J&J: playing patience

Wouldn't this just be the perfect time for a nice, big, value-destroying acquisition?

Johnson & Johnson shares have been underperforming, in the short term and the long. Year to date, its returns trail the S&P 500 by five percentage points and healthcare stocks by 11 points. The shares trail the index over five years, too, and have been absolutely smoked by healthcare and pharma stocks over that span. The pharmaceuticals division has been providing most of the growth, dragging the sluggish devices and consumer healthcare units behind it. But the trend is slowing there, too (whether the weak showing signals the failure of J&Js conglomerate model is irrelevant; it is not breaking up either way).

First-quarter results, reported on Tuesday, were in line with expectations, but will do little to take the pressure off the company. Even excluding divestitures and the ugly impact of a stronger dollar, the trend of slowing sales growth persisted, and the company's admirable efforts at controlling operating costs only partly offset the slide.

The worrying thing is how much money the company has to spend: $14bn in net cash on the balance sheet, and even after its dividend is paid, it generates $7bn of free cash each year. It has not done a big deal since it bought Synthes in 2012. And mountains of debt could be added to get a deal done.

The company has a rare AAA credit rating. Boss Alex Gorsky has said that preserving that rating would not be sacred if the company "came upon a technology that was truly transformational". Open-mindedness is probably the correct attitude. But the comment is a little nerve-racking all the same, at a time when "transformational" healthcare technologies - especially in pharma and biotech - are about as expensive as they have ever been. J&J, to its great credit, lost a recent auction for Pharamcyclics to AbbVie, which coughed up $21bn for the oncology drugmaker (and J&J partner). The AbbVie chief called the bidding the most competitive he had ever seen.

So shareholders must pray that J&J remains patient, at least until the fever breaks in the healthcare market. In the meantime it pays a solid dividend and buys back shares with any excess cash. Something has to be done at J&J, but investors have waited years. They can wait a little longer.

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