Nurturing Your Portfolio with Mead Johnson (MJN)

[Update 04/24/2015: The SeekingAlpha version is available here!]

Quick Background:

Mead Johnson Nutrition (MJN) is a global pediatric nutrition company. The company’s brands include the flagship Enfa family (including the well-known Enfamil), Nutramigen, Cal-C-Tose, and ChocoMilk. The company was founded by Edward Mead Johnson, also one of the co-founders of the legendary Johnson & Johnson (JNJ), in 1895. In 1967, Bristol-Myers Squibb acquired the company, only to spin it off again in 2009. The company is currently based in Glenview, Illinois, and is a member of the S&P 500. The company’s peer group includes Pfizer (PFE) and Abbot Labs (ABT).

For more basic information, check out the company’s website and the 2014 annual report.

Fun fact: An investment of $10,000 at the IPO in February 2009 would be worth $39,356.22 today, all dividends reinvested. This yields an annual rate of return of 25.0%, which slightly outperforms the S&P 500 during this time frame. (Source: FAST Graphs)

Sparknotes Analysis:

With our screening criteria:

• Pays a dividend: Yes
• Has 5+ years of dividend increases: Yes (7 years)
• Has not frozen dividend for over 8 quarters: Yes
• Has a Chowder number of 12 or more: Yes (25.6)
• Has am EPS payout ratio of less than 70%: Yes (46.61%)
• Pays a dividend monthly or quarterly: Yes (Quarterly; January, April, July, October)

• Has an S&P Quality Ranking of ‘A-‘ or better: Unknown (Not Rated)
• Has generally increasing earnings since going public: Yes
• Is fairly valued/undervalued according to the Normal P/E ratio (blue line): No
• Is fairly valued/undervalued according to the Intrinsic P/E ratio (orange line): No

Other Ratings:

• S&P Capital IQ: 3-star hold
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 9 (optimized score of 8)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 2 for safety; 3 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst
• Morningstar:
  • Moat: Wide
  • Stewardship: Standard

Financial Overview:

MJN has a dividend yield of 1.67%, which is a bit on the low side. With the most recent increase, MJN pays out $0.4125 per share quarterly, $1.65 annually. MJN has been paying a dividend non-stop since being spun off in February 2009. The dividend is raised every four quarters, usually in March. Growth has been pretty steady. The five year dividend growth rate is 24.0%, while the one and three year DGRs are a bit more reasonable at 11.0% and 13.4%, respectively. I would expect a five year DGR to be pretty high, as the company first got its bearings as a publicly-traded standalone company around them. It’s kind of early to say how the dividend will grow in the future, but based on the historical earnings trend, I would not be surprised to see raises in the range of 10% for the next few years. With earnings per share of $3.54 and cash flow per share of $4.01, as well as $1.297 billion in cash and cash equivalents, the dividend appears pretty safe. Long-term debt of $1.503 billion is a bit high, giving us a debt/equity ratio of 2.6. However, with an interest coverage ratio of 16.39, I am not insanely scared of said debt and don’t think it will affect the dividend at this point.

MJN is also a net share repurchaser, going from 204.52 million shares outstanding in 2010 to 202.30 million today. The company has yet to split.

MJN’s current P/E ratio of 27.9 is a bit high. The one year forward P/E ratio of 22.8 is still high, but much less so. Although it’s not really a fair comparison to compare them directly, let’s look at the margins of MJN and the peer group average:

• Gross: 61.43% MJN, 60.97% peers
• Operating: 22.41% MJN, 16.96% peers
• Net profit: 16.53% MJN, 11.54% peers

If we assume markets are rational, and stock prices always revert back to the mean, we can make some ballpark judgments on how an investment in MJN made today will fare some years down the road. Assuming that the compound annual growth rate will continue as it has in the past, and MJN eventually reverts to a standard P/E ratio of 15, we get an annual rate of return of 4.02% by 2020. Earnings will grow by 12% during this time. PFE’s AROR is 11.74%, and ABT’s is -2.50%, placing MJN solidly in the middle of the pack.

Risk Factors:

• Reputation – One of MJN’s primary assets is its brand. The reputation was garnered over decades of research, clinical studies (The company spends over $100 million annually in R&D), and advertising. This is especially important in developing markets (where MJN gains most of its revenue). Due to more lax quality controls, parents will often go with the brand that they perceive as having the most health benefits and safest products. If that reputation takes a hit, the loss in sales could be enormous. Just look at what happened to both McDonald’s (MCD) and YUM! Brands (YUM) in Japan and China over the past year or so.
• Private label competition – although MJN spends a lot on R&D to ensure that it has the best formula, and even more on marketing to drive home that fact into the minds of consumers, private label brands do exist. Of course, the quality is roughly the same, but the consumer often prefers to pay up for perceived quality. But given enough time, MJN could see some declines in sales as private label brands build reputations and market share.
• Government regulation – It’s always there, but is more focused on healthcare-related companies like MJN. Especially since MJN markets products for infants and young children, groups most people will protect viciously. MJN also has relationships with various government health departments to make formula accessible to larger groups of less-fortunate people. Regulation doesn’t seem to be a problem as of yet, but you know how fickle government can be …

Final Conclusion:

MJN does not meet my criteria for purchase at this time. If nothing else, it is overvalued. However, i don’t like the lack of an S&P Quality Ranking, which makes it harder for me to ballpark the financial state of the company. Further, I am not thrilled with the debt/equity ratio or the lower dividend. Conversely, the company spits out a lot of cash, which means a lot of large dividend increases. I like the leading market shares and exposure to developing markets as well. And fundamentally, the dividend appears safe, which at the end of the day is all I really care about. But since it doesn’t pass my criteria, I am taking a wait-and-see approach with the company. I’ll reevaluate MJN in a year or so, to see if it merits inclusion to my watchlist then.

Does MJN make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: Long JNJ, MCD, YUM

All data is accurate as of market close, 04/23/2015. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo image source is available here. Data source is FAST Graphs, David Fish’s US Dividend Champions List, or company materials, unless otherwise indicated.

Tags: dividend-stock-analysis, Mead Johnson Nutrition Co, MJN