Johnson & Johnson (JNJ -0.46%) is one of the healthcare sector's largest and most entrenched companies. However, with the 135-year-old behemoth spinning out one of its businesses into a standalone company later this year, shareholders could own shares of two different businesses.
While that could sound confusing, or perhaps too good to be true, it need not be. The precursor to getting the most out of your investment in this company is by understanding what's going to happen with this stock. So let's map out Johnson & Johnson's near-term future and explore how this could be a great opportunity for your portfolio.
This year will see J&J's biggest changes in decades
The once-in-a-decade opportunity with Johnson & Johnson stock stems from its plan to spin off one of its slower-growing segments. In short, the company will soon split into two public businesses, with one portion focusing on developing new medical devices and pharmaceuticals that'll retain the J&J name, and the other focusing on consumer health goods like over-the-counter medicines and Band-Aid.
The potential benefits to be reaped from the spinoff should be one of the primary investment theses for buying J&J stock right now (or, in the next few months). Whereas the "legacy" company (as it has existed for the past few decades) has been forced to split management's attention and resources between maintaining its consumer health brands and investing in pharmaceutical research and development (R&D), the new standalone entities will be able to focus on a smaller set of priorities. That should drive more meaningful growth and, hence, better returns for shareholders. Compared to the legacy Johnson & Johnson, the new company will be able to allocate capital more aggressively, perhaps by making more acquisitions of promising drug programs. Likewise, Kenvue, the new consumer health goods entity that'll be spun off, might be able to return more capital to its investors as proceeds from sales of its eternal brands continue to trickle in over the years.
The separation is planned to occur sometime before November 2023, which means that investors have at least a few months to contemplate if they want to start a new position in J&J stock in advance of the separation. Owning the stock today will grant investors shares of both entities when the split happens, though there's likely plenty of upside in store for those who would prefer to invest in only one of the pair in the aftermath.
Kenvue will own the rights to brands you probably recognize, like Listerine and Tylenol. Sales of those products brought in just over $15 billion in revenue and a touch more than $2 billion in net income for 2022. Investors probably shouldn't anticipate rapid growth, as demand for moisturizers and nonprescription painkillers is unlikely to rise anytime soon. In contrast, management thinks that J&J's pharmaceutical division could make around $60 billion in revenue by 2025, and its medicines sold more than $13.2 billion in Q3 alone. For now, the expectation is that the size of the combined dividends of both businesses at the time of the spinoff's completion will be equal to that of J&J today. However, it's likely the payouts will increase at different rates thereafter, and their dividend yields may differ considerably right off the bat.
What are the risks?
Such a major shift in J&J's business model entails a few risks. Management freely admits that the separation will cost money to implement, and it could also entail a significant tax liability. It's unclear precisely how much money might be spent, not to mention how much cash Kenvue will be taking with it when it leaves, but today J&J has more than $34 billion in cash and equivalents to go around. It also has roughly $32 billion in total debt.
Furthermore, there's no way to know precisely how the market will value the two new stocks, and it's possible that share prices will fall immediately. Given that J&J's market cap of around $468 billion will be split (inequally) between the two, both will remain among the largest healthcare companies in the world, more or less, no matter what happens.
The risks faced by the businesses after the separation will be similar to what investors are accustomed to with the legacy stock. Kenvue could fail to find new sources of growth, or rising costs of its inputs could drive it into unprofitability. J&J's pharmaceutical projects might falter in their clinical trials, disrupting its growth trajectory for years. But investors who buy shares of Johnson & Johnson before the spinoff, not to mention all of the legacy shareholders, already face these risks. Overall, it's a reasonably safe investment, which won't change once that business is divided into two.
And if management's plan comes to fruition, both companies might end up being even safer by becoming more efficient post-spinoff. Given J&J's track record, betting on its success seems a smart move, especially when there's a chance for things to get even better in the next few years.
