Image Shown: Johnson & Johnson reported strong performance across its three core business operating segments in the third quarter of fiscal 2021. Image Source: Johnson & Johnson – Third Quarter of Fiscal 2021 IR Earnings Presentation
By Callum Turcan
On October 19, Johnson & Johnson (JNJ) reported third quarter earnings for fiscal 2021 (period ended around the end of September 2021) that missed consensus top-line estimates but beat consensus bottom-line estimates. The healthcare giant also raised its full-year guidance (again) for fiscal 2021 as its ‘Pharmaceutical’ segment is growing at a robust pace, its ‘Medical Device’ segment is steadily recovering from the worst of the coronavirus (‘COVID-19’) pandemic, and its ‘Consumer Health’ segment is holding up well. We continue to like Johnson & Johnson as an idea in both the Best Ideas Newsletter portfolio and the Dividend Growth Newsletter portfolio.
Shares of JNJ yield ~2.6% as of this writing. We view Johnson & Johnson’s dividend growth trajectory quite favorably given its improving growth outlook, rock-solid balance sheet, and stellar free cash flow generating capabilities. Our fair value estimate for shares of JNJ sits at $172 per share, though should the firm outperform our “base case” scenario, the top end of our fair value range sits at $206 per share of Johnson & Johnson.
The company’s Dividend Cushion ratio sits well above parity at 2.3, as its forecasted future free cash flows over the next five full fiscal years less its net debt position at the end of fiscal 2020 are expected to cover its future forecasted dividend obligations during the next five full fiscal years more than twice over. We give Johnson & Johnson an “EXCELLENT” Dividend Growth rating and a “GOOD” Dividend Safety rating.
Image Shown: A breakdown of Johnson & Johnson’s Dividend Cushion ratio waterfall. We view the firm’s dividend strength quite favorably.
Shares of JNJ resumed their upward climb in the wake of Johnson & Johnson’s latest earnings update and guidance boost as investors apparently cheered the good results, as did we.
Earnings Update
Johnson & Johnson grew its GAAP revenues 11% year-over-year last fiscal quarter, hitting $23.3 billion, with growth reported across its three core business operating segments. Additionally, Johnson & Johnson reported strong sales growth performance across its key geographical markets as well last fiscal quarter.
Its GAAP gross margin rose by ~200 basis points year-over-year in the fiscal third quarter as improving economies of scale–with an eye towards its Medical Devices segment–supported the firm’s profitability. However, its GAAP net income margin dropped ~120 basis points year-over-year during the fiscal third quarter due in part to rising operating expenses (SG&A, R&D, and in-process R&D expenses) and growth in its ‘other expense, net’ line-item.
As it concerns the increases at its other net expense line-item, that was largely due to Johnson & Johnson incurring meaningful legal liability expenses last fiscal quarter according to management commentary provided during the firm’s latest earnings call. Furthermore, as it concerns its in-process R&D expenses, that stems in part due to an impairment expense associated with the acquisition of Auris Health (that was completed back in April 2019) according to recent management commentary.
The company’s GAAP net income rose 3% year-over-year last fiscal quarter, hitting $3.7 billion, aided by a sharp reduction in its provision for corporate income taxes. Johnson & Johnson’s GAAP diluted EPS rose by 3% year-over-year, hitting $1.37 last fiscal quarter. Its non-GAAP adjusted EPS rose by 18% year-over-year, hitting $2.60 last fiscal quarter when removing special items from this picture.
Supply chain hurdles weighed on Johnson & Johnson’s performance in the fiscal third quarter to a degree, with management recently citing supply constraints as it concerns its LISTERINE oral health offerings as one example holding down sales. The Delta variant of the COVID-19 pandemic along with “the growing impact from reduced medical staffing” impeded the pace of elective surgeries in some markets last fiscal quarter according to recent management commentary. This, in turn, weighed negatively on Johnson & Johnson’s business last fiscal quarter, though the firm managed to overcome most of those hurdles.
The company’s management team also noted in Johnson & Johnson’s recent earnings call that hospitals will likely have to continue dealing with labor shortages into 2022, which in turn could weigh negatively on the resumption of elective surgeries to a degree, though the longer term trend is that the pace of elective surgeries continues to recover. With that in mind, the J&J’s business model has proven to be quite resilient in the face of numerous exogenous shocks seen around the world.
