If you had read the Wall Street Journal every day since 2005, you would have read 118 articles that mentioned Johnson & Johnson's pharmaceutical biz, 71 articles on JNJ's medical device unit, and only 36 that mentioned the consumer products segment. It's not surprising that the pharma and medical device divisions garner 5x the coverage on Wall Street--those divisions produced 75% of JNJ's revenue and over 80% of its operating income last year. But are some investors missing an increasingly important driver of shareholder value at JNJ? We think so.
Since 2005, JNJ has invested significantly in its consumer products segment, most notably acquiring Pfizer's consumer health care division in 2006 for $16.6 billion, which included brands such as Zyrtec OTC and Listerine. Key to maximizing the return on this investment, JNJ has followed with impressive R&D spend within the consumer products segment, which was increased nearly 11% last year to $624 million. According to CEO Bill Weldon, management intends to continue to leverage its strong capabilities in science and technology to develop innovative consumer products, which is increasingly necessary in a world of surging demand for low cost brands. We took a closer look at what is now a $16 billion consumer products business that has created significant value for JNJ shareholders.
In 2005, JNJ's consumer products segment delivered $9 billion in sales and about $1.6 billion in pretax income. These results were largely driven by the OTC Pharmaceutical and Skin Care categories. Products such as Tylenol, Splenda, and Neutrogena contributed over half of the segment's revenue.Since 2005 revenue has increased over 75% to $16 billion as combined sales in the pharma OTC, skin care, baby care and oral categories have nearly doubled. The majority of this growth came from the acquired Pfizer business, which included the launch of Zyrtec OTC in 2008, Sudafed and Nicorette (all OTC Pharma), Lubriderm (Skin Care), and Listerine (Oral Care). In addition, international sales have benefited from organic growth of Johnson's Baby and Skin Care products and Listerine, as well as the acquisition of Beijing Dabao Cosmetics Co. Ltd, maker of the #1 skin moisturizer in China.
Value creation from consumer products appears to be meaningful to JNJ shareholders. Based on 2009 guidance, we think the division could generate twice as much cash flow than in 2005, thus doubling the value of the business to nearly $30 billion. Combined with growth in the pharma and medical device segments and recent share buybacks, we believe that management has increased JNJ shareholder value at an 11% annual rate since 2005, with about 1/4 coming from the consumer products division. With the share price down about 14% during that time, perhaps Wall Street is looking past JNJ's Main Street value.
How to Write a Letter to Shareholders
We look forward to reading the letters to shareholders that are included in corporate annual reports. This is the CEO’s opportunity to explain what happened in the past year, what their goals are, and how they are positioning the company to protect and grow shareholder’s investment. The best letters, like those of Warren Buffett and Sam Walton, are candid and insightful. Bill Johnson, CEO of Heinz, has produced an excellent letter this year and we recommend that all consumer packaged goods executives read it.
Coke’s Directors Caught Guzzling
Coca-Cola provided $12,500 worth of products last year to its 13 non-management directors, according to its recent proxy, an increase of 80% over 2007. Even at a retail prices, that’s nearly 3 drinks a day per director. Time for a bathroom break. Source: Footnoted.org.
Fill-er-Up
We noticed in the disclosure on executive compensation for Fresh Del Monte Produce (13% of 2008 sales to Wal-Mart) – that in addition to a company car for executives, shareholders were also picking up the tab for their fuel purchases. Last year, vehicle expenses (including fuel) in 2008 for the three top executives were about $38,000 apiece. Maybe they should switch from premium to regular gasoline. Source: Company Reports
"Haven’t They Suffered Enough?"Beano Cook, uttered that famous one-liner in 1981 when then Commissioner of Major League Baseball, Bowie Kuhn, offered lifetime baseball passes to the American hostages returning from Iran. Ditto the quote for top managers of Kingfisher, PLC. The UK home improvement retailer (800 stores) announced that it was rewarding top performing store managers with shares worth up to six months of their salary. The managers have already been “rewarded” with shares, which are down 50% in the past two years. Indeed, the company has doled out a whopping 15% of compensation expense over the past two years in the form of share-based payments (found here). Source: Company reports.
Demographics
If consulting firm McKinsey & Co. is correct, global consumer packaged goods (CPG) companies and retailers are in for some good times. In the next 13 years, the world population will grow by another 1 billion people. As well, populations are shifting from rural to urban centers. By 2100, 80% of world’s population will live in cities, up from 50% today. Significant expansion of the middle classes, major purchasers of consumer packaged goods, in China, India and Brazil should occur by 2050, or within one lifetime. In fact, the middle class has increased from about 30% of the world population since 1980 to nearly 60% today. Sidebar: the number of languages worldwide is expected to drop from 7,000 today to a few hundred. Read the full report here. Source; McKinsey, The Economist
Department of Corporate Doublespeak: 5,000 IBMers were notified in late March that they would be “participating in IBM’s current resource reduction action.” Translation: We’re outsourcing your job to India -- please exit your cubicle. Give IBM’s HR department a gold star for its word-smithing abilities. It’s an uncommon skill to deliver a psychologically-crushing blow to people while making it sound like it’s a reward. Source: Wall Street Journal
Quote of the day: “No thanks, I can lose my own money.”
This was Donald Trump’s response to Bernie Madoff asking “Why don’t you invest with me?” And it appears “The Donald” is doing an excellent job – Trump Entertainment Resorts filed for bankruptcy in February. Anyone remember shelling out 100 bucks at the Economics Arkansas luncheon last May to hear Trump share his wealth-building secrets? Source: New York Times
Weekend Reading: But Wait…There’s More! Author Remy Stern takes a hard look at the infomercial industry in But Wait..There’s More! The TV netherworld of Ronco, ShamWow, and our personal favorite, the Snuggie, (watch the clip) is a $300 billion industry, pumping out 300,000 infomercials at consumers each month. Unlike their highbrow counterparts at Madison Avenue agencies, the 1-800 types face instant accountability; they know pretty quickly whether or not the spot was successful. Source: Wall Street Journal.
Have a thought or comment? Give us a call or email.
Scott Alaniz, CFA
scott@bostonmmm.com
Joe Chumbler, CFA
joe@bostonmmm.com
Fayetteville (479) 251-8400
Rogers (479) 366-4474
Information in this report has been obtained from sources that we believe to be reliable. Boston Mountain Money Management does not guarantee its accuracy or completeness and assumes no responsibility for actions taken with respect to information contained herein. The authors held a position in Johnson and Johnson at the time of this newsletter.
