In many ways, healthcare conglomerate Johnson & Johnson (NYSE:JNJ) represents everything a risk-averse investor would be looking for in an investment.
Johnson & Johnson has been a picture-perfect investment
To begin with, Johnson & Johnson's business structure ensures that its earnings results are never compromised by a single puzzle piece. Comprised of more than 250 subsidiaries, J&J has the liberty to divest slower-growing and non-complementary businesses, and acquire complementary and faster-growing businesses, without disrupting its core operations.
Johnson & Johnson's three major business segments -- consumer health products, medical devices, and pharmaceuticals -- each serve a purpose. Consumer health is slow growing, but it's chock-full of healthy cash flow and strong pricing power. Medical device growth may be weak recently, but it's a long-tail growth opportunity with an aging population. And finally, pharmaceuticals provide the bulk of J&J's operating margin and growth.
The result is a consistently profitable company that has increased its dividend for 54 consecutive years and is one of just two publicly traded companies remaining with Standard & Poor's highest credit rating, AAA. As icing on the cake, J&J's beta of 0.4 (beta is a measure of volatility in relation to the S&P 500) implies it's a low-volatility stock, making it quite attractive to risk-averse investors.
Johnson & Johnson's reliance on pharma sales is climbing
But what if Johnson & Johnson wasn't such as a safe, low-volatility investment after all?
According to J&J's first-quarter earnings results released on April 18, pharmaceutical sales accounted for $8.25 billion of the company's $17.77 billion in total sales. This works out to 46.4% of J&J's quarterly sales, and it represents a high point in the company's reliance on pharmaceutical products to drive its top-line results.
In one sense, Johnson & Johnson is smart to have focused on pharmaceuticals in recent years. Specialty drug prices (e.g., cancer drugs) have been rising by a double-digit percentage annually, so it's in drugmakers' best interests to make use of these inherent advantages of selling branded drugs within the United States.
J&J has used both organic portfolio growth and acquisitions to supplement its pharmaceutical portfolio and pipeline. In fact, in January the company announced that it would be acquiring Swiss-based Actelion (OTC:ALIOF) for $30 billion. The acquisition gives J&J access to Actelion's lineup of pulmonary arterial hypertension drugs and a 16% stake in the upcoming spinoff of Actelion's developmental-stage therapies into a separate company.
Risk-averse investors may want to reconsider buying J&J stock
However, this growth engine is also a cause for concern for risk-intolerant investors. Once the Actelion acquisition closes sometime during this quarter, Johnson & Johnson will be generating between 48% and 49% of its total sales from pharmaceutical products. The pendulum is swinging away from J&J offering balance from its consumer health products and devices and further toward being ever more dependent on pharmaceutical sales to drive growth.
The danger in this is twofold. First, it leaves Johnson & Johnson more exposed than ever to the impacts of patent expirations. Understandably, J&J has a large product portfolio and pipeline, so it's not as if the wheels are suddenly going to fall off the bus. But, it's important to remember that branded drugs only have a finite period of protection from generic drugs. If J&J continues to lean more heavily on pharmaceuticals, its quarterly revenue figures could start getting a lot lumpier over the next decade as generic drugs begin to push its branded therapies out of favor. It could mean that J&J would have to get even more aggressive with acquisitions.
The other worry is that President Trump has taken exception to high prescription drug prices and targeted reform. Given the challenges the Trump administration has faced thus far, it doesn't guarantee that the president will have any success in reducing branded-drug pricing. However, it can't be ignored that he wants to focus on lowering drug costs. Even though J&J has been transparent with its drug costs, it could still be exposed to pricing restrictions if Trump gets his way. That's a concern given how important drug sales are to J&J's top and bottom lines.
The end result is we could see Johnson & Johnson's sales and stock price become more volatile in the years to come, which might make risk-averse investors think twice.
Don't discount this X factor
The one "X factor" that we can't discount for the time being is J&J's management team. Over 121 years, J&J has had just nine CEOs, eaxch of whom has done an exceptional job of keeping J&J on track. The company has seemingly had far fewer setbacks than its competition, and its 54-year dividend growth streak is a tangible indication of management's strategy in action.
Because Johnson & Johnson consists of so many subsidiaries, current CEO Alex Gorsky and his management team have incredible flexibility when it comes to acquiring and divesting businesses. If Gorsky sees the company becoming dangerously reliant on pharma, he and his team can always steer J&J toward other growth avenues.
As of this very moment, there's no reason for long-term investors to be overly concerned with J&J's reliance on pharma. Nonetheless, it is something that bears watching if J&J continues to increase the percentage of sales it derives from branded drugs.