In My Opinion Evaluating Johnson & Johnson

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By Holmesie
January 15, 2002

[Editor's Note: The following is an analysis of Johnson & Johnson, performed in September 2001 by one of the co-leaders of our last Choosing Stocks online seminar. It was posted on our private seminar discussion board and is just one example of the value you'll get as a participant. Enrollment for our next Choosing Stocks seminar will end on January 23, so be sure to sign up today if you want a spot.]

There has been some great analysis of Ford, eBay, McDonald's, and Walmart during this seminar. For a change of pace I am going to offer an analysis of Johnson & Johnson (NYSE: JNJ), maker of my children's favorite form of "body art" (Band-aids), and currently one of the few holdings in my portfolio that is still positive for the last year.

Background

JNJ has slightly over 3 billion shares outstanding, and a market cap of approximately $161 billion. The principal activity of JNJ is the manufacture of health care products serving the consumer, pharmaceutical, and professional markets. The consumer segment includes personal care and hygienic products like oral and baby care products, first aid products, nonprescription drugs, sanitary protection products and adult incontinence products. The pharmaceutical segment includes allergy, antifungal, biotech, central nervous systems, contraceptive, dermatology, gastrointestinal and immunobiology fields. The professional segment includes suture and mechanical wound closure products.

Pharmaceutical products accounted for 41% of 2000 revenues; professional products, 35%; and consumer products, 24%. JNJ reports that it is the "largest medical device company," the "7th largest pharmaceutical company," and the largest: over the counter pharmaceutical business, disposable contact lens business, surgical suture business, and blood glucose monitoring business.

Evaluating the Industry

Threat of Entry
Pharmaceuticals offer a good threat to entry and comprise over 40% of the companies income. The pharmaceutical segment is also the fastest-growing segment of JNJ's business and given the gentrification of the United States, should continue to grow. It is extremely difficult and expensive to develop pharmaceuticals. It is a long process. Few companies can afford to jump into the pharmaceutical business. On the other hand, the consumer products segment does not offer much in the way of a barrier to entry. I think everyone can make baby shampoo.

Bargaining Power of Suppliers and Buyers
JNJ is huge. I expect that given its size that the bargaining power of its suppliers is minimized. In those instances where JNJ has competition for scarce resources (e.g., pharmaceutical patents that carry high fees), JNJ has purchased the entire company. JNJ's recent purchase of Alza Corporation is a good example.

Buyer bargaining power will vary. Pharmaceuticals can present a tremendous disparity in bargaining power. For example, if a child has attention deficit disorder requiring medication, there are only a few options. One of those options is Alza's (now JNJ's) Concerta (a competitor of Ritalin). Concerta uses a sustained-release formula that allows once-a day delivery. If medical professionals believe that this is a benefit their patient needs they will prescribe it. Consumer goods are another story. If JNJ raised their price on bandages or shampoo 20%, I am sure that the competition would see their sales increase as buyers considered other products.

Availability of substitutes
As discussed above, while the pharmaceutical and professional goods groups have a great deal of protection in the area of substitutes, the consumer goods group would not. Fortunately, pharmaceuticals and professional goods are the more profitable groups for JNJ.

Competitive Rivalry
There are a sizeable number of companies that develop pharmaceuticals, professional goods and consumer goods, and because these areas are so profitable, fierce competition exists. Some of the most promising companies in today's market are pharmaceuticals. Fortunately, obtaining a patent on a pharmaceutical product serves to protect JNJ from competition. It is an expensive and lengthy process for a competitor to develop a similar product merely to compete with JNJ. As discussed above, in the area of consumer goods, there is less of a barrier to entry, and therefore much more competition. Finally, JNJ reports that approximately 75% of sales are derived from products/ businesses that have a #1 or #2 global market share provision. Thus, if there is competition, JNJ is usually winning.

Brand Value
In health care, they have extremely high brand value, thanks in large part to their consumer goods divisions.

Growth Potential in Industry?
As mentioned earlier, the pharmaceutical industry is expected to continue to grow. U.S. demographics continue to point to high growth throughout the health care industry. Due to JNJ's position across the entire industry, JNJ's future looks strong.

Business Economics (High Margins or Profitable Business Models)
Margins in the pharmaceutical industry are high and JNJ has a 70% gross margin. Further, the pharmaceutical industry is recession resistant. Finally, JNJ has established a profitable business model -- to say the least -- by having its net income grow an average of 10.5% for the last 100 years.

Evaluating the Company's Quality

Business Model
JNJ is in a great position economically. It owns 190 companies that operate in 51 countries. It has developed a broad distribution and manufacturing system. Forty-four percent of its sales are outside of the United States. As mentioned above, JNJ's ability to provide goods to the health care industry through pharmaceuticals and medical devices offers it high margins.

Past Performance
JNJ has a tremendous history of growth. Its profitability has grown over the last several years; net income having risen 15.3% annually over the last 10 years. For an old corporation that one would think has reached its prime, it appears that JNJ is really just starting to realize its future potential.

Management Integrity and Honesty
The company's management has demonstrated a high level of integrity and honesty. JNJ's timely response to the Tylenol scare remains a lesson to other companies in crisis management. I also enjoyed reading Management's credo. Based on all that has been written about the company, it appears that they really do carry it out corporately.

Industry Leadership and Innovation
One doesn't make money in pharmaceuticals and medical services unless one is researching and inventing. JNJ spent $2.9 billion in Research & Development spending in 2000. The return on this research is demonstrated by the statistic that approximately 30% of products sold in 2000 were introduced in the last five years. In addition to research spending, JNJ continues to invest in new products, often through investments in start-up companies and acquisitions of more established companies (e.g., Centocor and Alza acquisitions). See, TMF Centaur's review of the Alza acquisition.

In conclusion, JNJ appears to look fairly "healthy" from an industry quality and company quality view. I'm looking forward to learning more about their finances in the coming lessons.

Enrollment for the January 2002 Choosing Stocks online seminar ends on January 23. Enroll today!

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