A table with three legs is more stable than a table with only one or two. And so it is with businesses. Johnson & Johnson's three businesses -- drugs, medical devices and consumer products -- together create a solid foundation. And when the ground becomes uneven under one of the legs, the other two can provide support. Indeed, the diversity of J&J's business is a big reason why the stock should perform well in 2007.
J&J's fourth-quarter earnings, released on January 23, underscore the point, says Morningstar analyst Heather Brilliant. Sales of $13.7 billion led to profits of $2.4 billion, or 81 cents per share (excluding charges related to J&J's recent acquisition of Pfizer's consumer-products business). The results beat the average analyst estimate of 79 cents per share. For the entire year, profits rose 11%, to $11.1 billion, or $3.76 per share (excluding various one-time gains and charges) -- helping the health care giant extend its streak of earnings increases to 23 years.
J&J's pharmaceutical division, the largest of its three businesses, has been going through a rough patch. Like other big drug makers, J&J has been hurt by intense competition from both brand-name competitors and manufacturers of generic drugs. Strong performance from drugs for schizophrenia, autoimmune disease and epilepsy boosted sales in the fourth quarter. And J&J has a robust pipeline of new drugs. Brilliant notes that J&J has 15 new drugs in late-stage development and a host of other potential drugs in the earlier stages of development. She expects the firm to apply for up to ten new-drug approvals in 2007.
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A potential problem for investors is that the Democratic-controlled Congress could try to force drug makers to cut prices. Although investors should watch developments carefully, enactment of legislation that would severely harm this important industry isn't likely, especially with Republicans still in control of the White House. Further shielding J&J is, yes, its diversification. The drug division accounts for a little more than 40% of its business, and that share is likely to fall because J&J's medical-devices and consumer-products businesses experience faster growth rates. "We think the pharmaceutical division could constitute less than 30% of sales by the end of the decade," Brilliant says.
Medical devices, J&J's second-largest business, will get a boost from powerful demographic trends. An aging population and increasing wealth around the world mean more people can afford treatments with J&J-made devices. Although safety concerns have hurt sales of drug-coated stents in recent months, Brilliant expects J&J to develop innovative new stents and orthopedic devices in the future. The company's acquisition of Pfizer Consumer Healthcare, which closed in the fourth quarter and contributed names such as Listerine and Nicorette to J&J's stable, should lift sales for the consumer-products division in 2007, Brilliant says. The new brands combined with J&J's existing consumer products will generate roughly one-fourth of the company's revenues.
Despite the solid performance for the fourth quarter, the stock closed down 1% on January 23, to $66.50. The stock (symbol JNJ) sells for 16 times the average analyst earnings estimate for 2007 of $4.04 per share. That compares with a five-year average price-earnings ratio of 19, according to investment newsletter Dow Theory Forecasts. The newsletter, which believes J&J's 2007 profits will beat analyst expectations, includes the stock on its one-year "buy" list as well as its list of long-term picks. Kiplinger's agrees. For more information, see Stocks to Own in 2007.
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