Don't Underestimate J&J's Best-Known Products

In the second of a three-part series I take a closer look at J&J's (NYSE: JNJ) consumer segment to find out if it could make the stock take off.

Mar 28, 2014 at 6:30PM

Despite being one of the major pharma stocks in the world, J&J (NYSE:JNJ) is a very diversified company. For instance, the consumer segment accounts for a significant proportion of revenue and, as such, is a key component of future returns for the stock. Therefore, it seems logical to take a deep dive into the consumer segment to see how it fits into J&J's overall operations.

Sales growth
Consumer products accounted for just over 20% of J&J's total sales in 2013. Overall, the segment delivered mild growth during the year, with sales for the consumer segment being 1.7% higher in 2013 than they were in 2012. This marks a turnaround from 2012, when sales for the segment fell by 2.9% year-over-year. In 2013, three of the six franchises delivered year-on-year growth, compared to just one in 2012.

However, when the effect of currency headwinds is taken into account, the results look much better. That's because negative currency effects reduced sales growth by 1.1%, meaning the operational growth figure was 2.8%. Sales outside of the U.S. were relatively strong, with operational sales growth (i.e., excluding negative currency impacts) of 3.1%, while in the U.S. operational sales growth of 2.3% was reported.

Franchises and margins
In terms of franchise sales growth within the consumer segment, the over-the-counter franchise was the top performer and delivered sales growth of 7%, growth driven by analgesics and upper-respiratory products. Indeed, all franchises with the exception of oral care performed significantly better year on year from 2012 to 2013 than from 2011 to 2012, although oral care's growth was only marginally down and was affected by the divestiture of the manual toothbrush product line in the U.S.

Meanwhile, pre-tax margins showed improvement in 2013 and went some way to returning to their 2011 levels after falling in 2012. A key reason for the improvement was cost-containment initiatives, which the company is targeting more of in the future, as well as gains on the sale of intangible assets. As 2012 margin was impacted by write-downs, margin improvements in 2013 may not be as strong at first glance but still show that J&J is making progress in reducing its operating expenses.

The competition
With regard to competition, sector peer Merck (NYSE:MRK) also has a consumer segment, although it is much smaller than that of J&J and accounted for 4.3% of Merck's total sales in 2013. Unlike J&J, Merck reported a decline in sales for its consumer segment in 2013, with the top line falling by 3% compared to 2012 figures (including a negative currency impact of 1%). The main reason for this was the termination in China of certain consumer care distribution arrangements, as well as a reversal of sales that had already been made to these distributors. Excluding these costs, Merck's consumer segment would have posted sales growth of 1% (including the negative currency effect), which is still below that of J&J.

There is also a significant amount of crossover between J&J's consumer segment and Procter & Gamble (NYSE:PG), which is solely focused on consumer goods. It posted total sales growth of 1% in 2013, although as with J&J and Merck, there was a negative impact from foreign exchange, which reduced net sales growth by 2%. Were it not for this, Procter & Gamble would have recorded the highest sales growth of the three companies, being slightly ahead of J&J's 2.8% growth and well ahead of Merck's sales decline of 2% (figures exclude the negative impact of foreign exchange fluctuations).

The reason for Procter & Gamble's strong relative top-line increase was a mix of price and volume growth, with baby care and family care franchises showing strong volume growth in particular and health care also making improvements on the prior year.

Looking ahead
Although top-line growth at J&J was slightly below that of Procter & Gamble, 2.8% (excluding currency impact) is still relatively strong. Certainly, Merck's 2% decline (excluding currency impact) was significantly affected by one-off items, but it still shows that J&J's consumer segment is holding its own among peers.

Indeed, the consumer segment is an important part of J&J and, I feel, is often overlooked by some investors. That's because it doesn't provide the highs of the pharma segment, in terms of creating blockbuster drugs that can make a huge difference to an already vast top line. In other words, it isn't as exciting as the pharma segment. However, while it doesn't come with the highs, it also doesn't deliver the lows of patent expiry and instead provides stability, modest growth, and a reliable, repeat income for J&J.

As such, while the consumer segment may not be prove to be a super-hot catalyst for J&J in 2014, it plays a key role in diversifying the company's operations and in generating top- and bottom-line growth for the business. In the long run, this should be valued by investors and, I believe, will mean a strong showing from J&J's share price over the long run, too.

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Peter Stephens has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. It recommends and owns shares of 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.

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