Johnson & Johnson

Moat: 4/5

Understandability: 2/5

Balance Sheet Health: 4/5

Johnson & Johnson is a multinational healthcare company engaged in the research, development, manufacture, and sale of a broad range of products in the healthcare field across the world.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Analysis (4/5): Johnson & Johnson possesses a strong moat, though not entirely impenetrable, primarily derived from its intangible assets, specifically its brand strength and patents. Here’s a breakdown: 1. Intangible Assets (Strong): * Brand Recognition: JNJ has an array of well-known brands in consumer health (such as Tylenol, Band-Aid, and Listerine), pharmaceuticals (like Stelara and Tremfya), and medical technology (such as Ethicon). These are globally recognized and generally hold a premium in consumers’ eyes. They foster trust and loyalty, which are hard to replicate. However, the power of a brand, though large, doesn’t mean it can command a premium if the products can be sold much cheaper and if switching costs are low. * Patents & Regulatory Approvals: JNJ’s business relies heavily on patents and regulatory approvals, specifically in pharmaceuticals and medtech. New drugs typically have patent exclusivity for an average of 20 years, and FDA approval is an extremely difficult and time-consuming process, both of which create significant barriers to entry. New medical devices must go through clinical trials and various other government regulations, which are also very expensive. The moat is created due to large number of tests and regulatory bodies which are very difficult and extremely time consuming to pass by other manufacturers, which give JNJ a good lead, but they are not permanent advantages as patents eventually expire and regulatory approvals can be contested. 2. Switching Costs (Moderate): * In some of JNJ’s MedTech and pharma operations, the switching costs are high. This is because doctors might not want to change from familiar medicine or medical devices due to safety/compatibility concerns which makes the customer less likely to switch. The more specialized a product and the more it needs to work seamlessly in operation, the stronger are the switching costs. 3. Scale and Distribution (Moderate): * JNJ’s scale provides some cost advantages in manufacturing, R&D, and marketing, especially in its consumer and pharmaceutical segments. It’s been producing drugs and consumer goods for more than 100 years which gives them an edge over other players. Moreover, JNJ has distribution network in countries all around the globe. Although these advantages can be replicated through enormous costs and time, the advantage is still considerable.

Despite its strengths, the moat is not a perfect one. JNJ competes in numerous fields where there’s continuous innovation, strong competitors, or limited brand power. For these reasons, it doesn’t get the highest moat rating, despite very high strengths in some of its businesses.

Risks to the Moat and Business Resilience:

  1. Patent Expiration: JNJ relies on patented drugs for a significant portion of revenue, so patent expiration could lead to sales decline and a drop in profit, especially for its pharmaceutical business.
  2. Litigation: JNJ faces substantial litigation risks related to its products, which could result in significant liabilities and damage its reputation. For example the company is a party to a number of lawsuits regarding certain products. JNJ has also settled opioid lawsuits that have resulted in enormous payouts and expenses. These legal challenges not only incur huge expenses, they also put a dent in company’s reputation and credibility.
  3. Regulatory Changes and Increased Regulation: Regulatory changes can increase operating costs, which could lead to a decrease in profit margins. For example, the new drug price rules that give government more say on pharmaceutical prices is a danger to most pharma companies including JNJ.
  4. Competition: JNJ faces competition from both established and emerging companies in all its segments. This is most prominent in the pharmaceutical business, where generic competitors aggressively attack the market after patent expires. A shift in consumer taste or an upcoming better product or service from competitors can lead to decline in JNJ’s sales and market share.
  5. Product Recalls and Safety Concerns: Recalls or safety issues can hurt JNJ’s brand reputation and impact sales. This can be particularly damaging to its consumer and medical device businesses.
  6. Technological Disruption: A new or better technology that might displace old technology in either pharma or medical devices can harm the business for JNJ.
  7. Global Economic Slowdown: A slowdown in global demand can disproportionately affect large multinationals like JNJ. Even though JNJ’s products are essential, economic slowdown can cause less income to be available for discretionary spending, leading to lower revenues for JNJ.

