Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Johnson & Johnson – Fourth Quarter of Fiscal 2020 Earnings IR Presentation

By Callum Turcan

In alphabetic order by ticker: JNJ, LMT, MSFT

Three of the newsletter portfolio ideas recently reported stellar earnings updates and provided promising outlooks that we want to draw to our members' attention. With global health authorities working towards putting an end to the coronavirus (‘COVID-19’) pandemic, aided by ongoing vaccine distribution efforts, the outlook for the global economy is bright and getting brighter.

Johnson & Johnson (JNJ)

We include healthcare conglomerate Johnson & Johnson (JNJ) in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Shares of the company have been on a steep upward climb since early November 2020 as investors warmed up to the company’s improving outlook. On January 26, Johnson & Johnson reported fourth quarter earnings for fiscal 2020 (historically, its fiscal year ends in late December) that beat both consensus top- and bottom-line estimates. Within the company’s earnings presentation covering the final quarter of fiscal 2020, Johnson & Johnson noted it generated ~$20.0 billion in free cash flow last fiscal year and exited fiscal 2020 with a ~$10.0 billion net debt position. Given its ability to generate meaningful free cash flow in almost any environment, a product of its impressive business model, we view Johnson & Johnson as well-positioned to manage its net debt load and dividend obligations going forward.

The company’s GAAP revenues rose by 1% annually in fiscal 2020 as did its non-GAAP operational sales due to strength at its ‘Consumer’ business operating segment (driven in part by rising demand for its over-the-counter Tylenol pain medication and its Listerine mouthwash offerings) and at its ‘Pharmaceutical’ business operating segment (driven by rising sales of its STELARA, which treats various immune-mediated inflammatory diseases, and at its oncology offerings such as DARZALEX, IMBRUVICA and ERLEADA). Johnson & Johnson’s ‘Medical Devices’ segment was negatively impacted by the sharp slowdown in elective surgeries last fiscal year, though things are beginning to improve on this front, which played a key role in its GAAP net earnings falling by 3% year-over-year in fiscal 2020.

The company provided guidance for fiscal 2021 that calls for 9.5%-11.0% in reported sales growth and 17.1%-19.6% in adjusted non-GAAP EPS growth on an annual basis, aided by a recovery in its ‘Medical Devices’ business operating segment. Johnson & Johnson also noted that it expects its adjusted non-GAAP pre-tax operating margin to improve over 200 basis points this fiscal year, due to expected improvements at its Medical Devices segment and cost containment efforts. While the COVID-19 pandemic created material headwinds for Johnson & Johnson last fiscal year, the company’s outlook indicates the firm is well-positioned for a rebound.

Johnson & Johnson is working on its own COVID-19 vaccine, and interim clinical trial data has been promising. The company’s management team noted that it was getting ready to share data from its Phase 3 clinical trial soon, which could add yet another arrow to the quiver of global health authorities assuming the clinical trial provides promising efficacy and safety results. Though we do not expect Johnson & Johnson to generate needle-moving revenue from the potential COVID-19 vaccine should the vaccine candidate receive emergency authorization, if the company proves to be successful on this front, that would go a long way to improving its corporate image worldwide.

We're big fans of Johnson & Johnson’s stellar cash flow profile and view its outlook quite favorably. The company has a Dividend Cushion ratio of 2.1, which earns the company a “GOOD” Dividend Safety rating (note these metrics incorporate our expectations that its dividend will grow at a brisk pace going forward). Johnson & Johnson has an “EXCELLENT” Dividend Growth rating. As of this writing, shares of JNJ yield ~2.4% and we like exposure to Johnson & Johnson in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Johnson & Johnson’s stock price is currently near the top end of our fair value estimate range, though there is room for JNJ to run higher still as the firm is supported by strong technical performance of late.

Lockheed Martin (LMT)

Defense contractor Lockheed Martin Corporation (LMT) is included in the Dividend Growth Newsletter portfolio. The firm reported fourth quarter earnings for fiscal 2020 (period ended December 31, 2020) on January 26 that beat consensus top-line estimates but missed consensus bottom-line estimates. All of its core business operating segments reported annual sales growth in fiscal 2020 which enabled its GAAP revenues to grow by 9% annually last fiscal year, though its GAAP operating profit grew by just 1% in large part due to incremental costs related to the COVID-19 pandemic. Lockheed Martin delivered 237 aircraft in fiscal 2020, down from 260 in fiscal 2019, though still impressive given pandemic-related headwinds. We appreciate the resilience of Lockheed Martin’s operations and its ability to generate sizable free cash flows in almost any environment.

The company generated $6.4 billion in free cash flow in fiscal 2020 which fully covered $2.8 billion in dividend obligations and $1.1 billion in share repurchases. Lockheed Martin intends to repurchase ~$1.0 billion of its stock in fiscal 2021. At the end of fiscal 2020, Lockheed Martin’s total backlog stood at $147.1 billion, providing significant cash flow visibility, though its net debt load stood at $9.0 billion (inclusive of short-term debt) at the end of this period. Given Lockheed Martin’s strong cash flow profile, we view the firm as being fully capable of managing its net debt load and dividend obligations going forward, even when factoring in a pending acquisition.

