Johnson & Johnson: An Update Following The Kenvue IPO
Contributor since 2011 / 23721 Followers
Summary:
- Johnson & Johnson has spun-off its consumer health business called Kenvue.
- The IPO was a modest success, and despite a >$50 billion enterprise valuation, it is not a game changer for Johnson & Johnson.
- The move increases exposure to higher growth pharmaceutical and medical device segments, but the talc litigation concerns remain (largely) with Johnson & Johnson.
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In January, I concluded that shares of Johnson & Johnson (NYSE:JNJ) started to look interesting again. The company was showing continued GDP + pace growth, closed on the Abiomed deal, preserved balance sheet integrity, as the combination of a 15 times forward earnings multiple and low leverage looked reasonably interesting.
Unfortunately, the talc powder overhang came to life again, following some recent court rulings, creating some uncertainty to come of course.
Some Perspective
Johnson & Johnson is a household name, not just because many of its products can be found in many households, but because its shares are well known to many investors as well. The company has delivered on sound shareholder value creation over time on the back of strong positioning, modest usage of leverage and sound capital allocation skills.
The company grew 2021 sales by a convincing 13% growth number, albeit aided by easier comparables, with sales advancing to $94 million. Adjusted earnings grew even quicker to $26 billion, equal to earnings of $9.80 per share.
The core pharmaceutical business was the largest unit with $52 billion in sales, complemented by a $27 billion medical device business and a $15 billion consumer health business, with that letter segment set to be spun off. This business is called Kenvue (KVUE) and has just made its public offering, on which I will elaborate on below.
Based on earnings power of $10 per share, a $160 per share valuation looked reasonable as leverage was very modest, yet the thesis changed a bit due to some events which took place last year. This includes a $16 billion deal for Abiomed in the fall of last year, the announcement of the spin-off of Kenvue, and perhaps worst: the continued emerging lawsuits related to asbestos in talc products, notably baby powder.
In January the company guided for 2023 sales to advance to $97.5 billion and adjusted earnings to be up in a modest fashion to $10.50 per share, as a $162 per share valuation in January looked quite reasonable. Net debt came in at $16 billion, a very modest debt load. Worrisome is that the Third Circuit Court of Appeals ruled against the usage of bankruptcy to shield Johnson from the lawsuits related to the talc asbestos issues.
With ten thousands potential lawsuits in play, the risks and realistic price tag of such legal outcome is very hard to estimate, but it is clear that these liabilities have not disappeared here. While this uncertainty was not welcome, I liked the ability to buy some shares in the high $150s given the excellent earnings power of the business.
And Now? – Kenvue
After having picked up a few more shares in March in the $150s shares have now settled at $162 again. In the meantime we have seen the release of the first quarter results by the business, but moreover the public offering of Kenvue.
My mid-April, Johnson announced the first quarter results for 2023 with reported sales up 5.6% to $24.7 billion, as this number was even held back by a stronger dollar, as otherwise growth came in around 9%. Adjusted earnings fell a percent to $7.1 billion as modest buybacks made that earnings per share rosy by a penny to $2.68 per share. The company posted a minimal GAAP loss due to a $6.9 billion litigation expense being taken.
On the back of the solid underlying trends, the company raised both the top line and bottom line guidance for the year, although in a relative minimal fashion.
The consumer health business posted $3.9 billion in sales in the first quarter, as this business has seen its IPO which I covered in this article. Kenvue went public at $22 per share, as the 173 million shares sold by Johnson grant it $3.8 billion in gross proceeds. The company holds about 1.72 billion shares in the company after the IPO and with these shares trading at $26 and change, that remaining stake is valued in excess of $45 billion as well.
Moreover, Kenvue has assumed $7.7 billion in net debt, so the sum of these three numbers can be attributed to Johnson & Johnson (assuming it would sell all of its shares) valuing its interest in Kenvue at more than $56 billion!
Concluding Thoughts
Johnson & Johnson reported a share count of 2.63 billion shares by the end of the first quarter, giving the company a $426 billion equity valuation. Net debt stood around $15 billion based on the 2022 results, for an enterprise valuation of around $441 billion. The $56 billion valuation in Kenvue is equal to 13% of the enterprise value, as Kenvue is responsible for about 16% of 2022 sales, albeit with a subpar margin profile.
Despite the substantial valuation attached to Kenvue, it is responsible for just over 10% of Johnson‘s valuation, and this valuation looks largely fair (at least in relation to Johnson‘s valuation, while I think that the standalone valuation of Kenvue is a bit rich). Given this conclusion it is not surprising that shares of Johnson hardly reacted in response to the IPO. If any, shares lost about a dollar in the second half of the week.
Given all this I remain constructive on Johnson & Johnson as the spin-off really does not alter the outlook for Johnson here, as I continue to be constructive on its long term potential, but cautious at the same time given the talc asbestos concerns.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of JNJ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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