JNJ: Dividend Stocks Have Little Downside Protection

  • Investors assessing macro vs. micro factors in JNJ and sector as a whole.
  • Strategy requires a look ahead to managerial factors likely to impact earnings.
  • Risk levels to watch for investors looking to take a more protective stance on positions.

Whether you are bullish or bearish on equities, it is hard to deny that the last few months have generated a sea change in the ways that investors view the financial markets. Already, we have seen drastic upward revisions in the rate hike expectations that are currently seen in a majority of the reports released by analysts, and this is something that could weigh on some of the most commonly traded dividend instruments.

When assessing these types of situations, one of the first names that should come to mind is Johnson & Johnson (NYSE: JNJ), which can either be traded individually or through the iShares U.S. Healthcare ETF (NYSEARCA: IYH). When looking at the components of the ETF, JNJ exposure makes up more than 11% of the holding so there are some interesting advantages here for investors that are still bullish the sector but are wary about entering into specific stocks that might be vulnerable to systemic changes in the current macro environment.

Johnson & Johnson is a holding company that was founded in the late 1880s, and the main businesses reside in health care products largely classified into three segments: consumer, pharmaceutical, and medical devices. Johnson & Johnson uses 120 facilities to structure the sale and manufacture of one of the most diverse range of products that can be found in the sector and, in terms of brand recognition, the company is most commonly associated with its baby and skin care products so these are likely the businesses that will receive the most scrutiny over the next 2-3 months.

Chart View: iShares U.S. Healthcare ETF

In the IYH chart below, we can see that there have been some significant headwinds for the sector as a whole, and there are still macro factors that will need to be taken into consideration when adding exposure in a stock like JNJ.

On the face of it, there are positives that should be remembered. Fourth quarter earnings were particularly strong, showing $18 billion in revenues and earnings-per-share results of $1.58. This helped confirm the decision by Fitch to reaffirm Johnson & Johnson’s IDR at ‘AAA’ with a stable outlook.

But the fact that markets had major difficulty rallying following the release shows that the sector as a whole might have much bigger problems in terms of the market’s overall sentiment and expectations that have come with the new Trump Presidential administration. ¬†Overall, these trends have lifted stock markets and sent the forex market in the US currency much higher. ¬†Whether or not these trends can continue, however, remains to be seen.

Managerial Changes

So it is important to assess some of the company’s latest strategy changes in order to get a sense of how this will impact the directional value of the next earnings releases made available to the market. Significant developments have been seen over the last few months as Johnson & Johnson arranged for collaborations between pharmaceutical company Janssen and ChemDiv in an effort broaden the company’s range of targets across multiple therapeutic areas. This is something that should contribute to better earnings results over the next few quarters if the company is able to meet its base expectations.

Other developments that should continue to influence sentiment will depend on the outcomes seen in JNJ’s decision to avoid selling its equity stake in their Actelion research and development unit. Previously, there were some disagreements over this strategy direction and the decision to wait for the full two-year agreement period to complete could ultimately lead to managerial changes if the expected performance results are not achieved in these areas of the business. This added uncertainty factor is enough to tip the scales negative and suggest a weaker outlook for the stock over the next few months.

Chart View: Johnson & Johnson (JNJ)

The Q4 earnings-per-share of $1.58 were roughly in line with the consensus expectations of $1.56 but Q4 sales still came in at a disappointing $18.11 billion. This will place a greater focus on this year’s results and the Thomson Reuters surveys currently show that FY 2017 sales are expected to reach $74.65 billion, with adjusted earnings-per-share of $7.02. The expectations for FY 2018 are $77.37 billion and $7.37, respectively.

JNJ is currently trading just above $113, showing relatively respectable gains from a year ago when it was trading around $100. Range activity has been defined by the highs near $125 in July but prices have been falling steadily since then. The third consecutive lower peak on the yearly chart suggests that the long-term downtrend is still in place and that critical support at $110.99 (low from December 8th) is likely to draw prices. This is the central line in the stand in terms of protective support, and it is likely that many investors will start changing position stance if declines extend from there.

Corporate Earnings

That said, all hope is not lost for those still long the stock. JNJ’s trailing twelve-month earnings-per-share is $5.94 at current prices, giving the stock a 19.06 x P/E, which is well below the industry average of 28.94. These better valuations come with a company that is one of the most dependable dividend payers in the market, so there are advantages for investors that are able to withstand more potential downside in the stock price. JNJ pays its dividend quarterly, paying $0.80 a share dividend over the last two quarters, and JNJ’s dividend yield is currently 2.83%. This is well above the industry’s average yield of 1.58%, so there is some incentive to buy if you are investors that can withstand the potential downside.

So while the macro environment is providing little immediate protection for large sections of the dividend investment space, this does not mean that the baby should be thrown out with the bath water. Johnson & Johnson has posted a 13.32% annualized return-on-investment and a 20.05% annualized return-on-equity over the last 5 years. The company also enjoys better margins when compared to the industry average: Its gross margin is TTM 69.21% vs the industry average of 51.86%, and net profit margins 20.47% vs the industry average of 11.1%.

But all of these positives must be considered alongside the increased potential for downside likely to stem from a negative macro framework and a somewhat uncertain strategy docket within the company. Add the fact that the company is currently showing a 5-year annualized sales growth rate of 2.03% (while the industry average is 10.35%) and we can clearly see there is a confluence of events that is capable of clouding the outlook, even for dividend staples like JNJ.

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