Interactive Investor

This massive healthcare business should be worth even more

3rd May 2023 09:42

by Rodney Hobson from interactive investor

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Currently the 13th largest company in America, overseas investing expert Rodney Hobson thinks its luck is about to change and sees light at the end of the tunnel.

medical health hospital chart johnson 600

A tub of talcum powder can go a long way one sprinkle at a time, as maker Johnson & Johnson (NYSE:JNJ) has found to its considerable cost. This particular nightmare for an otherwise highly successful pharmaceutical and consumer goods company could at last be coming to an end.

Some of the talc-based baby powder in question allegedly contained traces of asbestos, sparking thousands of lawsuits claiming the product caused cancer. Despite J&J’s protestations to the contrary, it is generally cheaper in the long run to settle litigation in the US and move on, which is what J&J hopes to do now. Unfortunately, the price of settling all claims has gone up, from the $2 billion originally proposed and rejected by claimants, to $8.9 billion to be paid over the next 25 years.

If approved by the courts and by 75% of claimants, which seems highly likely, this would rank for size alongside compensation paid by tobacco companies and opioid manufacturers. J&J had already set aside $2 billion to cover claims, so has now had to put away another $6.9 billion, more than wiping out profits in the first quarter and producing a loss of $68 million.

What is especially annoying about this settlement is that consumer goods are the smallest part of the three divisions at Johnson – the others being pharmaceuticals and medical devices – and the one that brings in least cash.

Yet shareholders can take comfort that there is light at the end of the tunnel. For a start, excluding the settlement, first quarter profits rose from $5.2 billion in the previous first quarter to nearly $7 billion this time, beating analysts’ expectations. Sales, too, were better than expected, up from $23.6 billion to $24.8 billion.

J&J promptly increased its quarterly dividend payment by 5.3% to $1.19 a share and ungraded its sales and profits guidance for the full year, claiming the latest results “demonstrate strong performance across all three segments” of the business. Sales are now expected to be up about 6% as opposed to the anaemic 1% previously indicated.

Costs rose in the quarter, but by only 3.4%, a highly satisfactory outcome in these inflationary times.

J&J had a good pandemic followed by a mediocre 2021, when sales tailed off. It is good to see them firmly on the rise again, indicating that this is a solid company with products across a number of sectors. Over half its sales are in the United States, so there is reasonable protection from exchange rate movements, although these were a negative factor last year.

Meanwhile, J&J is pressing ahead with bringing new drugs to market. It has just received European Union approval for a prostate cancer treatment after successful trials. Similar approval in the US is likely soon. Early tests from a bladder cancer drug are promising, although there are many more hurdles to clear.

Johnson & Johnson.PNG

Source: interactive investor. Past performance is not a guide to future performance.

The shares took a nasty dip to $151 in March, but they have reacted well to news of the admittedly expensive proposed legal settlement for the talc product, which in any case is no longer sold in the main markets of the US and Canada where litigation is more widespread than in other countries.

They are now back to $165 and, despite a somewhat challenging price/earnings ratio of 34.3, should edge back towards their peak of $180 if 2023 continues as it has begun. The yield is 2.8%.

Hobson’s choice: I recommended the shares at $170 and again after they had slipped to $163, expecting the previous support level around $160 to hold. This company is still a buy up to $170, with the increased dividend offering adequate compensation for any possible short-term slippage in the share price.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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