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J&J Boasts Below-Market Earnings Multiple; Deal with Actelion Not Concerning

publication date: Jan 24, 2017
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author/source: Brian Nelson, CFA

Image Shown: J&J’s robust pharma pipeline; source: J&J

There’s a lot to like about J&J’s investment opportunity, not the least of which is its strong pharmaceutical pipeline. Deal-making could challenge its pristine balance sheet, but we don’t expect much to derail our thesis.

By Brian Nelson, CFA

J&J (JNJ) reported solid fourth-quarter 2016 results Tuesday, January 24. Uncertainty regarding the healthcare landscape in the midst of a Trump Presidency is the main dynamic weighing on shares, but operational sales growth of 2.3% and adjusted fourth-quarter earnings per share expansion of 9.7% weren’t bad by any stretch. They were actually quite good. We wonder if many portfolio managers are rotating out of some of the strong healthcare entities on the basis of political concerns rather than any tangible financial performance reasons.

J&J’s management spoke favorably about the performance of its ‘Pharmaceutical’ business, its ‘Medical Device’ business, and talked about share gains and enhanced profitability in its ‘Consumer’ division. For 2017, the consumer and healthcare giant is targeting full-year reported sales guidance in the range of $74.1-$74.8 billion, implying operational growth, excluding acquisitions and divestitures, in the range of 3%-3.5%, and adjusted reported earnings per share in the range of $6.93-$7.08 ($7.05-$7.20 on an estimated operational basis). Priorities remain set on delivering on its robust pharmaceutical pipeline, accelerating growth through innovation, while returning capital to shareholders (J&J has returned 70% of free cash flow to shareholders during the past 10 years).

Though shares are facing some selling pressure, J&J is now trading at ~16 times the high end of its 2017 bottom-line guidance range. The company’s cash and marketable securities total ~$40.4 billion, while long-term debt is ~$23.5 billion as of its latest regulatory filing—good enough for a substantial net cash position. That said, we continue to monitor news related to its potential $20+ billion deal with Swiss biopharma Actelion (ALIOY), but we don’t envision anything that would derail our thesis. J&J’s top line is increasing, free cash flow generation is fantastic, shares are trading below the market multiple on the S&P 500 (~17 times), and its net cash on its balance sheet makes the valuation consideration even more attractive.  

We expect J&J to remain a holding in both newsletter portfolios for the foreseeable future.


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