According to the company, Johnson & Johnson exited the fiscal third quarter with a modest net debt load of ~$3 billion, with its debt load offset by its sizable cash and cash equivalent position on hand as you can see in the upcoming graphic down below. Johnson & Johnson remained incredibly free cash flow positive during the first three quarters of fiscal 2021, with management noting that “we continue to generate strong free cash flow with $15 billion year-to-date” according to management commentary during the firm’s latest earnings call. When Johnson & Johnson publishes its 10-Q SEC filing covering the fiscal third quarter, we will have more to say on the company’s latest financial performance.
Image Shown: Johnson & Johnson’s balance sheet is relatively strong, and its free cash flow performance continues to impress. Image Source: Johnson & Johnson – Third Quarter of Fiscal 2021 IR Earnings Presentation
During the fiscal third quarter, Johnson & Johnson’s Consumer Health segment posted solid sales growth at its over-the-counter (‘OTC’) offerings. TYELNOL and MOTRIN analgesics, upper respiratory products, and digestive health (including its IMODIUM brand) products were cited as strong performers last fiscal quarter. Its AVEENO and NEUTROGENA skin health and beauty products also sold well in the fiscal third quarter.
At its Pharmaceutical segment, Johnson & Johnson’s DARZALEX (treats certain cancers), STELARA (treats plaque psoriasis and psoriatic arthritis), TREMFYA (treats moderate to severe plaque psoriasis), and ERLEADA (treats certain cancers) offerings posted solid revenue growth alongside several other treatments. Its treatments for schizophrenia for adults, INVEGA SUSTENNA/ XEPLION/ INVEGA TRINZA/ TREVICTA, and its treatment for pulmonary arterial hypertension, OPSUMIT, also posted solid revenue growth last fiscal quarter highlighting the breadth of Johnson & Johnson’s pharmaceutical portfolio.
The company’s Medical Devices segment posted growth across the board as well. Johnson & Johnson’s latest earnings press release noted that its electrophysiology products, wound closure products, surgical vision products and contact lenses, trauma products, hips products, knees products, energy endocutters products, and biosugrical products posted solid sales growth last fiscal quarter.
With the worst of the COVID-19 pandemic potentially behind key geographical markets in the US, Europe, and East Asia, elective surgeries are resuming in earnest. The ongoing recovery at its Medical Devices segment is playing a key role in supporting Johnson & Johnson’s improving cash flow growth outlook as that supports both its revenue growth outlook and provides room to expand its margins via increasing economies of scale.
Guidance Update
In the upcoming graphic down below, Johnson & Johnson provides an overview of its updated full-year guidance for fiscal 2021. The company’s ‘base business’ which excludes sales of its COVID-19 vaccine is expected to grow its revenues at a slightly stronger rate than previously forecast at the midpoint of guidance, and the same goes for its forecasted non-GAAP adjusted EPS at the midpoint of guidance. Please note Johnson & Johnson also boosted its guidance during both the first and second quarters of fiscal 2021, highlighting the firm’s growing confidence in its near term performance.
Image Shown: Johnson & Johnson once again boosted its guidance for fiscal 2021. Image Source: Johnson & Johnson – Third Quarter of Fiscal 2021 IR Earnings Presentation
We appreciate Johnson & Johnson’s guidance boost as that indicates the company is set to post a strong fiscal fourth quarter performance and potentially enter fiscal 2022 on the upswing. That sets the stage for future dividend growth and further capital appreciation upside, underpinning why we are big fans of the firm.
COVID-19 Vaccine Update
After contending with some hiccups while ramping up its manufacturing capabilities, Johnson & Johnson’s COVID-19 vaccine is starting to post solid sales performance. The US Food and Drug Administration (‘FDA’) has given the firm’s COVID-19 vaccine emergency use authorization, and the vaccine is in use in the US and elsewhere in the world. During Johnson & Johnson’s latest earnings call, management noted that “global sales in the quarter included a $502 million contribution from the COVID-19 vaccine, bringing the year-to-date total to $766 million. Through the first 9 months of the year, revenue has been recorded at a not-for-profit price of $7.50.” Additionally, management expects Johnson & Johnson will record $2.5 billion in sales of its COVID-19 vaccine this fiscal year.