As we covered in the past (link here), Lockheed Martin is in the process of acquiring Aerojet Rocketdyne Holdings (AJRD) through an all-cash deal for a total equity value of ~$5.0 billion when including special dividend considerations. That deal is expected to close in the second half of 2021 according to recent management commentary. During Lockheed Martin’s latest earnings call, management noted that the company was intrigued by the synergies the deal could create as it concerns hypersonic missile systems (both offensive and defensive capabilities).

In fiscal 2021, Lockheed Martin forecasts it will generate $67.1-$68.5 billion in sales (up 4% year-over-year at the midpoint versus fiscal 2020 GAAP revenues), $26.00-$26.30 in diluted EPS (up 8% year-over-year at the midpoint versus fiscal 2020 GAAP diluted EPS), and $8.3 billion or more in cash from operations in fiscal 2021 (up 1% year-over-year at the low end of this guidance). What we really appreciated was management’s longer term guidance which called for Lockheed Martin’s annual cash flow from operations to steadily climb higher going forward, hitting ~$9.0 billion in fiscal 2023.

We continue to like exposure to Lockheed Martin in the Dividend Growth Newsletter portfolio. The firm has a Dividend Cushion ratio of 1.8, earning it a “GOOD” Dividend Safety rating (note we expect the firm to push through moderate dividend increases going forward which is incorporated into these metrics). Lockheed Martin has a “GOOD” Dividend Safety rating. As of this writing, shares of LMT yield ~3.1% and are trading in the lower bound of our fair value estimate range. We like Lockheed Martin for its dividend growth potential, though there could be room for decent capital appreciation upside as well. Share repurchases are a good use of capital given that shares of Lockheed Martin are trading at a significant discount to our fair value estimate, in our view.

Microsoft (MSFT)

The tech giant Microsoft Corporation (MSFT) is included in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. On January 26, Microsoft reported second quarter earnings for fiscal 2021 (period ended December 31, 2020) that beat both consensus top- and bottom-line estimates. Microsoft’s GAAP revenues rose by 17% year-over-year in the fiscal second quarter with growth reported across the board. Even Microsoft’s ‘search advertising excluding traffic acquisition costs’ posted year-over-year sales growth in the fiscal second quarter. Note sales at this segment were down 10% year-over-year during the first quarter of fiscal 2021 (period ended September 30, 2020).

Microsoft’s cloud-computing unit Azure posted 50% year-over-year sales growth in the second quarter of fiscal 2021 as enterprises continued to accelerate their shift towards such IT offerings. Additionally, the firm’s ‘Xbox content and services revenue’ was up 40% year-over-year last fiscal quarter due in large part to the firm recently launching the latest edition of its Xbox, the Xbox Series X, which also likely supported growth at its subscription-based digital gaming services (such as Xbox Live and Xbox Game Pass). Its Dynamics 365 segment posted 39% year-over-year sales growth last fiscal quarter, which offers cloud-based enterprise resource planning (‘ERP’) and customer relationship management (‘CRM’) services along with providing AI-driven insights.

We continue to be huge fans of Microsoft. The firm had roughly $71.4 billion in net cash (inclusive of short-term debt) on the books at the end of December 2020 along with an additional $3.8 billion in equity method investments, some of which could be considered cash-like assets. During the first half of fiscal 2021, Microsoft generated $22.8 billion in free cash flow (up from $17.6 billion in the same period the prior fiscal year) while spending $8.1 billion covering its dividend obligations and another $13.3 billion buying back its stock.

Due to its pristine financial position and very promising outlook, Microsoft earns “EXCELLENT” Dividend Safety and Dividend Growth ratings. Its Dividend Cushion ratio sits at an impressive 4.4, a metric that includes our expectations the firm will push through impressive payout growth going forward. Shares of MSFT yield ~1.0% as of this writing. Furthermore, shares of MSFT are trading near our fair value estimate of $236 per share as of this writing; however, should Microsoft outperform our “base” case assumptions, the top end of our fair value estimate range sits at $283 per share.

We continue to like exposure to Microsoft in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. The company provided guidance for the third quarter of fiscal 2021 that indicates its promising growth trajectory will continue going forward, highlighting the resilience of its business model. Microsoft’s success in the realm of cloud-computing and enterprise productivity software (Azure, Dynamics 365), along with its enduring strength in the consumer-facing realm (Office 365, Xbox), underpins its promising outlook.

Concluding Thoughts

Earnings season is now underway and so far, we are quite impressed with the performance of the ideas included in the newsletter portfolios. Johnson & Johnson and Lockheed Martin are both on the rebound while Microsoft continues to be an “unstoppable” growth juggernaut. All three of these firms have stellar free cash flow generating abilities and have promising growth outlooks, which underpins why we are big fans of each company. 

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Related: AJRD, JNJ, LMT, MSFT

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Callum Turcan does not own shares in any of the securities mentioned above. Johnson & Johnson (JNJ) and Microsoft Corporation (MSFT) are both included in Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Lockheed Martin Corporation (LMT) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.