Drip Portfolio Report
Tuesday, September 30, 1997
by Jeff Fischer (TMF Jeff@aol.com)


ALEXANDRIA, VA (Sept. 30, 1997) -- In 1996, sales at JOHNSON & JOHNSON (NYSE: JNJ) grew 14.7% to $21.6 billion after increasing 19.8% in 1995. The 1996 figure includes the results from the $1.8 billion acquisition of Cordis. This year Johnson & Johnson acquired Mycitracin, an antibiotic ointment, as well as rights to sell Motrin (ibuprofen) over the counter.

Rather than just seeking mergers with major health care companies, Johnson & Johnson is growing by forming partnerships with younger, small firms that develop new products that Johnson & Johnson can then take and quickly stuff through its distribution channel, offering instant worldwide exposure. Though, as stated yesterday in the Johnson & Johnson introduction, the company has also made thirty complementary acquisitions this decade, while at the same time spinning off divisions that didn't mesh with its business.

While sales grew 19.8% and 14.7% the past two years, earnings per share grew 19.2% and 16.7% respectively. With nearly half of sales coming from outside the United States, currency fluctuations can affect earnings per share significantly. In 1996, earnings grew primarily through sales volume increases, while pricing pressures kept margins on many products from improving other than through volume efficiencies. Meanwhile, return on shareholders equity has declined over the past three years, from 31% to 29%.

From yesterday, we saw sales in 1996 broke down as:

In 1996, the revenue broke down as:

                           1996 Sales

                        $ mil.   % of total
Professional products    8,068      37
Pharmaceuticals          7,188      33
Consumer products        6,364      30
                        -------
                        $21,620

Professional product sales grew 19.8% last year, pharmaceuticals 14.6%, and consumer product sales grew 9%. Recall from yesterday that we most want to see pharmaceutical sales growing, because that division has the best operating margins at 34%, compared to 17% and 5.6% for professional and consumer products, respectively. Johnson & Johnson spends over 9% of revenue on research and development, at around $2 billion last year. Our smaller healthcare considerations spend a greater percentage of sales on R&D, and Pfizer leads the way, expected to spend $2 billion itself this year, or nearly 17% of revenue.

The company is expected to grow earnings 15% annually over the next five years. Let's take a glance at Johnson & Johnson's primary products.

PROFESSIONAL: Accounting for 37% of sales and 33% of operating profits in 1996, Johnson & Johnson's professional products division sells suture and mechanical wound closure products, ACUVUE disposable contact lenses (which you might think would be considered a consumer product), cardiology and surgical instruments, joint replacements, blood glucose monitoring products (Abbott sells here as well), and products related to wounds and infections. The largest segment of the company based on revenues, professional product sales grew 19.8% last year, as stated, to $8 billion. The Pacific Rim fueled growth, as well as the merger with Cordis and continued growth of sales in cardiology products.

PHARMACEUTICAL: This division, at 33% of total sales and accounting for 58% of total operating profits, grew nearly 15% last year, to over $6 billion. The segment's primary worldwide products are in allergy (Schering-Plough's specialty), antibacterial (nearly all of our companies sell here), antifungal, biotech, central nervous system (Schering-Plough as well), contraceptives, and dermatology fields. The company sells over 90 prescription drugs -- 26 drugs had sales in excess of $50 million last year and 19 of those had sales above $100 million.

Suffice it to say, Johnson & Johnson is well diversified in the drug department, and at year-end the company had several new chemicals and compounds going through the FDA approval process. Research directly related to pharmaceuticals increased to $1 billion last year, or 15.2% of pharmaceutical sales. Research and development spending as a percent of pharmaceutical sales alone has compounded at 15.3% annually over the past ten years. Johnson & Johnson's 9% of total sales spent on research and development under-represents the amount that the company spends on researching pharmaceuticals alone.

CONSUMER: Finally, the division that you can talk to your kid about and he'll understand where you're coming from. The consumer division is often perceived as the "least important" to earnings at this company, as with all of our healthcare considerations. Here the merits of "repeat purchase consumer-oriented business" initially falls on its face when you consider the measly profit margins of 5.6%. The benefits of having millions of customers across the world making repeat purchases, though, and the resulting name brand recognition, are very important in leading to sales of the company's pharmaceuticals and professional products as well. So the division isn't so "unimportant" to the overall business as one might conclude, though it directly adds the least to annual earnings.

At 30% of total 1996 sales, or $6.3 billion, the consumer product division accounted for only 9% of operating profits. Products sold (in a price competitive environment) include ACT Fluoride Rinse, BAND-AIDS, Johnson's Baby products, Neutrogena skin and hair care, Mylanta, Pepcid AC, Imodium AD, Sundown products, Reach toothbrushes, and of course Tylenol, among several others. Sales in this division grew 9% last year. 50% of sales were international.

OVERVIEW: We know what our four companies do and where they make money (all of the the past recaps are available in the archives), and now we want to compare them, beginning with the numbers involved. These "snapshot" comparisons of numbers will serve to remind and to complement the knowledge that we have about the underlying business of each company. We're a day or two away from drawing conclusions, which we'll write about as we draw them -- on our way to a decision. We're also going to ask you which company you'd buy, as we make our decision.

1. Schering-Plough, which makes most its money in allergy-related drugs and has pharmaceuticals accounting for 90% of sales.
2. Pfizer, with cardiovascular drugs comprising a big bulk of revenue, and 72% of sales coming from pharmaceuticals.
3. Abbott, with four divisions each adding about an equal amount of revenue to the overall top line business.
4. Johnson & Johnson, the largest and most diversified company, with twice the sales of the second-largest company.

We're looking for the company most likely to grow earnings at a market-beating pace, improve margins among other measures, and provide the best return over the next twenty years. Tomorrow we'll look at comparative "snapshots" of our four considerations side by side.

Fool on!

--Jeff Fischer