Mead Johnson Has a Winning Formula

 | Dec 07, 2011 | 12:00 PM EST
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How is this for disclosure? My clients own the stock, and my six-month-old son uses the product every day.

Today, I am writing about Mead Johnson Nutrition (MJN). Fully spun off from Bristol-Myers Squibb (BMY) in 2009, Mead Johnson is once again the only global company with a singular focus on pediatric nutrition. The company goes back to 1905, when one of the co-founding brothers of Johnson & Johnson left to form it as a science-based nutrition business.

One hundred-plus years later, Mead Johnson has more than 70 products based around its Enfa brand that focus exclusively on the nutritional needs of infants, children and expectant and nursing mothers. With its industry-leading market share, this business generated $3.1 billion in sales in 2010 and an operating profit of $754 million, an operating margin of 24%.

My initial column last week presented the importance of predictability and sustainability in selecting an investment. Mead Johnson epitomizes these investment characteristics.

Let's look into some examples of Mead Johnson's sustainability and predictability. In the severe global recession of 2008 and 2009, the company's premium-priced products grew from less than half of category sales to over 60%. What could be a better test of inelasticity of demand? Infant formula is the sole source of nutrition for many children, and parents are highly unlikely to compromise on quality.

An additional important takeaway from the countertrend growth during this awful economic period is the increasing number of children being born in households that can afford Mead Johnson's products. About 70% of 2011's expected profits for Mead Johnson will be derived from emerging markets, where economic growth remains robust, even if at a potentially slowing pace.

Throughout Asia (China is Mead Johnson's second-largest market after the U.S.) and Latin America, demographic shifts have presented multiple opportunities to Mead Johnson. Women are increasingly pursuing professional careers, the middle class is expanding, and people are choosing science-based products over traditions -- these factors continue to serve as market-expanding opportunities.

Worried about competition? Well, it exists, but it's buried in bloated and diluted organizations within multi-line consumer product or health care companies such as Abbott Laboratories (ABT), Danone and Nestle. Pediatric nutrition is a highly regulated industry where new product development often requires a five-to-seven-year investment cycle. Mead Johnson clearly has a competitive edge by not having to compete internally for research-and-development dollars with other business lines. This has allowed Mead Johnson to "acquire, retain and extend" the market for its products while competitors are arguing internally.

Mead is not cheap on a price-to-earnings basis, trading at 22x 2012 expected earnings of $3.20 and projected 15% sales growth. As I have said previously, P/E does a poor job of capturing the real value of compounded returns in a business that has a superior sustainability and predictability profile. I believe Mead Johnson to be a good example of this.

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