriving from this division (some through a recent acquisition) and we'll get to some of them soon.
1998 in a Nutshell. With earnings per share set to rise 11% on slow sales, the year's largest events included the December announcement of a corporate reorganization. We've talked about this possibility since 1997. The company is streamlining (it always is) and is closing several branches across the world. This is a defensive move. Recognizing that it needs to grow earnings without the benefit of large sales growth, J&J is working to leverage its size and market position to create cost savings and cover its earning estimates for the next few years before it gets all of its engines firing again (hopefully).
Also significant, this year the company bought DePuy Inc. for $3.5 billion. This greatly rounds-out J&J's product line in orthopedic replacements, positioning the company to grab market share by offering complete solutions, more or less head-to-toe. J&J also battled with Amgen (Nasdaq: AMGN) and lost, as Brian covered last week, and it announced several small acquisitions and alliances this year, including the Johnson & Co. skin care acquisition first shared last week. J&J is smartly building a presence in the $47 billion skin care market, with flagship product Neutrogena having $300 million in sales.
1999 and the years ahead...
Sales growth should begin to accelerate now. It's estimated that in 1999 J&J will achieve actual sales growth (with currency prices included) of about 8%, to $24.9 billion, with earnings per share growing a market-beating 12.5%. Look at what lies ahead by division.
Pharmaceuticals are estimated to see sales climb 12% next year, up from 8.7% this year, as international sales increase again. Procrit is expected to grow 16% in '99, according to J.P. Morgan, with 25% growth in the U.S. (obviously Amgen isn't killing this drug yet). Risperdal should grow 16% and J&J's leading anti-infective drugs should see revenue jump 23%, give or take. The most important drugs in J&J's near-term pipeline include Aciphex/Pariet, a proton pump inhibitor, Cladribine, an antibody to treat multiple sclerosis, and Reminyl, for the treatment of Alzheimer's.
If all goes well, these three drugs combined could add $200 million in new revenue in 1999 and $650 million in 2000. Three other new drugs (which have begun to sell in 1998), and one bone marrow drug and one estrogen patch both expected to hit the market in 1999, along with new pharmaceuticals, could provide J&J with $535 million in new revenue in 1999 and $1.1 billion more in 2000.
Professional products are estimated to see sales growth of 6.0% next year, up from a decline in 1998. The company is launching three new stent products in the first quarter of 1999, Crossflex and Mini-Crown, as well as a heparin-coated Mini-Crown. These should help, but the stent division (Cordis, with $900 million in sales) will still lag. (We'll be watching for Cordis's new radiation solutions in 2000 and beyond.) Elsewhere, growth should come from a new Dermabond product (a wound closure solution), as well as past strong markets that continue to grow (including blood glucose monitoring if it stays the course). Then there is the recent DePuy acquisition, which gives J&J 23% market share in orthopedic replacements. DePuy should add $900 million to 1999 sales, but won't likely add to earnings until 2000.
The consumer product division has several new offerings arriving in 1999, all of them likely helping sales to grow again. Also, costs here should decline as the company restructures, so margins could improve. New products include Benecol, a "nutraceutical" meant to reduce the absorption of cholesterol in the body, and Sucralose, a noncaloric sweetener with several uses. It already sells under the name "Splenda" in many markets. Renova, Nizoral shampoo, and bifocal contact lenses also offer new revenue streams. All told, consumer sales could hit $6.8 billion next year, up 5%.
J&J is as healthy as a giant is large, but it does need to beef up its new product arsenal and it is working to do just that. We made it through 1998 with the stock rising some 30%, and 1998 was arguably the weakest year for the business (in sales growth) for several years. It won't be the worst year for the stock (obviously), because the stock will decline some years, but still... we can always say that we plodded through this "slower" time period and made market-beating returns by DRP-investing into the stock. Because we have, so far.
Overall, the company is healthy and we're happy to keep slugging more money into it. We're hoping that its three key new drugs come to the market soon, and that more enter the pipeline very soon. Meanwhile, J&J has a solid foundation upon which to build, and with its aggressive R&D spending, it surely will, given time. Also, its recent move to reorganize and cut costs is also smiled upon.
The stock, around $80 per share, trades at 26.5 times the $3.00 to $3.05 per share earning estimate for 1999. This premium to the company's 12.5% long-term growth rate seems very reasonable, especially given J&J's relative certainty to produce healthy returns over the long haul. (For much more on the pharmaceutical industry, check out the Fool's new Industry Focus 1999, just shipped yesterday.)
Tomorrow, Dale will cover Mellon Bank (NYSE: MEL), and the next day Brian will return to wrap up a successful 1998 for us. Here's to a wonderfully Foolish 1999! Until then, take care! (To discuss J&J and Drip companies with other Fools, please visit the message boards linked in the top right of this page.)
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