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Johnson & Johnson: Q2 Earnings Raise Some Questions

Published 2022-07-20, 12:03 p/m
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  • Latest Johnson & Johnson earnings offer reason for short-term concern
  • Outlook for coming year was reduced
  • Long-term outlook for JNJ, however, should be fine
  • Second quarter earnings from Johnson & Johnson (NYSE:JNJ) don’t look great. The results did beat Wall Street estimates, certainly. But the outlook for the year was reduced, and the stronger U.S. dollar is a threat to 2023 performance as well.

    Indeed, on a green day for the market — the S&P 500 gained 2.76% — JNJ dropped 1.5%. It was one of only two stocks in the Dow Jones Industrial Average to decline during the session; the other, not coincidentally, was IBM (NYSE:IBM), whose own Q2 report looked disappointing as well.

    Long-term, JNJ stock should be fine. I argued for the stock back in April; with the price about 6% cheaper, the “buy and hold” case still holds.

    Short- to mid-term, however, the Q2 report does highlight some potential reason for worry. Investors still should be looking closely at JNJ, but it seems likely they don’t need to rush in.

    The Dollar Problem

    With the Federal Reserve raising rates, the U.S. dollar has strengthened markedly. The U.S. dollar index, often referred to as the DXY, has hit a nearly 20-year high:

    DXY Chart

    For a multinational, U.S.-based company, the strong dollar can cause some problems. J&J certainly qualifies. In 2021, just shy of half of revenue came from overseas.

    A stronger dollar means sales made in other currencies translate at a lower level. For the Consumer Health business — which J&J plans to spin off — competitive problems can also follow, as in-country rivals don’t have the same currency pressures.

    The impact of currency was notable in J&J’s Q2 report. Despite the fact that the quarter beat analyst estimates, J&J pulled down its guidance for the year. Adjusted earnings per share now is projected to come in at $10.00-$10.10, against a range of $10.15-$10.35 after Q1.

    The reduction came almost entirely from currency impacts: adjusted “operational” EPS was barely changed (the high end of the range came down a nickel).

    To be sure, the stronger dollar isn’t destroying J&J results. The midpoint of adjusted EPS guidance was reduced just 2%. But the quarter does raise some concern about that consumer health spin-off. The business didn’t have a great quarter, in part because it’s the most impacted by currency. 55% of 2021 revenue came from overseas, and consumer sales face more competitive pressure than, say, a cancer medication or a knee implant.

    Again, this doesn’t break the case for JNJ stock. But it’s possible to see a poor reception for the spin-off next year, given modest top-line growth (U.S. sales actually declined in the quarter) and currency effects. That might dim some optimism for owning JNJ ahead of the spin.

    The Market Problem

    With the post-earnings decline, JNJ now has declined 8% from its 52-week high. That’s actually quite a strong performance in the context of the broad market: the S&P 500 is down 18% from its peak.

    The question is if that outperformance will hold if the market takes another leg down. We’ve seen precisely this pattern before:

    J&J Chart

    When broad markets (the blue line here is the S&P 500) turned south in the spring of 2008, JNJ held up. But when the decline in U.S. equities accelerated, J&J stock eventually gave way.

    If the recent bounce in the S&P — which has rallied 8.3% from its lows — reverses, JNJ stock probably follows. At about 17x this year’s earnings, the stock appears cheap. But in the context of pharmaceutical and medical device names, 17x earnings implies a reasonable premium. Drug-maker Merck (NYSE:MRK) trades at about 13x 2022 EPS estimates, and medical device giant Medtronic (NYSE:MDT) is at 16x.

    Relatively speaking, JNJ is one of the safer stocks out there. But the lesson of 2008-09 is that “relatively” is the key word. A stock that declines at a slower rate than the market still declines.

    The Long-Term Case for JNJ Stock

    To be sure, this may all be a bit too complicated. Again, I was a bull on the stock near the highs — and long-term, I remain bullish. As I noted earlier this year, J&J commands nearly 1% of worldwide medical spending. That’s an incredible feat, and a reasonable tailwind; as humans get older and developed economies grow, medical spending is going to rise over time.

    History too suggests JNJ will be just fine. Including dividends, JNJ has returned 7% over the past year, 8% annualized over the past five, and a total of 230% over the past decade. $10,000 invested 25 years ago would be worth $105,000 now — total returns of almost exactly 10% a year.

    Getting that level of return going forward might be a bit more difficult, given political pressures on drug pricing in developed markets and a slower rate of growth in developing economies. But this is still a company that will grow earnings, increase its dividend (J&J has raised its payout for 60 consecutive years), and likely see its stock price rise.

    In that context, there’s a “set it and forget it” case for JNJ stock still. But, at the same time, it’s fair to wonder if the stock might be available just a little bit cheaper at some point in the not-too-distant future.

    As of this writing, Vince Martin has no positions in any securities mentioned.

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