Share tip of the week: Sick stock will deliver healthy returns
By
Paul Hill Oct 30, 2009
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A fortnight ago, Johnson & Johnson surprised Wall Street by reporting quarterly revenues down 5.3% to $15.1bn. They were dragged lower by adverse currency movements and a 14% plunge in pharmaceutical sales. Obviously not great news but, unlike some commentators, I am not overly worried.
Indeed, I sense a buying opportunity.
Not only is Johnson & Johnson the world's largest healthcare firm, with a market capitalisation of around $167bn, it's also a classic 'widows and orphans' stock, offering lower than average volatility. Sure, it might suffer a few setbacks, but over the long term I just can't see investors losing money. In fact, I think it will deliver annual returns in the low double digits for possibly the next 50 years. This is based on 7%-9% capital growth plus a 3%-4% dividend yield.
Its three main divisions – prescription drugs (36% of revenues), medical devices (38%) and consumer products (26%) – are all leaders in their fields and should be able to weather even the harshest of downturns. The dividend and earnings per share (EPS) have both risen for the past 47 and 25 years respectively. One of the reasons has been the group's immense geographical reach and wide product range – it doesn't rely on any single territory or sector. Around half of its revenues are derived outside America, and it sells around 100 drugs across nine treatments, generating turnover of more than $1bn.
Johnson & Johnson (NYSE: JNJ), rated a BUY by Argus Research
Thus, unlike many of its peers, it doesn't have to worry about being dependent on just one or two large blockbuster medicines. On top of that, Johnson & Johnson boasts a rock-solid balance sheet, a triple-AAA credit rating, $2.7bn of net cash and positive cash flow of over $1bn per month.
So why are the shares in the sick bay, trading on an undemanding price/earnings ratio (p/e) of 13, despite paying a healthy 3.3% yield? Well, most of this under-performance is down to Wall Street ramping up its risk appetite and selling defensives like Johnson & Johnson. This is unfair, given that the group is set to deliver 2009 sales and underlying EPS of $61bn and $4.60 respectively, rising to $63.8bn and $4.90 in 2010.
What should an investor watch out for? In line with the rest of its big pharma rivals, Johnson & Johnson's major threats come from generic competition, product pipeline setbacks, pricing pressures and tighter government legislation (particularly in the US).
Furthermore, Johnson & Johnson must successfully navigate the minefield of new rules being established as part of President Obama's healthcare reforms. Nonetheless, with its enormous research base and leading consumer brands, the firm is well placed to benefit from the long-term trends of ageing populations, improved lifestyle expectations and increasing healthcare demand from emerging markets.
Recommendation: BUY at $60
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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