Strategy

With inflation stubbornly raging still at four-decade highs and fears that the Federal Reserve's stance against inflation may send the economy into a recession, we believe the prudent way to position your portfolio is in consumer staples whose products are necessary no matter what, and whose profits remain reliable regardless of the state of the economy. We want to focus on profitable companies that can increase dividends, repurchase stock, and trade at reasonable valuations. These companies provide a degree of dependability in an otherwise uncertain economic environment. 

Johnson & Johnson (JNJ) We like J&J as a slowdown play because its three businesses have little to no economically sensitivity. Take its pharmaceutical business, which is one of the best out there and is growing faster than the industry. Last quarter, worldwide adjusted operational sales increased by about 9%, and six assets had double-digit growth. The pipeline is strong with 13 new drugs expected to be filed for approval between now and 2025. Of those 13 new drugs, five have the potential of more than $5 billion in peak sales. As a whole, J&J expects its drug business to grow at a 5% compound annual growth rate through 2025, which is when they expect to achieve $60 billion in revenue. 

Meanwhile, its medical device business has seen recently seen a resurgence, thanks to a recovery in elective procedures that were delayed during the pandemic. First quarter sales grew 8.5% year over year. The franchise has 11 different platforms delivering $1 billion of sales, and of those 11 platforms, the majority of them are either maintaining or gaining share.

For the consumer health business, which has many iconic brands like Neutrogena, Tylenol, Listerine, and Johnson’s, this may be a slower grower relative to the others parts of the enterprise. But the potential is there for an acceleration if the business turns into an industry consolidator. This business will have every opportunity to double down into faster-growing categories like skincare and baby care thanks to its investment-grade profile and balance sheet.

What also has us interested in this company is its upcoming breakup. The company announced last November its plan to separate its consumer-staple-like Consumer Health business from its faster-growing and best-of-breed Pharmaceutical and Medical Device business. We believe this breakup makes a lot of strategic sense as the two independent, market-leading companies will become more focused. Management will be able to move faster and more effectively allocate capital as they navigate different industry trends to meet the needs of their customers and patients.

In the meantime, we understand that the breakup is going to be a very long process — the separation is expected to happen in 2023 — and that’s why we like how J&J is paying you to wait with its 2.6% dividend yield, a dividend backed up by one of the rare AAA balance sheets in the S&P.

For the past 10 years, shares of JNJ trade at an average of 16.2x on a forward P/E basis. Applying this number to 2024's estimated earnings of $10.88/share, JNJ's fair value appears in the $175/share.