Johnson & Johnson’s Earnings Raise Concerns

Johnson-and-Johnson-logoI have not been a fan of Johnson & Johnson (NYSE: JNJ) for some time. I think it is an overpriced elephant sluggishly tromping through the market, and that investors are mistakenly flocking to it for its overrated dividend.
Johnson & Johnson’s earnings results – released Tuesday – tell the story, and why I think you should sell the stock. Let’s parse the numbers and then discuss why I think there are better choices.
First quarter sales were $17.4 billion, down 4.1% compared to Q1 2014. Operational results increased 3.1% and were impacted by the strong dollar, which resulted in a currency impact of 7.2%.
Breaking down revenue, domestic sales rose 5.9%. International sales fell 12.4%, which the company said reflected negative currency effects of a whopping 13.2%, which offset operational growth of 0.8%.
So let’s back out those currency impacts, along with Johnson & Johnson’s usual bevy of impacts from acquisitions and divestitures. Now we see some decent numbers, as domestic sales rose 9.1%, international sales rose 3.0% and global sales rose 5.7%.
Backing out all the non-cash items, the company ended with adjusted net earnings of $4.4 billion, or $1.56 per share, which means that earnings per share fell 4.3%. Yuck.
So now we are forced to look for bright spots within individual divisions. On the consumer side, global sales increased 4.7% after backing out all the currency and non-cash items. That breaks down to a 5.1% increase in domestic sales and 4.5% growth in international sales.
The pharmaceutical division came in with domestic sales increases of a fantastic 16.9%. Currency negatively impacted international sales by 14.4%, which turned the division’s 3.7% operational increase into a 10.7% decline.
Over in the medical devices segment, organic sales declined 4.6%, exacerbated further by a 6.8% currency impact.
So what we’re seeing is, indeed, a lumbering elephant. The revenue increases, not including currency impacts, were generally good. They obviously suggest that consumers continue to buy up Johnson & Johnson’s products at a fine clip. Five percent is nothing to sneeze at. Domestic pharma is doing really well.
We can complain about the currency impact all day, and some investors choose to disregard it. I’m not sure that’s the right move, because currencies always fluctuate. Over time, they likely have a median, and so I think you have to consider the post-impact numbers to be the “real” number. After all, do we complain when the currency effects flip to the other side?
Pre-tax earnings only rose 2.8%. Net income actually fell 6.7%, and that doesn’t even factor in the 2% decrease in shares outstanding. So while we can say that business is OK, but not great, I’m not seeing a bottom line impact that thrills me in any way.
However, it’s not like Johnson & Johnson is going out of business. It makes a lot of money and its free cash flow is insanely good – some $15 billion annually. It pays about half of it as a dividend, which is 2.8%.
The problem is valuation. The company says to expect $6.04 to $6.19 in earnings per share this year. At a median of $6.11, that’s a 2.4% increase over fiscal year 2014 EPS.
Now, if Johnson & Johnson were a typical Peter Lynch stalwart that organically grew earnings at 8% per year, along with a 3% dividend, I’d give it a forward P/E ratio of 11, and even bump it to 13.5 for its world-class brand name and amazing cash flow. We might get that 8% per year if currency impacts returned to normal.
However, with a net-cash-adjusted price of $94 per share, it trades at 16 times fiscal year 2015 estimates. That’s above the price I’m willing to pay in the best of circumstances.
I think Johnson & Johnson is overvalued. If you want a comparable dividend yield, get diversification and a 3.41% yield with PowerShares High Yield Equity Dividend Achievers ETF (NYSEArca: PEY).

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