This healthcare giant is clean and clear and under control

If anyone had a good time during the COVID-19 pandemic, it was the healthcare sector. It was its time to shine. Investors were flocking to the door. 

The companies responsible for vaccines were rock stars. And then the world moved again, and global concern switched to inflation and rising interest rates. Healthcare may have dropped in popularity, but there’s nothing to complain about in terms of the future of this healthcare giant. Or even the sector itself.

Johnson & Johnson (NYSE: JNJ) released its Q3 reports overnight, in line with market expectations. Its results were predictable, stable, and even a little boring and that’s how Chad Padowitz, CIO of Talaria Asset Management likes it.

“The key thing about Johnson and Johnson is actually its stability, its resilience, its predictability. So, in terms of a positive attribute to the results was that they didn't give you anything to be concerned about," he said. 

There’s a good reason JNJ markets itself as being a ‘take care of your whole life company’. There’s something for everyone, regardless of age or needs. Its revenues are spread across consumer health, pharmaceuticals and medical technology.

That’s not to say the company itself doesn’t have highlights.

Padowitz points out that its pharmaceuticals business generated $32 billion in 2015. This figure is expected to be just shy of double that by 2025. That’s without even factoring in M&A activity which JNJ consider a major part of their ongoing strategy.

It also has a great pipeline alongside existing products, with a number of product approvals in just this quarter alone across the US and Europe. These included treatments for chronic lymphocytic leukemia, multiple myeloma and for pediatric patients with active psoriatic arthritis and chronic graft-versus-host disease.

In this wire, Padowitz shares some of the highlights from JNJ’s FY22 result and provides his outlook on the company and its sector for the year ahead.

Johnson & Johnson (NYSE: JNJ) FY22 Q3 key results

• Reported sales up 1.9% to $23.791 billion
• Worldwide consumer health sales down 0.4% to $3.8 billion
• Worldwide pharmaceutical sales up 2.6% to $13.2 billion
• Worldwide medtech sales up 2.1% to $6.8 billion
• R&D up 5.1% to $3.59 billion
• Net earnings up 21.6% to $4.45 billion
• Earnings per share (diluted) up 22.6% to $1.68 

Note: This interview took place on Wednesday 19 October. JNJ is a holding in the Talaria Global Equity Fund.

In one sentence, what was the key takeaway from this result?

In one? Steady as she goes, solid with strength and resilience across all three divisions.

The key thing about Johnson & Johnson is actually its stability, its resilience, and its predictability. A positive attribute of the results was that they didn’t give you anything to be concerned about.

There was certainly some level of concern going into the results about the fact that 50% of their sales are outside the US, given the US dollar has been so strong. Obviously, it did impact them by the tune of about over a year, about 5%. It’s not a material impact, but the market is pretty on top of that. So, there were no real surprises that came out of that either.

What was the market’s reaction to this result? In your view, was it an overreaction, an underreaction or appropriate?

Rating: Appropriate

The market itself was up 1%. But this isn’t the kind of share that is that closely linked to the market. The share price was effectively unchanged. I would say the key comment would be indifferent. Broadly speaking, the results and guidance were in line with what was expected. I think that should be taken positively in the context of this calendar year.

This year, JNJ is basically flat, whereas the S&P500 is down over 20% and the NASDAQ over 30%. We know what sort of pain there is in many places.

I think for a US dollar earning asset to be doing that and have results that don’t change should be commendable.

Were there any major surprises in this result that you think investors should be aware of?

One of the key attributes of JNJ is its exceptional suite of assets across the healthcare space, alongside an excellent balance sheet and a very good mergers and acquisition track record. The combination of that continues to deliver. There was nothing in the results that made you any less condiment in those attributes. Notwithstanding, they certainly did highlight that inflation is having an impact on staffing shortages in those who use their products, such as hospitals and so on. This is a challenge as well. JNJ are not without their challenges but it’s the strength of the business, the products and the diversity of its assets that allow them to effectively walk through those risks with a ‘nothing to see here’ result.

They trade at a premium to their peers, so you aren’t getting this strength for free. They are superior to most of their peers. I’ll give you the one stat that I think differentiates it from its peers. It’s a remarkable stat in and of itself. JNJ has been a mature business and one regarded as steady but slow. 

Their pharmaceutical business is about 70% of the business and generated about $32 billion in 2015 and about $52 billion this year. Yesterday they reiterated that they should be at around $60 billion in 2025 before factoring M&A.

If you step back a second, they are going to double pharmaceutical sales over 10 years to a very large number. This is in an industry that has a lot of patent flips along the way. Most of their peers have not done anything close to that. If most of their large-cap peers can stand still over the next several years or grow slightly, that would tend to be a reasonable outcome. So that is one of the most remarkable things about JNJ. They’re doing that with a net cash balance sheet, still buying back shares and paying a reasonably attractive dividend. They are a stand-out and that is why they do trade at a premium. They have held up this year in what has obviously been a very tough year.

Would you buy, hold or sell Johnson & Johnson on the back of these results?

Rating: Buy

We would buy. We think the price is fair to good. It's not off-the-charts attractive. For instance, there’s about a 6% free cashflow yield. What that means is every year, the company is returning 6% and growing at the 3-5% level. They’re buying back some shares and paying a 2.7% dividend. 

There’s definitely a pathway to get 7-10% a year return without too much change in valuation. The 16 times earnings is roughly in line with the market, but with a superior suite of assets and balance sheet. 

We are a buyer of it. We do hold it in the fund but we are also valuation-led. If it were to go up, say for instance 5-10%, we might look to start reducing. Certainly, at the current price and given the opportunity set elsewhere, it does present us with quite a uniquely attractive asset.

What’s your outlook on Johnson & Johnson and its sector over FY23? Are there any risks to this company and its sector that investors should be aware of?

I think we’ve got to step back a bit to look at the risks because we can put our money anywhere. So, what else is out there in the current environment? You have a slowing economy, where it's recessional or not is the question. But certainly, a significantly slowing economy and you have inflation and interest rate headwinds. At the same time, it's not entirely certain which products and services will be paid for and attractive.

Healthcare specifically, and pharmaceuticals within that, is quite immune to the economy, quite immune to interest rates and inflation. In that regard, we think the sector is remarkably well placed.

It is also made up of a lot of companies, like JNJ, which look reasonably attractively priced with strong balance sheets.

We are very favourable towards the sector for that reason. The greatest sector exposure in our fund is healthcare. We expect JNJ, in particular, to continue delivering what it has for the last decades without much difference in 2023. So, a continuation of their steady, not spectacular, low volatility growth with potential. They’ve got such a strong balance sheet, strong cashflows and a more uncertain market. There may absolutely be the ability for them to do some very attractive accretive M&A along the way.

They did reiterate in their call yesterday that M&A is a key part of their strategy. They have three broad divisions and these are quite diversified so there are many places they can look.

One risk I haven’t touched on is the continuing risks of the pharmaceutical space. There are always challenges with spending and legislation, along with the elections coming up. There’s a medium to long-term challenge in how they deal with that. They do deal with that, as do their peers, quite well. Legislative risk is something to always be aware of as to how impactful it might be.

For more from Chad Padowitz, please select his profile to follow. You can find out more about the Talaria Global Equity Fund below:

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