Investors ready to resuscitate Johnson & Johnson's ailing stock

Johnson & Johnson shareholders have endured a painful year amid worries about prospects for its many businesses, but investors capitalising on the stock's relatively cheap valuation may be set to apply a Band-Aid to the declines.

Shares of J&J, the largest U.S. healthcare company by market value, had slumped 11.2 per cent this year as of Friday's close, although recent gains may indicate the start of a rebound. The stock's year-to-date decline compares to more than 2 per cent gains for both the S&P 500 healthcare sector and the blue-chip Dow Jones Industrial Average, of which J&J is a member.

If J&J ends the year with its current 11.2 per cent decline, 2018 will be the worst calendar-year performance in 25 years for the stock, a bellwether for the healthcare sector and one traditionally considered a safe-haven investment during periods of market uncertainty.

The diversified company, whose products include Band-Aid bandages, Tylenol pain reliever, replacement knees and cancer and immunology medicines, faces concerns in all three of its main segments - pharmaceuticals, medical devices and consumer.

But the stock's swoon makes it look particularly cheap, based on its price-to-earnings ratio of 14.8 times forward earnings estimates, which is enticing investors, along with the stock's above-market dividend yield of 2.9 per cent.

"We are much more upbeat about J&J today than we were six months ago," said David Katz, chief investment officer at Matrix Asset Advisors in New York, as the stock traded just above $120 a share.

"We definitely think it's an attractive investment opportunity," Katz said.

J&J shares are up more than 3 per cent in June, following five straight months of declines, the stock's longest such losing streak in over a decade.

J&J's pharmaceuticals segment, roughly half of company revenue, saw sales jump by 19 per cent in the first quarter. But concerns about generic-drug competition eroding sales of prostate cancer medicine Zytiga, a standout in the first quarter, and rheumatoid arthritis drug Remicade have investors leery about the segment's future performance.

Pharmaceuticals has been the strongest segment of J&J's businesses, but "the ability to sustain an above-average growth rate has been a question," said Dean Dillard, senior research analyst at USAA Investments in San Antonio.

J&J's medical devices segment including its orthopaedics business has been losing market share, said Jeff Jonas, a portfolio manager focusing on healthcare for Gabelli & Co.

Performance in J&J's consumer segment has been "pretty lacklustre for a few quarters," Jonas said. The division also may be subject to weak investor sentiment in general for consumer brand companies, amid fierce competition and other concerns.

"There is concern around all three of the businesses," Jonas said.

J&J shares may also be suffering from concerns about scrutiny over prescription drug costs that are undermining pharmaceutical shares broadly.

"Sentiment remains fairly negative for the group, so that by and large does not help Johnson & Johnson," said Kevin Gade, a portfolio analyst, who follows pharmaceutical stocks at Bahl & Gaynor Investment Counsel in Cincinnati.

VALUATION ATTRACTIVE

The stock's recent valuation at 14.8 times earnings estimates for the next 12 months is its lowest since late 2015 and well below its five-year average of 16.5 times, according to Thomson Reuters Datastream.

J&J is also trading at a nearly 10 per cent discount to the S&P 500, compared to the slight premium it has held over the benchmark index on average over the past five years.

Also appealing, investors said, is J&J's dividend yield of 2.9 per cent compared to 1.9 per cent for the S&P 500, as well as the company's track record of consistently raising it.

Aside from paying its dividend, some investors want J&J to use its cash for a stock buyback or for an acquisition to improve its growth prospects.

J&J is "capable of doing 10 $5 billion transactions. We don't have to do a $50 billion transaction," Chief Financial Officer Dominic Caruso told an investor conference last week.

J&J's broad healthcare portfolio, which offers products that people will require even in economic down times, helps position it as a safe-haven stock in the event of market volatility or an increasingly uncertain economy.

"If and when the economy sees negative growth," Gade said, "relative to the market, Johnson & Johnson is the type of company and business model an investor would want to hold."