Overall, the diversification of JNJ’s portfolio, along with its well-established brands, geographic reach and long history, all lend to the company’s business resilience. JNJ has a long history of recovering from past problems and continuing to show positive results.

Business Explanation: Johnson & Johnson operates across three main segments:

1.  **Innovative Medicine (Pharmaceuticals):**  This segment focuses on the development and sales of drugs for various therapeutic areas. JNJ has many blockbuster drugs and a wide pipeline, which they use to replace revenue lost from patents expiring. The focus here is on specialized treatment.
    * **Revenues:** $14.52 billion in Q2 2024, representing 53% of total sales.
    *   **Key areas:** Immunology, infectious diseases, oncology, cardiovascular, neuroscience.
    *   **Growth Drivers:** New drugs, pipeline progress, and geographic expansion into emerging markets. JNJ has continued to invest and innovate in this business, and has a long history of blockbuster drugs with high demand.
    * **Profit Margins**: Typically carries the highest margin of all segments due to high pricing power with patents.
2. **MedTech (Medical Devices):** This business develops and sells medical devices and equipment used for a variety of medical procedures. It is also a leader in innovation, for example robotics surgery and new technologies for different treatments.
    * **Revenues:** $7.87 billion in Q2 2024, representing 29% of total sales.
    *   **Key areas:** Orthopedics, surgery, vision, interventional solutions, and other services related to medical devices.
    *  **Growth Drivers:** Medical procedure volume, new technologies and acquisitions. There is a good demand in this area, and it is only expected to rise with aging population and more access to healthcare in developing markets.
    * **Profit Margins**: Profit margins are generally lower in this business due to reliance on manufacturing and equipment sales which carries lower profit margins and high capital investment. However the margins are good, and can be improved through efficiencies and new technologies.
 3.  **Innovative Medicine (Pharmaceuticals):**
  *    This segment has been separated into new entity, called Kenvue, in 2023. It deals with sales of products in skin health, self care, baby care, essentials care.
     *   **Revenues:** Sales are no longer consolidated, however are available for historical comparison. These products face less regulatory obstacles and higher consumer awareness.
     *   **Key areas:** OTC medicines, beauty brands, skin care, hygiene products, baby products.
     *   **Growth Drivers:** Brand expansion, new products, and geographic reach into emerging economies, this business does not require much investment and also benefits from brand strength. 
    *   **Profit Margins**: Profit margins are generally lower in this business compared to pharma, but it requires less investment and can be scaled easily.

Competitive Landscape: JNJ faces stiff competition in all its segments. In pharmaceuticals, it competes with large drug companies and generic drug manufacturers. In medtech, it competes with medical device companies and innovators. In consumer health, it is facing increasing competition from both established and new companies.

Financials in-Depth: JNJ’s financials are a complex tapestry of large, diverse businesses.

*   **Revenue:** JNJ's Q2 2024 revenue was $21.4 billion, growing 6.3% year-over-year. There was also a favorable impact from currencies in this quarter due to their strengthening against USD.    * **Earnings:** Net income for the same quarter was $5.15 billion, representing a significant increase over the year. However, for the first half of 2024, EPS declined to $3.18. The company is still trying to grow its earnings, after losing substantial revenue for COVID vaccine and medication in 2021 and 2022, though the recent trends are promising.
*   **Margins:** JNJ has shown a pattern of declining operating margins, especially during COVID. The Operating margin for JNJ in Q2 2024, was 26.3%, which is higher than previous quarters and shows a good trend of growth in margins. 
* **Capital Allocation**: JNJ spends about 15 percent of net sales towards research and development. A considerable part of capital also goes towards M&A. There has also been a push towards returning cash to shareholders through dividends and buybacks, as evidenced by the increase in payouts for Q2 2024.
*   **Debt:** The company has total debt of approximately $28 billion as of September 2024. It is important to follow the net debt and the debt repayment capacity of the company in future financial reports to see how the company manages the debt. 
* **Cash & Equivalents**: The company has $24.8 billion in cash and cash equivalents. This helps the company navigate difficult times and also invest in acquisitions and R&D for better business outcomes.    *   **Cash Flow:** JNJ generates huge free cash flows because it is in a mature industry and it has high profitability and lower capital needs. These FCF can be seen in the cash flow statements.