The vaccine recently received unanimous support from an advisory panel to the US FDA concerning booster shots of the vaccine for those aged 18 years and older that have already received their first Johnson & Johnson vaccine dose. On October 20, the US FDA gave the green light for a booster shot of Johnson & Johnson’s COVID-19 vaccine while also allowing “mix-and-match” uses of certain COVID-19 vaccines.
Johnson & Johnson put out a press release in October 2021 noting that clinical trials highlighted the substantial increased efficacy of a booster shot. For reference, the vaccine was originally designed as a single-dose regimen, but in the wake of variants of COVID-19, a booster shot provides much better protection against adverse health effects from the virus. A single dose still provides meaningful protection according to the clinical study data cited in Johnson & Johnson’s recent press release, however.
While we do not expect Johnson & Johnson’s COVID-19 vaccine to generate needle-moving revenues or profits (please note the vaccine is being sold at a not-for-profit basis), the rollout could earn the firm goodwill from regulators and households across the globe. Johnson & Johnson is currently contending with various lawsuits and legal liabilities, and playing a leading role in ending the global health crisis should help maintain its brand power as it works out its legal woes in the courts and via settlements.
Legal Update
On a related note, Johnson & Johnson reportedly placed its talc liabilities stemming from its baby powder offering into a new entity, LTL Management, and then had that company file bankruptcy to consolidate ongoing litigation. We view Johnson & Johnson as having the financial capacity to manage these liabilities while maintaining its financial strength going forward, and for reference, Johnson & Johnson has vigorously defended itself and its products during legal proceedings. The firm reportedly advanced $2.0 billion into LTL Management while also providing the entity with royalty streams with a present value of $0.35 billion to cover future legal expenses and legal settlement costs. Management confirmed the creation of this entity during Johnson & Johnson’s latest earnings call.
Johnson & Johnson is contending with other legal liabilities as well, including those that stem from its therapeutic RISPERDAL, which treats certain mood and mental health disorders. Here is what management had to say on the issue during its latest earnings call:
“Other income and expense in the third quarter includes a $2.1 billion charge of litigation expenses, primarily driven by an incremental $1.4 billion charge associated with a recently announced qualified settlement fund for current and future Talc claims. The qualified settlement fund is intended to facilitate a final equitable resolution of all Talc litigation in a structured manner through established bankruptcy law precedent. Additionally, there is another $800 million legal expense in the quarter representing final resolution of outstanding claims related to RISPERDAL.” — Joseph Wolk, Executive VP and CFO of Johnson & Johnson
The company is actively working to put these legal issues behind it so Johnson & Johnson can focus on the future.
New CEO
In August 2021, Johnson & Johnson announced that its current CEO and Chairman, Alex Gorsky, would transition towards the Executive Chairman role starting in early-January 2022. Joaquin Duato, currently Vice Chairman of the firm’s Executive Committee, will take on the top job as part of this transition. We wish both of them the best in their new roles, and we appreciate that Johnson & Johnson is separating the CEO and Chairman roles.
Concluding Thoughts
Johnson & Johnson is firing on all cylinders, and we liked what we saw in its latest earnings update. Its core business is performing well, its financials remain rock-solid, and the rollout of its COVID-19 vaccine worldwide is starting to pick up steam. The company’s outlook is bright and getting brighter, which in our view is why management felt confident in raising Johnson & Johnson’s near-term guidance once again in conjunction with its latest earnings report. We continue to view Johnson & Johnson’s capital appreciation and dividend growth upside quite favorably. Johnson & Johnson is a great company.
Downloads
Johnson & Johnson’s 16-page Stock Report (pdf) >>
Johnson & Johnson’s 2-page Dividend Report (pdf) >>
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Callum Turcan does not own shares in any of the securities mentioned above. Johnson & Johnson (JNJ) and Health Care Select Sector SDPR Fund ETF (XLV) are both included in Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Vertex Pharmaceuticals Inc (VRTX) is included in Valuentum’s simulated Best Ideas Newsletter portfolio. UnitedHealth Group Inc (UNH) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Vanguard Consumer Staples ETF (VDC) is included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Long put options on the SPDR S&P 500 ETF Trust (SPY) with an expiration date of December 31, 2021, and strike price of $412 are included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.