J&J’s Portfolio Rx

It’s unusual, but (ticker: JNJ) and the broad market have gone their separate ways. In the past 11 months, J&J stock is down slightly, compared to an 10% rise in the Dow Jones Industrial Average—of which J&J is a member—and a 23% jump in the health-care sector. Friday, the stock jumped $1.81 to $101.47, but shares are off 7% from a high of $109.49.

The strong dollar and worries about the health-care giant’s pharmaceuticals growth can be blamed for the weakness, but long-term investors interested in a high-quality name with both income and price-gain potential might take a second look. As the clouds dissipate, J&J could deliver a double-digit annual total return.

One issue has been the muscular greenback. J&J gets more than half its sales overseas, and the rising dollar had a negative impact of nearly 5% in the fourth quarter, and another 7% in the recently reported first quarter, causing sales declines in both periods—yet another unusual thing. Sales comparisons will likely be pressured for another quarter or two.

The more important concern is Remicade, J&J’s autoimmune medication that, at $6.9 billion last year, made up 9% of total sales of $74.3 billion. Its future growth could be dented by new competition and adverse U.S. patent rulings. It recently went off patent in a number of European countries.

Celltrion (068270.Korea) is attempting to introduce its CT-P13 biosimilar in the U.S., and J&J has filed a lawsuit alleging infringement on its Remicade patents. Additionally, a Remicade patent is being challenged by recent decisions from the U.S. Patent & Trade Office, though appeals are ongoing.

The Remicade battles shouldn’t be ignored, but a long-term investor has the luxury of viewing the head winds facing a giant like J&J in a wider context. This is a healthcare firm with unrivaled product and geographic diversity; a bulletproof balance sheet; a culture of capital discipline; a strong pipeline of medicines; and a stable consumer business made up of powerful brands such as Tylenol. Moreover, the Remicade issues will probably take some time to play out.

J&J isn’t overly reliant on any single product, notes Darren Pollock, a portfolio manager at Cheviot Value Management. It has been a consistent performer over decades, “a profits machine,” he says. Cheviot has added lately to a longstanding J&J stake. Underlying trends remain strong. Adjusted for the dollar, sales in the most recent two quarters were up a healthy 3% to 4%, he points out. Deleterious currency effects should roll out of comparisons in the next 12 months.

In recent years, J&J has changed its pharma approach and become more nimble, adds Jack Oliver, managing partner at RBO Investment Management, which has also added J&J shares lately. The company is more amenable to partnering on products, instead of taking on the entire development, cost, and risk, he says.

J&J’s valuation, at a P/E ratio of 16.5 times this year’s midpoint guidance of $6.12, is roughly in line with its historical average. However, relative to the market, the shares trade near the bottom of their long-term range.

There should be no discount, says Pollock. J&J has more consistent cash flow, better operating metrics, a higher dividend yield, and a stronger balance sheet than most companies in the market. During the past 20 years, J&J’s valuation carried an average premium to the market of 20%, he says. Pollock looks for a $120 stock at some point in the next three years, which, combined with a 3% dividend yield, would be close to a double-digit annual total return.

“J&J is a tough company to bet against,” says RBO’s Oliver. “If you have reasonable expectations in an aging bull market, then J&J stock works.”

The risk is that Remicade biosimilars will be available in the U.S. this year, but it is more likely that challenges to the drug will be held up in courts for another 12 to 18 months. Remicade goes off patent in 2018. In the meanwhile, J&J continues to develop its drug pipeline, about which investors will learn more on May 20, when the company will give a pharma-division outlook.

J&J stock won’t shoot the lights out, but it should outperform in a downturn and provide a stable but steady rise in a bull market. What’s wrong with that?


The securities discussed in the posted article are current holdings of Cheviot’s clients. The viewer should not assume that investments in the securities identified and discussed were or will be profitable and it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. All information is provided for informational purposes only and should not be deemed as a recommendation to buy the securities mentioned. Cheviot closely monitors its positions and may make changes to the portfolio’s investment strategy when warranted by changing market conditions. If a security’s underlying fundamentals or valuation measures change, Cheviot will reevaluate its position and may sell part or all of its position. There can be no assurance that Cheviot’s clients will continue to hold the same position in companies described herein, and their portfolio positions may change at any time. If you would like a complete list of securities purchased or sold during the past twelve months as a block group in client accounts, please contact Cheviot via our contact page or by phone. Thank you.

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