Johnson & Johnson
Bull's Pen
by Jeff Fischer ([email protected])

Not only is Johnson & Johnson a widely respected company, it's one of the most consistent in the country, with 65 years (and counting) of consecutive sales growth and nearly forty years of consecutive earnings growth. Therefore, it's ironic that Brian, my opponent, will focus on the past performance of Johnson & Johnson when presenting his bear argument; and it's equally ironic that I'll focus on the future plans of the company in my bull argument rather than wax "prosthetic" about J&J's amazing ability to build wealth in the past.

Brian will make Johnson & Johnson look like a bandaged-together, hobbling company because two of its three divisions are suffering slow sales growth. I'm going to largely wait for his bear argument, which follows, and then I'll prove in my rebuttal where he's forgotten information and where he's lacking clarity of vision. (Note, J&J has a drug in the pipeline for Alzheimer's, and it sells Acuview contact lenses.) I aim, dear Fools, to win this duel with a bone-crushing rebuttal.

But first, the specs.

Johnson & Johnson is divided into three main businesses: pharmaceuticals, professional products, and consumer products. J&J has the second-largest pharmaceutical business in the country by market share, second only to Glaxo Wellcome. Its other two divisions make it the most diversified healthcare leader in the world, causing many to call it a virtual "healthcare index fund." All three divisions have been growing by volume, but with 50% of sales taking place in international markets, weak currencies overseas have had a negative impact on sales -- sometimes to the tune of 4% to 5% -- in primarily the professional and consumer product divisions.

But weak sales growth in the two divisions isn't new. The company -- like most international giants -- has been dealing with weak foreign currencies for over a year. Yet, because of strong growth in pharmaceuticals, Johnson & Johnson's stock has continued to prescribe itself new all-time highs throughout 1998. In fact, Johnson & Johnson was one of the Motley Fool's Industry Focus picks for 1998 and it has gained over 32% since then. (1999's Industry Focus will be published in December.)

That's the past, though. As for the future: Entering 1999, the company will have much easier year-over-year sales comparison numbers to grow from, and if international currencies improve by even a scratch, Johnson & Johnson should see overall revenue growth in the high-single digits again, up from mid-single digits this year. But even if currencies don't improve, Johnson & Johnson should see revenue rise more strongly next year due to new products and initiatives, as well as potential acquisitions.

Examining the three divisions more closely:

Johnson & Johnson's pharmaceutical business is one of the most diverse in the country and in the world. The company sells over 90 drugs, 20 of which have annual sales of over $100 million, while 26 exceed $50 million in yearly sales. Total revenue in the pharmaceutical division rose 26% in the U.S. in the second quarter, and 16% domestically in the third quarter. Worldwide, J&J's pharmaceutical sales rose 9.4% in quarter three. This division accounts for 34% of J&J's sales and 56% of operating earnings, and is easily the highest-margin business for the company. With the help of drugs, Johnson & Johnson has been improving margins every year -- a trend that is expected to continue. The company's operating margins are a healthy, world-beating 23%.

Johnson & Johnson has some promising drugs in the pipeline, including Ergoset for type 2 diabetes and Cladribine for all types of multiple sclerosis. Other drugs in the pipeline include treatments for ulcers, contraception, and hormone replacement, to name just a few. (Meanwhile, in the professional division the company has a promising new product called Dermabond. This is an adhesive that can replace stitches in up to 30% of all laceration cases -- there are 12 million annually.)

But Dr. Brian isn't going to diagnose J&J's all-important pharmaceutical division as anything but healthy. Johnson & Johnson may not have giant blockbuster drugs in the works right now (that we know of), but its pharmaceutical division is very broad-based and has dozens of extremely successful drugs and more promising ones on-deck -- and Brian knows this. The division is growing domestic sales in double-digits and, at this size, it's hard to complain about that. Instead, Brian is going to address the wounds scarring the much slower growing (and lower margin) professional product and consumer product divisions. Here, too, however, the company already has new products and solutions in motion and is ready to jumpstart growth.

Put bluntly, the bear that I think Brian will be riding (because there are only a few bear arguments to mount here) has already left the woods. The bear arguments surrounding J&J are old news. Brian's argument will likely focus on sharply falling stent sales and intense competition in the professional product market. The sharp decline in J&J's market share has already taken place, however, and management is already addressing the problem with a renewed focus on medical device innovation. In fact, the company is launching many entirely new products in early 1999. We'll address this further if Brian makes it necessary, but after the steep decline in professional product sales at J&J, the next direction is most likely going to be: up. The bad news is old news. It's time to recover.

In consumer products, currency translations cut a chunk from sales in the past year, but they should improve and promising new products are set to launch in 1999 here, too. Or sooner. Late this year, Johnson & Johnson should launch Benacol, a nutritional supplement. Benacol will be used in a margarine spread and can help consumers actually reduce bad cholesterol levels. It will later be used in other edibles. And, in 1999, the company is introducing a no-fat sweetener. Meanwhile, its Neutrogena skin care product line should continue to see double-digit sales growth.

Johnson & Johnson is a company that has grown sales every year for 65 years and counting, earnings for nearly 40 years and counting, its dividend as many years and counting, and has improved margins every decade since it was founded over 100 years ago. And margins continue to improve, hitting record levels this year. The company has experienced several periods of bumps and bruises -- any company this large will -- and yet, having suffered many this year, the stock continues to make new highs because it's a well-diversified, recognized long-term powerhouse. J&J's decentralized management teams are able to get each division humming smoothly given time. Meanwhile, the company spends more on research & development than all but four other U.S. firms at last count, increasing the potential for an even better future.

Let's see what Brian the Bear has to say and then answer with specifics!

Next: The Bear Argument