It’s important to note the revenue and financial profile can vary based on the business segment, the details of which are given above. In recent quarters, JNJ has been able to achieve high growth in its innovative medicine sector while also seeing growth or stabilization in its other sectors.

Recent Concerns/Controversies:

  1. Opioid Litigation: JNJ faced numerous lawsuits regarding its role in the opioid crisis. While JNJ has reached a settlement, it may still incur some expenses or liabilities in the future.
  2. Product Liability: The company is facing lawsuits, primarily concerning talc-containing products. These lawsuits may result in liabilities. Investors should watch out for the outcomes of those lawsuits as it can impact the business in future.
  3. Inflation: JNJ has had to deal with the rising costs of inflation in raw material prices as well as supply chains, which has decreased its profit margin. This has created a headwind to the business.
  4. Economic Slowdown: There has been concern on a possible slow down or recession in global economies which can hurt JNJ’s sales and profits. This risk has to be constantly monitored as recession might lead to reduced consumer demand and might also pose challenges to the financial flexibility of companies.
  5. Patent cliffs: Some major patents for its drugs have expired, or are soon expiring, which may create a drop in profits and may also be a hurdle for long-term success.

While the company has tried to address most of these concerns by settling lawsuits, taking steps to mitigate inflation and creating new pipelines, these concerns should still be on the radar of a prudent investor.

Understandability Rating (2/5): JNJ’s business operations are complex and difficult to assess by an average retail investor.

  1. Complex Structure: JNJ operates across pharmaceuticals, medtech, and consumer health, each with its own nuances, regulations, and market. This complex structure of a diversified organization requires significant understanding of different markets, products and businesses.
  2. Accounting Complexity: JNJ’s financial statements are quite extensive and complex, given its many divisions, operations, and M&A activities, requiring significant financial knowledge. For example, the company has multiple layers of subsidiaries and different legal entities, and many of them are consolidated in financials which might create confusion. There are also several one-off and non-operating expenses that require careful analysis of financial statements to properly account for the value of the company.
  3. Technological Nuances: The scientific complexity of drug and medtech divisions can be challenging to grasp without a deep domain knowledge of those industries. For investors, it can be especially difficult to assess the pipeline progress, evaluate new medical technologies and forecast the future growth accurately.
  4. Regulatory Environment: The company’s business is affected by diverse regulatory structures across different countries. Also patent laws for drugs and regulatory approvals for medical devices are tough to understand and can add more complexity to analysis.

Due to these complexities, a layman investor may have difficulties in making an independent opinion on value and progress.

Balance Sheet Health Rating (4/5): JNJ has a strong balance sheet overall, but has some complexities.

  1. Liquidity: The company maintains good cash reserves which can be used to maintain operations during downtimes, but also to seize any new opportunities that might arrive. Cash on hand, along with available credit facilities provides a great financial flexibility and security.
  2. Solvency: While the total debt of $28 Billion might sound like a high number, most of it is in highly rated instruments. Also the company makes significant profits and returns on capital, which will allow them to pay down debt when needed. Interest coverage ratios are also good and the company doesn’t have significant trouble covering its interest payments on debt.
  3. Asset Quality: Most of JNJ’s assets are in the form of equipment, patents, investments and intangible assets like goodwill and brand. The valuations of these assets can change drastically because of market disruptions and technological changes.
  4. Financial Flexibility: JNJ can continue to generate considerable cash through operations, and its huge size allows the company to easily acquire more credit whenever they want. The company is also cash rich with substantial liquid reserves to finance future strategies. They also have a strong history of buying and selling off businesses as the business landscape changed.

While the debt numbers are not low, the company’s ability to repay them makes it a very healthy balance sheet, but requires a closer look for any future changes in business.

In conclusion, Johnson & Johnson is a very strong and diversified business with a notable moat stemming from its many well-known brands, patents, regulatory approvals, large distribution network, high R&D investments, and some switching costs in its products and services. However, the company does face significant legal and other risks. This large multi-business corporation with global reach will need diligent analysis for any investor, however it also poses substantial opportunities for wealth creation.