Johnson & Johnson announced this morning its intention to separate its consumer health division, which accounts for roughly 16% of sales and includes iconic consumer brands like Band-Aid, Tylenol, and Listerine.
The decision to break up the world's largest pharmaceutical conglomerate is rooted in the belief that its business units will have more significant growth opportunities as separate companies where they can more intently focus on their specific customers and markets that have diverged so much through the years.
While this is significant news, Johnson & Johnson will still remain the world's largest healthcare company as it continues on with its pharmaceutical and medical device divisions.
Looking forward, Johnson & Johnson and the soon-to-be-formed consumer health company both provide compelling investment opportunities.
The pharmaceutical and medical device businesses have historically achieved higher profit margins and better growth opportunities. However, their earnings can be more volatile given the perpetual need for research and development to translate into new life-changing drugs and devices.
In contrast, the consumer health division generates lower margins but has more stable earnings from its strong brand portfolio, solid market leadership, and established distribution network.
Each company will carry forward as an industry leader with sound financials and heightened attention on a focused customer base. Pharmaceuticals and medical devices can focus solely on patients and medical providers, while the newly formed consumer health company can focus on retail consumers.
While Johnson & Johnson did not outline the financial terms of the separation expected to take place in 18 to 24 months, it did communicate the transaction would be tax-free and that it expects to continue paying dividends "at least at current levels."
We estimate that Johnson & Johnson's payout ratio will remain below 60% following the separation. With its still healthy payout ratio and management’s stated commitment, we expect the dividend to remain Very Safe.
We will continue to watch for updates on the separation and will provide more thoughts as details emerge.