Managerial Finance - Johnson & Thesis

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76), ROE has ranged from 21.6% to 28.3% in recent years, with the 2007 figure being 25.6%. This reflects outperformance of both the industry and the market. The ROA has exhibited similar outperformance of both industry and market. The return on assets for JNJ over the past several years has ranged from 13.1% in 2007 to 17.l% in 2005. The industry five-year average is 8.85% and the market five-year average is 7.50%.

SWOT Analysis

Strengths

Net Income increased despite decline in revenues

Growth in each business segment

R&D expense growing slower than revenues

2-year upward trend in net income

Upward trend in cash levels

Upward trend in cash flow from operations

Current ratio 46.36% higher than industry

Interest coverage 80.09% higher than industry

Net margin 14.04% higher than industry

Return on Equity 1414.79% higher than industry

Return on Assets 48.02% higher than industry

Weaknesses

Decline in revenue this year (1st time in 75 years)

Cost of revenue increasing faster than revenue

SGA expense increasing faster than revenue

Incurred income expense for the first time in years

Increase in LT debt

Increase in overall leverage

P/E 10.19% lower than industry

Quick ratio 27.7% lower than industry

Debt-to-equity ratio 160% higher than industry

Gross margin 0.2% lower than industry

Opportunities

Further absorption of PCH can reduce costs

Strong emerging market performance

Geographic expansion of major consumer product lines

New pharmaceutical products, especially in HIV (PRESTIZA, ustekinumab)

7-10 new SEC filings in next 2 years

New MD&D products (REALIZE, ANIMAS insulin pump)

2.8 trillion in untapped health care market segments

Threats

Need for FDA approval for new drugs

Strong competition in most segments

Economic downturn hurts core U.S. market

Economic downturn stunts growth in lucrative emerging markets (especially BRIC)

Dependent on aging population for continued growth

Overall, Johnson & Johnson is a strong company. Their finances are stable and the company has demonstrated that they are able to identify and improve upon areas of financial weakness, such as the recent decline in cash holdings. They are a well-diversified firm, which allows them to weather weakness in any one segment. This does leave them exposed to broader economic downturns, and in 2008 they appear poised to post their first year of declining revenues in 75 years. However profits and cash flow from operations both grew in 2008 despite this. They are an industry leader and there is far more cause for optimism than pessimism given their current financial position. Their low P/E ratio is more indicative of an opportunity to buy than any long-term fundamental weaknesses in their financial statements or their market performance.

Recommendations

The current challenges facing Johnson & Johnson are largely based on struggles in the global economy. JNJ is very well-diversified, but further improvement of diversification will help them to kick start growth in the face of a slowing economy. To that end, the first recommendation is to increase their presence in emerging markets.

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While some markets are subject to the same slowdown facing the U.S., others such as Russia and Brazil are more insulated. The Chinese and Indian economies are hurting relative to their recent successes but again there are long-term opportunities in each of those nations. JNJ should expand into these countries to gain a measure of economic diversification.

The second recommendation is that Johnson & Johnson should increase research and development expenditures. This will allow them to move into new markets within their core health care and consumer product fields. More importantly it will allow them to have a multitude of quality drugs in the development pipeline when the economy begins to improve and the baby boomers are still in their prime health care spending years. After a couple of years of stabilized R&D expenses and faced with sharply declining sales in core products now subject to competition from generics, the time has come for JNJ to renew its commitment to new product development.

The third recommendation is that Johnson & Johnson should tap into the $2.8 trillion in health care segments in which they do not presently compete. They have strong advantages in terms of cost, brand and distribution that can enable them to be a formidable competitor in any medical product business they enter. They can achieve growth in the face of a slowing economy by expanding the breadth of their product offerings. They can take advantage of rock bottom equity prices and their strong cash position to purchase companies that will help them enter these new markets.

The fourth recommendation is that Johnson & Johnson should continue to pursue the most efficient capital structure. This means that they should continue to take advantage of their low multiple to buy back stock, and that they should increase their debt level. They have ample ability to cover an increased debt load and can be expected to have a very low cost of debt at current interest rate levels.

A fifth recommendation is that JNJ should seek to contain its cost of revenues. This has, in general, been increasing at a faster rate than have revenues. While overall JNJ's gross margin is in line with past performance and with its performance in relation to the market, the company should take the approach that by being a leader in gross margin, they can increase their profits at a faster rate. Every 0.1% improvement on their gross margin is worth $80 million, so this is an area where JNJ can improve the bottom line rapidly.

The final recommendation is that JNJ should contain the growth in its Selling, General and Administration expense. This has been increasing more rapidly than sales in the past couple of years, which is cause for concern. In tougher economic times, the company should hold the line on this type of expenses and plow their money.....

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