For the most part, Wall Street and investors love the Big Pharma sector. Large pharmaceutical companies often have diverse product portfolios that are capable of producing billions in operating cash flow each year. This cash flow generally leads to a superior dividend yield relative to the average yield of the S&P 500.
Of course, Big Pharma also has its downsides. For example, Big Pharma product portfolios are often well established, but tend to grow pretty slowly. When the stock market is on a major bull run (like we're seeing now), large pharmaceutical stocks tend to underperform the overall market. Additionally, Big Pharma portfolios are susceptible to patent loss expirations, which can expose their most important drugs to generic competition.
But if there is one Big Pharma that I personally believe offers a good balance of growth potential and stability, it's Johnson & Johnson (NYSE: JNJ).
Johnson & Johnson isn't your traditional pharmaceutical company -- it's actually a healthcare conglomerate comprised of a consumer healthcare products division, a global medical devices segment, and of course its gigantic pharmaceutical segment. J&J's pharmaceutical segment is where the bulk of the company's double-digit gross margin is derived, while its consumer healthcare product operations deliver predictable cash flow and strong pricing power year after year.
Yet like all Big Pharma stocks, even Johnson & Johnson needs to stay nimble in order to grow its bottom line. Here are three long-tail growth drivers that I believe could supercharge Johnson & Johnson's share price growth for many years to come.
The Affordable Care Act
If it seems like the Affordable Care Act, which you likely know best as Obamacare, is as popular as a root canal, you may not be far off. In the latest Kaiser Family Foundation Health Tracking Poll, just 41% of respondents had a favorable view of the health reform law, while 43% had an unfavorable view. In fact, it's been more than two years since the number of "favorable" views outnumbered the "unfavorable."
In spite of what might be called "Obamacare angst," the long-term outlook for a lowering in the uninsured rate, along with an aging U.S. population, bode extremely well for Johnson & Johnson's medical device segment.
Based on the latest results from Gallup, just 12.9% of respondents were uninsured in the fourth quarter of 2014. For context, this compares to 17.1% of respondents claiming to be uninsured the quarter prior to Obamacare going into effect. Based on estimates from the Department of Health and Human Services, nearly 12 million people enrolled in Obamacare in the latest enrollment period (Nov. 15, 2014 – Feb. 15, 2015), and the Congressional Budget Office predicts this figure could nearly double by 2025. More enrollees should mean better access to preventive-care doctor visits and possibly more surgical procedures being conducted.
In spite of medical devices arguably being a commoditized business, the sheer volume surge that J&J could see over the long term more than makes up for slightly weaker margins and gives plenty of hope for substantial long-tail growth in its medical device segment.
Secondly, even though Johnson & Johnson has brought a number of organically developed new therapies to market in recent years, I believe its opportunity for long-tail growth that'll keep it ahead of the patent loss curve is its ability to seek out and partner with smaller biopharmaceutical companies with potentially blockbuster drugs.
To be clear, not all collaborations that involve J&J are going to end in success -- and that's OK. If J&J isn't failing, it's probably not trying hard enough! For instance, in 2012 a joint venture with another equally large pharmaceutical giant led it to test experimental Alzheimer's drug bapineuzumab in multiple phase 3 trials. It eventually failed miserably, and the drug was scrapped.
Bu Johnson & Johnson has plenty of success stories as well. For example, in 2011, Johnson & Johnson agreed to partner with little-known Pharmacyclics (NASDAQ: PCYC) to assist in the development of Imbruvica, a drug targeting various blood cancer malignancies. J&J agreed to pay potentially up to $975 million in milestones to Pharmacyclics, including a $150 million upfront payment. Now approved in three indications, Imbruvica could net peak annual sales in the neighborhood of $7 billion (which is largely dependent on the drug gaining additional indications).
Imbruvica was tested in mantle cell lymphoma, where it delivered an incredible overall response rate of 66% and wound up being approved by the Food and Drug Administration months ahead of schedule. For chronic lymphocytic leukemia, the most common form of leukemia in adults, 58% of patients experienced cancer shrinkage, and the average duration of response ranged from 5.6 months to as high as 24.2 months. What's so remarkable about Imbruvica's clinical results is that the average CLL patient in its study was diagnosed nearly seven years prior, and Imbruvica stlll delivered this significant of a response.
Johnson & Johnson's latest "project" is Geron's (NASDAQ: GERN) experimental myelofibrosis drug imetelstat. Imetelstat has certainly had its fair share of safety concerns over the past year and change, but it could also transform myelofibrosis treatment as we know it.
Whereas the current standard of care for myelofobrosis -- a disease characterized by abnormal blood cell buildup in a patient's bone marrow -- is JAK inhibitors, which have shown some degree of clinical benefit and symptom relief, imetelstat actually demonstrated partial or complete responses in a handful of patients. Disease-reversing responses had not previously been observed prior to imetelstat, lending plenty of hope for its future.
In November 2014, Johnson & Johnson paid Geron $35 million up front to collaborate on the development of imetelstat and could pay Geron an additional $900 million based on development, regulatory, and sales milestones. This is just one of possibly many more collaborations that could fuel J&Js pharmaceutical growth for years to come.
A dividend streak for the ages
Finally, Johnson & Johnson could use its incredible cash flow from all three segments to continue to grow its stellar dividend, which is more than enough of an allure for income investors.
Johnson & Johnson is what we'd refer to as a Dividend Aristocrat, or a company that's raised its dividend in a minimum of 25 straight years. There are less than five dozen companies listed publicly that qualify as a Dividend Aristocrat, or in other terms less than 1% of all publicly listed stocks. Johnson & Johnson has specifically raised its dividend in 52 consecutive years, and I'm fairly convinced that J&J will again raise its annual payout in its upcoming quarterly report later this month.
Currently yielding 2.7%, J&J has regularly paid a yield that's outpaced the S&P 500 average yield. What's more, J&J's dividend encourages long-term buy and hold investors looking for income to purchase the stock, ultimately helping to reduce volatility.
Sporting a payout ratio of just 45% based on its estimated 2015 EPS, I'd opine that J&J still has plenty of dividend increases left in the tank to drive, which in turn could drive share price appreciation.
Clearly, you're better off thinking of Johnson & Johnson as a mature buy-and-hold investment. In essence, it's not going to double over the next six months. However, just because J&J has an established business model doesn't preclude it from solid long-term growth prospects. Risk-averse and income investors would be wise to give Johnson & Johnson a closer look, in my opinion.
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Sean Williams has no material interest in any stocks mentioned in this article.