The Good of J&J
...which will be followed by the bad

by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA (Oct. 21, 1998) -- As promised, today we begin to diagnose Johnson & Johnson, pro and con, before greasing up for our next area of study (oil).

Our second purchase and second-largest position, Johnson & Johnson (NYSE: JNJ) has been our most successful investment, rising steadily but not ascending too quickly that we weren't able to buy shares at better prices. Our average cost per share is $71.40, and the stock is currently near $81.

For a giant Dow company that we only began to buy in earnest in January, the 14% difference between our dollar-averaged cost and the market price is much larger than one would expect. A Foolishly patient investor expects these two numbers (cost basis and market price) to closely mirror each other for a few years -- especially when buying slower-moving $100 billion companies on a monthly basis.

Helping our cause, Johnson & Johnson was one of the lower-priced pharmaceutical leaders when we began to purchase it, trading at 21 times 1999 earning estimates. It now trades at 26.8 times 1999 estimates. The stock has gained 24% this year, not including dividends, while the company has been able to grow earnings per share 12% despite weak international economies and very poor currency translations. Both of these situations have impacted sales negatively all year. But while Coca-Cola, Gillette, and other international giants are experiencing flat or negative earnings growth, continued double-digit EPS growth is being achieved at companies like J&J and Pfizer thanks to new pharmaceutical sales.

When it comes to drugs, Johnson & Johnson has some standouts. Sales of Risperdal, a schizophrenia drug, were up 29% worldwide as of the second quarter, and the product now has 25% market share. Risperdal is benefiting from a lack of competition from Pfizer's Zeldox drug, because earlier this year Zeldox was given a nonapproval rating due to side effects. Other major J&J drugs include Procrit for anemia (worldwide sales up 23% in Q2) and Duragesic for pain (sales up 45% in Q2). Other drugs: Floxin/Levaquin sales rose 73% worldwide in Q2, Ultram sales rose 30%, and Procrit revenue rose 16%. (I don't have exact Q3 sales figures yet -- we'll address this unfortunate situation in a coming column.)

Total sales in the pharmaceutical division rose 26% in the U.S. in Q2, and 16% domestically in Q3 (the larger jump in the second quarter was due to early buy-ins from customers who were expecting price increases). Worldwide, J&J's pharmaceutical sales rose 9.4% in Q3. This type of sales increase (for any division) is uncommon for giant international companies this year. Many U.S. internationals, other than drug firms, are seeing flat to declining sales worldwide.

Can sales growth continue for Big J?

Johnson & Johnson has several promising drugs in the pipeline, including Ergoset for type 2 diabetes, and Cladribine (say that word fast ten times) for all types of multiple sclerosis. The company also has a promising new product called Dermabond. This is an adhesive that can replace stitches in up to 30% of all laceration cases (there are 12 million annually). Other drugs in the pipeline include treatments for ulcers, contraception, hormone replacement, and constipation, to name some. Finally, in early 1999 the company should launch Benacol, a new nutritional product. It's a margarine-like spread that can help patients actually reduce bad cholesterol levels. Also of note, Risperdal is in tests for indications in bipolar disorders as well as conduct disorders involving mental retardation. This drug is already selling very well for schizophrenia.

Yet, not all is roses at Johnson & Johnson. In fact, some divisions smell as sickly as a hospital. Tomorrow Brian Graney (TMF Panic) will provide a bearish Drip Port column on Johnson & Johnson. (The two of us are battling over the company in a Dueling Fools soon.) What ails J&J? I'll be the first to admit, as will management, that performance is weaker than a broken leg in many areas.

The professional products division is under siege, while growth in the consumer product division is non-existent.

Focusing on the former, worldwide professional product sales declined over 8% in Q2, though the bleeding slowed and sales fell only 2.2% in Q3. Even so, revenue at J&J's Cordis division plummeted 39% in Q2, with a giant 52% decline in domestic sales. Cordis is facing intense competition in the stent business. Before discussing this issue and others, though, let's see what negative arguments Brian will share tomorrow (I haven't read his column yet), and then we'll address his topics in a following column. I believe -- because Johnson & Johnson is addressing its own weaknesses as we speak -- that we'll be able to address the many weaknesses that Brian raises, too.

For comments, questions, or discussion, please visit the Drip message boards linked in the top right of this page. For more discussion of Johnson & Johnson specifically, check yourself into the J&J message board. We'll be there to greet you. If you have anything to add to our diagnosis, or vital questions to ask, please don't hesitate to post.

Fool on!

--Jeff Fischer

FoolWatch -- It's what's going on at the Fool today.

10/21/98 Close

Stock Close Change CPB 55 15/16 - 1/2 INTC 87 1/16 +2 1/2 JNJ 80 13/16 - 7/16
Day Month Year History Drip 1.02% 3.79% 16.30% (0.96%) S&P 500 0.56% 5.20% 10.25% 12.46% Nasdaq 2.17% (1.13%) 6.65% 5.08% Last Rec'd Total # Security In At Current 09/02/98 8.027 CPB $52.867 $55.938 09/01/98 9.727 INTC $80.238 $87.063 10/07/98 7.850 JNJ $71.405 $80.813 Last Rec'd Total # Security In At Value Change 09/02/98 8.027 CPB $424.36 $449.01 $24.65 09/01/98 9.727 INTC $780.50 $846.89 $66.39 10/07/98 7.850 JNJ $560.53 $634.38 $73.85 Base: $2000.00 Cash: $186.08** Total: $2116.35

The Drip Portfolio has been divided into 85.474 shares with an average purchase price of $23.399 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

**Transactions in progress:
9/21/98: Sent $77 to buy/enroll in MEL.