Chapter on "Start Management Simulation"

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[EXCERPT] . . . .

Johnson & Johnson to Competitors Within Its Sectors

Johnson & Johnson filed their latest 8-Q April 17; figures trailing one year (ttm) are from 20 April 2012. The next earnings report date was not released as of April 20. Profit fell f.y. 2010-2011 in all three segments, from $16.974 billion (2010) to $12.361 billion for f.y. 2011, i.e. A drop from 27.5% of operating profit to 19% of sales retained as earnings for all sectors. Margin as per 20 Apr. 2012 was 14.8% overall. The pharmaceutical segment lead at 26.3% profit: sales year end 2011, down from 31.6% operating profit 2010; Medical Devices / Diagnostics fell by 13% from 33.6% earnings to sales last year, to 20.4% or $5.26 billion (Johnson&Johnson 31). The wider picture is that Pharmaceuticals is now the highest performing segment instead of Devices, and margin performance has fallen markedly overall. On the other hand revenues have increased quarter over quarter for JNJ trailing twelve months by 3.9% to 65 billion, but quarterly earnings growth was negative 88.8% (Yahoo!Finance, 2012e, n.p.) as of 20 April.

Biggest competitors by market capitalization are Pfizer ($170 Bil.) and eventually Novartis AG ($135.5 B.) and Covidien plc with about a fifth of that. Industry average is $1.63 billion for whatever that comparison is worth. Quarterly revenue growth for these largest firms trailed the industry by at best less than half with smaller firms as a rule growing faster than the top three for size. Pfizer is more profitable than JNJ with nearly the same market capitalization but fewer employees, more revenue and dominant gross and operating revenue margins, if a billion less net income twelve months prior 20 April '12. Pfizer cannot be discounted as a competitor in the Drug Manufacturers: Major industry. Despite a lower EPS by half given comparable market cap and current P/E ratios, Pfizer's stock price is expected to increase faster than JNJ, indicated by a higher PEG ratio presumably given earnings and P/E at a much lower nominal price to begin with, around $23 to JNJ's $63 or so. A brief glance at Table 1 (Appendix a) reveals / supports that comparing a huge, mature, dominant multinational like JNJ to "TRABI.BO"s 761.5% industry-leading revenue growth rate or RHO5.DE's 73% ROE to JNJ's 17.02% may not be particularly relevant. Investors may prefer Pfizer. Investors may prefer copper, or information security startups. Many industries outperform Pharmaceuticals but fewer deliver the stability of brand recognition and assets that back up JNJ even given share price volatility in the short-term.

Compare the industry to other industries

Comparing the $37,805B entire Healthcare industry to say "Consumer Goods" would be to consider an industry to one with a $159,409 billion market capitalization (Yahoo!Finance 2012a) and to say that Healthcare offers 140-basis point higher dividend yield would deliver limited utility. If the invester prioritized return on equity over dividend yield, they would clearly prefer the Basic Materials sector. This yields very little guidance as to when or in which issues to invest. Within Healthcare, "Health Care Plans" and "Specialized Health Services" both beat JNJ for ROE (Yahoo!Finance 2012e, n.p.) but "Services" has higher P/E so investors see that sector's stock prices growing faster, but Major Drug Manufacturers and Specialized Health Services have nearly identical P/Es (Yahoo!Finance 2012e), so deciding where to buy diamonds becomes a matter of which indicator investors prioritize since there are two 'best industries' in either category. Drug Manufacturers have higher profit but Specialized Services more cash to share price at the same time as negative book value. If growth is the objective, JNJ may not win the beauty contest but risk-averse investors may prefer stability, 65% institutional ownership notwithstanding.

Indeed out of 27 analysts by April 20th, JNJ got 7 buys, 7 strong buys, 13 holds and zero underperform or sell. The year-out stock price varied between today's $65 to $90 with the general consensus stable, perhaps unenthusiastic but safe if not exciting. Fifteen brokers set a mean price point of $71 per share a year from now (Yahoo!Finance, 2012b, n.p.). Percentage of shares short was 1.6% as of March 30 (Yahoo!Finance, 2012b); insiders hold about a million shares, of which they've sold about 32% in the last six months, compared to a lowly 3,000 shares purchased (Yahoo!Finance, 2012c). Institutions, who hold about 65% of JNJ equity, are bullish but not even by less than a percent of holdings over the last six months (Yahoo!Finance, 2012c, n.p.). In the big picture, JNJ's total market capitalization represents half a percent of the $31,000-billion segment "Drug Manufacturers-Major" alone, effectively unlimited market share to capture on the other hand an interesting New York Times article April 19 (Pear, n.p.) points out Medicare may be able to cut $42 billion over ten years through competitive bidding, and such pressures could plausibly continue from Congress (Johnson&Johnson 35). These forces face all competitors, and analysts, insiders and institutions predict increasing or flat stock price next year, regulatory and liability issues that affect Johnson&Johnson alone notwithstanding.

Differences in structure and conduct between healthcare and other industries

A global view of the marketplace suggests health care may be a special type of good, if the possibility of saving lives or preventing negative health outcomes generates an underlying urgency to release medicines and devices faster than commodities or products that deliver utility without the potential sacrifice cost of human life. If a drug was demonstrated to save lives, and proved risk free, then witholding that from the market for too much testing may in fact be less ethical than accepting some risk of failure if the majority of units of a new product never fail at all. In a similar way, keeping a drug for example off the market for three generations in order to make sure no long-term side-effects will ever arise, would result not only in removing incentive to innovate and thus discover new beneficial treatments and products, but would also have kept many of the most valuable medical advances from preventing the spread of disease or healing from those willing to take the risk of side effects. Many of Johson&Johnson's products have passed this mature stage of the product cycle and have become standardized and tested enough as to bear very little such risk.

Johnson&Johnson states that 2011 costs specifically of recall and liability for products that had already been released increased from 2010 by $1 billion for product liability (31) and what they call at first $200 million, then $280 million, and finally either $325 million for a specific hip prosthetic (31) or $521 on p. 56. These actual costs are difficult to identify conclusively because in various notes product liability and recall figures are bundled with gains from divestiture or costs of merger and acquisition. Many of these figures are adjusted net of other successful litigation, which for 2010 actually generated revenue for the corporation (Johnson&Johnson 30). Product liability is cited first in the list of "primary drivers" for profitability declines year-over-year in Pharmaceutical and Devices segments for 2011 and along with "unfavorable product mix" as the two drivers in over the counter Consumer product (31).

Likewise the firm faces significant criminal charges for pricing behaviors specifically claiming higher costs than the U.S. government finds justifiable for a number of products, with potential results demonstrated by criminal fines of over $1 billion in Arkansas alone before appeal for a single product RISPERDOL (Feely & Francis, n.p.). While Johnson settled with Texas before the Arkansas verdict, eight other states as of Jan. 2011 are next in line and the Arkansas verdict could provoke them to turn down settlement by the company in hopes of higher awards at the bench now that JNJ has been found in violation of criminal fraud statutes misrepresenting cost that basically boils down to overbilling Medicaid, marketing the… READ MORE

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