To Wall Street, Johnson & Johnson (JNJ) has been sounding like Dumb & Dumber. In the past year, the health-care giant has gone from nearly grabbing Guidant (GDT) in a friendly merger to blundering into a bidding war for the cardiac-device maker with rival Boston Scientific (BSX). Whoever wins Guidant, I just hope J&J ends up looking D, D, & D.
Dumb, Dumber, & Dumbest, I mean. The reason is simply that I want to buy the stock, and I'm hoping the Street's hot-money pros keep pounding it into a better bargain. Trading lately below 62, J&J is already cheap, less than 17 times this year's estimated earnings, according to Capital IQ (MHP), a data unit of Standard & Poor's (MHP). That's down from highs last spring near 70. It may get cheaper yet. Morningstar (MORN) analyst Tom D'Amore puts J&J's intrinsic value at 76, but that was before the company began raising its bid for Guidant to fend off Boston Scientific. If J&J ultimately pays up for Guidant, D'Amore figures he will cut his estimate of its value, maybe to 72. "Guidant has so many problems with quality control," D'Amore told me. "It's going to wind up being a major distraction for Johnson & Johnson, even though the growth in the [implantable cardiac] devices market is so attractive."
Fair enough. But for patient investors, any opportunity to buy J&J when it's out of favor is one to grab. Do I know that a merger with Guidant won't come too expensively? No. Do I know that absorbing Guidant won't prove distracting to J&J management? No, and I'm sure that the 13 months J&J has spent trying to lock up Guidant have taken a toll. But here's the thing: In the context of J&J's overall operation, Guidant is far from a make-or-break deal. Analysts expect Guidant to take in a bit less than $4 billion in revenue this year, or about 7% of J&J's expected sales.
THAT $55 BILLION IN TOTAL SALES WILL BE flowing to J&J's New Brunswick (N.J.) headquarters from one of global capitalism's most powerful collection of products and businesses. These include the familiar baby-care shampoos and lotions, over-the-counter medicines such as Tylenol, a bunch of prescription drugs, including schizophrenia medication Risperdal, plus increasing numbers of medical tools and devices, notably cardiac stents, a market where it competes fiercely with Boston Scientific. While pharmaceuticals had been contributing an outsize share of operating profit, medical devices now are chipping in a bigger portion, nearly 39% through last year's first three quarters, up from 31% in the comparable year-earlier period. (One dolorous source of growth: surgical cutting tools for bariatric operations on the obese.) When J&J reports its full 2005 earnings on Jan. 24, it's expected to post revenue growth of about 8%, to $51 billion. Net earnings are seen nearing $11 billion, up from $8.5 billion the previous year.
If you ask me, those earnings are underappreciated by the market, because not every investor fully takes into account the company's financial impregnability. A triple-A borrower in the view of S&P, J&J at last report had $15.2 billion in cash and short-term investments against just $2.4 billion in total debt; earnings covered fixed charges more than 32 times over. J&J's operating cash flow, $11.2 billion in the past four quarters, is so strong that, after subtracting capital spending, acquisitions, and stock repurchases, along with $3.7 billion in dividend payments, it still had almost $2.4 billion left over.
Even as operating cash flow has grown -- in 2001 it came to $8.9 billion -- the market has been steadily knocking down J&J's value, as measured by the ratio of its total enterprise value (that is, net debt plus equity value) to earnings before interest and taxes. Now, with the uncertainty over the Guidant deal helping to obscure the company's fundamental strengths, there looms an opportunity for investors to buy a share of J&J's cash flow even more cheaply. If J&J winds up with Guidant, I hope the market reacts badly and pushes the shares under 60. At that, J&J would be paying a 2.2% dividend yield, compensation enough for me until the pros on the Street get smart, or at least smarter.
By Robert Barker