Johnson & Johnson (JNJ 0.82%) announced last year that it would be spinning off its consumer health business. The separation, which could take as long as 24 months to complete, will leave shareholders with some important decisions to make. Among them: Should they remain invested in both companies, one of them, or neither?
Let's take a closer look at whether the spinoff is a good move for the business, why the company is likely doing it, and if investors will be better off in the long run.
Image source: Getty Images.
Why is the company doing this?
Johnson & Johnson management says that hiving off its consumer health business into a new, publicly traded entity will leave the remaining operations better-positioned to serve patients and consumers, and give it the ability to "pursue more targeted business strategies and accelerate growth." Simplifying operations and focusing on core competencies can often lead to better results for businesses and their investors.
An unstated motivation may also be to get rid of some of its problems and negative press. The healthcare company announced in May 2020 that it was discontinuing the sale of its talc-based baby powder products in the U.S. and Canada, citing a lack of demand, which it blamed in part on consumers' changing habits and in part on the bad press it has received related to litigation. The company is defending itself against more than 21,800 lawsuits filed by plaintiffs who allege that J&J's talc products were contaminated by asbestos, which caused their cancers.
Johnson & Johnson has created a new subsidiary to put its talc liabilities into, LTL Management, which is filing for bankruptcy. That move could help lessen the impact of those financial concerns. But further distancing itself from its troubled consumer brand could still be a motivator, especially since its problems don't stop at those products. In July 2021, the company also announced a voluntary recall of Neutrogena and Aveeno aerosol sunscreen products after finding "low levels" of benzene, a known carcinogen, in some of its samples.
While Johnson & Johnson management says it believes both companies will be successful after the spinoff, investors shouldn't overlook the huge advantages for the parent company that will come from offloading a business unit that has been weighing down the overall company, both in terms of legal costs and negative press. In addition, the various businesses have had varying levels of success.
How the different segments of its business compare
Here's a quick overview of how Johnson & Johnson's main segments performed over the nine-month period ended Oct. 3, 2021. You can see that the consumer health business is the smallest of the three by revenue and accounts for an even smaller share of earnings:
| Segment | Sales | Growth (YOY) | Earnings Before Taxes | Profit Margin |
|---|---|---|---|---|
| Consumer health | $10.978 billion | 5.2% | $956 million | 8.7% |
| Pharmaceutical | $37.792 billion | 13.5% | $13.8 billion | 36.6% |
| Medical devices | $20.201 billion | 23.4% | $3.8 billion | 18.8% |
Table by author: Source: Company filings. YOY = year over year.
Is this a good move for Johnson & Johnson?
I'm a fan of companies not being overly diversified and focusing on their core competencies. In J&J's case, the consumer health business hasn't been a huge growth driver for the company, and considering the bad press it has been receiving, it's not likely that will change in the near to medium term.
By contrast, pharmaceuticals and medical devices generate more revenue for the business and are more profitable. In focusing on those segments, J&J can perhaps achieve better results in the long term. And that, in turn, may help garner more excitement for the stock. Johnson & Johnson's shares are coming off an underwhelming 2021 during which they rose by 8.7%, badly underperforming both the S&P 500 and the Health Care Select Sector SPDR ETF.
Is the stock a buy today or after the spinoff?
Johnson & Johnson's pharmaceutical and medical device businesses look solid. They contain the company's core operations, which could be a much better investment over the long haul, no longer weighed down by the consumer health segment, and operating eventually in a post-pandemic world where hospitals are functioning normally.
The consumer health business, however, is one I would avoid. It's not generating great growth numbers, and its profits aren't all that impressive either. The raft of lawsuits it faces only adds to the list of negatives. That's why I would wait until after the spinoff is complete before investing in Johnson & Johnson.
In terms of valuation, Johnson & Johnson's stock trades at a forward price-to-earnings multiple of only 16. That's modest in comparison to the 29 times future profits investors are paying for drugmaker Eli Lilly's stock. Without its consumer business, investors may be willing to pay more of a premium for Johnson & Johnson, which is why it could be a much better buy in the future.
