Shares of healthcare giant Johnson & Johnson (JNJ) have declined more than 10% since a Reuters story alleged that the company knew about asbestos in its talc powder for decades. Investors have responded quickly by selling the stock, presumably due to fears of potential financial payments.
There is no question the elevated headline risk has had a significant impact on J&J's market valuation. The question for investors, however, is whether the selloff has become overdone. While J&J faces the risk of a severe financial penalty, the long-term earnings power of the underlying business has not deteriorated. At least, not to the extent of the decline in J&J's share price.
J&J remains a premier dividend growth stock. The company has increased its dividend for over 50 years in a row. That makes it a member of an exclusive club: The Dividend Kings, a short list of stocks with 50+ years of annual dividend increases. As a result, long-term dividend growth investors could view a continued selloff in J&J shares as a buying opportunity.
Recent Events Overview
Johnson & Johnson's share price has declined by over $19 per share since the Reuters report broke on December 14. According to the investigation, J&J's internal documents showed that the company was aware of possible contaminants in its talc powder going back to the late 1950s. The scale of the situation is considerable, as the company is working through almost 12,000 product liability lawsuits related to its baby powder.
In response, J&J's CEO issued a video statement, reiterated its contention that its talc powder is free of contaminants and has not caused cancer or asbestos-related diseases. However, investors do not seem to be reassured. Shares of J&J continued to fall on December 19 when the company lost a motion to reverse a $4.7 billion jury award to plaintiffs claiming that its talc products caused their ovarian cancer.
The selloff in J&J stock has wiped out its gains for the year, despite the fact that the company has performed well on the basis of fundamentals.
J&J reported a strong third quarter on October 16. Revenue grew 3.6% to $20.3 billion, coming in $300 million ahead of analyst expectations. U.S. sales increased 3.6%, while international sales grew 3.5% for the quarter. On the bottom line, J&J earned $2.05 per share excluding non-recurring items. Adjusted earnings increased 8% from the same quarter last year, and also came in ahead of consensus analyst expectations.
Long-Term Growth Remains Intact
J&J operates three major business segments: Consumer, Medical Devices, and Pharmaceutical. The Consumer segment includes the company's baby powder, as well as many other consumer brands such as Band-Aids and Listerine. The consumer business is steady and profitable, but is not a growth area. Last quarter, consumer product sales increased just 1.8% from the same quarter last year.
J&J's growth segment is Pharmaceutical. Last quarter, pharmaceutical sales increased 6.7% to $10.3 billion. International sales rose by nearly 10%, as the company's immunology and oncology drugs continue to perform well. Inflammatory disease product Stelara posted 16% sales growth, while prostate cancer drug Zytiga grew by 43%. J&J raised earnings guidance along with the third-quarter report, to a range of $8.16 per share at the midpoint. This would represent 11% earnings growth for 2018.
There is still a long runway of growth for J&J. The company expects to ¿le for the approval of up to eight compounds by 2021, each of which has peak revenue potential of $1 billion per year, with multiple additional products with $500 million of annual revenue potential. J&J's strong pharmaceutical pipeline is the result of huge investments in research and development over the past several years. Last year, R&D spending exceeded $10 billion.
J&J's R&D platform is one of its biggest competitive advantages. The company has research facilities in the United States, Belgium, Brazil, Canada, China, France, Germany, Israel, Japan, the Netherlands, Switzerland and the U.K., with additional R&D support in over 30 other countries.
J&J Is Still Dividend Royalty
Johnson & Johnson has a dividend history that places it among the stock market's royalty class. The company has increased its dividend to shareholders each year for the past 56 years. It has one of the longest histories of annual dividend increases in the entire S&P 500. In 2018, the company raised its dividend by a healthy 7.1%.
J&J also returns cash to shareholders with share repurchases. As a show of confidence in its long-term business prospects, J&J announced a new $5 billion share buyback on December 19. Share repurchases help boost earnings growth, as fewer shares outstanding results in higher earnings-per-share.
The selloff in J&J shares seems overdone. Due to the declining share price, J&J's dividend yield has risen to 2.8%, and exceeds the 2% average dividend yield of the S&P 500. Furthermore, J&J's stock could be a bargain for value investors. Since the Reuters story broke, J&J stock has. Based on an average diluted share count of 2.73 billion reported in the most recent quarter, this means J&J stock has lost more than $46 billion of market value.
Investors seem to have overreacted, as the financial penalties from the lawsuits are likely to come in far below the loss of market value. A one-time charge is not going to impair J&J's long-term business model. The company is still a world-class dividend stock.
(This article was originally sent Dec. 20 to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this each day from Nick McCullum, Peter Tchir, Chris Versace and others.)