A Dividend Stock on the Mend

This icon of Big Pharma is well-suited to conservative investors, but at least one analyst believes it could emerge as a growth story, writes John Heinzl, reporter and columnist for Globe Investor.

For years, Johnson & Johnson (JNJ) was one sickly health care stock.

Plagued by quality control problems that led to recalls of brands such as Tylenol, Motrin, and Benadryl, the stock spent the better part of three years trading between $60 and $65. Recalls of thousands of artificial hips, along with patent expirations affecting key prescription medications, only added to investors’ worries.

Lately, however, J&J has been rebounding, as the company begins to put some of those issues behind it. And there may be more upside ahead, given that the stock trades at less than 14 times next year’s estimated earnings, even as the company is on the mend.

“We believe J&J is at the early stages of re-emerging as a growth story,” Odlum Brown analyst Felix Narhi, who has a “buy” and $85 target price on the shares, said in a recent note.

J&J is well suited to conservative investors, given the company’s strong balance sheet, AAA credit rating, and the entrenched position of its consumer products, pharmaceutical, and medical device businesses, he said.

For dividend investors, in particular, the stock has a lot to offer. J&J, which currently yields about 3.1%, has raised its dividend for 50 consecutive years. In April, it’s expected to hike the dividend again, by about 7%, according to Bloomberg.

Backed by the company’s bulletproof balance sheet and a payout ratio of about 50% of earnings, the dividend is “extremely safe,” Narhi said in an interview.

Judson Clark, an analyst with Edward Jones, agrees that J&J’s growth is poised to accelerate. With patent expirations largely behind it, the company stands to benefit from several new drugs targeting prostate cancer, hepatitis C, and other diseases. It also has a strong product pipeline that should help to drive earnings higher over the next several years, he said.

“We expect Johnson & Johnson to continue to grow the dividend in line with earnings, at a rate of 7% per year, on average,” Clark said in a recent note.

J&J’s diversified business units are another plus, he said. If the over-the-counter consumer business struggles, for example, the medical devices and pharmaceutical units can pick up the slack. What’s more, J&J is poised to benefit from demographic trends over the next few decades, as baby boomers consume more prescription drugs and other medical products.

That’s not to say the company is completely out of the woods.

The biggest question mark is how much J&J will have to pay in costs arising from more than 10,000 lawsuits over its recalled artificial hip implants. In the first of those cases, a jury in Los Angeles this month ordered the company to pay about $8.3 million to a Montana man who claimed to have suffered metal poisoning and other health problems.

Ultimately, J&J’s costs could soar well into the billions of dollars, but Narhi said it’s highly unlikely that the average award will be as high as in the first case. That’s because lawyers usually start medical litigation with plaintiffs who have a strong likelihood of winning a large award.

That said, worries about the potential costs to J&J are almost certainly weighing on the share price. Without the hip implant lawsuits, Narhi said the stock would be trading at a substantially higher price-to-earnings multiple.

Not everyone thinks now is a good time to jump into J&J. In February, Credit Suisse analyst Catherine Arnold downgraded the shares to “underperform” from “neutral.”

The consumer division is on the right track, but probably won’t be completely fixed until the end of 2013, she wrote. And while recent drug launches and the 2011 acquisition of medical device maker Synthes are positives, she said they are already reflected in J&J’s share price. Her main concern, however, is that the Street’s estimates for the pharmaceutical division are overly bullish for 2015 and beyond.

“Many of [J&J’s] new products will have increased competition (e.g. arthritis, prostate cancer, and hepatitis) and this could lead to lowering of pharma estimates for the years 2015 forward,” Arnold wrote.

With large, diversified companies, there are always going to be divisions experiencing problems, Narhi said. J&J has suffered more than its share of setbacks recently, but investors who wait for everything to be rosy could well miss out on the biggest gains.

“You want to get ahead of these stocks before it’s totally obvious” that the business has turned around, he said.

The author personally owns shares of Johnson & Johnson. Read more from Globe Investor here...