Fitch Affirms Johnson & Johnson's IDR at 'AAA'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed Johnson & Johnson's (JNJ) Issuer Default Rating at 'AAA'. The Rating Outlook is Stable. A complete list of Fitch's rating actions follow at the end of this press release.

KEY RATING DRIVERS

The company's 'AAA' rating reflects the following:

--Potential biosimilar competition for Remicade in the U.S. in late-2016/early-2017 and adverse foreign exchange movement will weigh on revenues during 2016, but Fitch expects the company's operating and financial trends to remain positive.

--JNJ will likely maintain a commitment to deploying cash for dividends, acquisitions, collaborations and internal investment opportunities that it believes will support long-term profitable growth.

--Fitch believes JNJ will operate with leverage consistent with its 'AAA' rating and with solid liquidity supported by significant cash balances and ample access to credit markets. Current leverage leaves the company little flexibility to take on additional debt.

Innovation-Driven Growth Despite Headwinds: Fitch expects that JNJ will continue to generate moderate intermediate-term top-line growth, despite facing a number of challenges during 2016 and beyond. The company continues to bring innovative new products to market and expand the utilization of established products and franchises. Nevertheless, unfavorable foreign exchange rates and competition in select franchises will likely dampen reported sales growth during 2016. Remicade faced biosimilar competition in Europe during 2015, which modestly reduced year-over-year sales in those affected countries. Fitch expects this trend to continue during at least the four-year forecast period. In addition, biosimilars could challenge Remicade in the U.S. in late-2016/early-2017.

JNJ pursues innovation across all three of its business segments, which provides it with favorable long-term growth prospects, as well as opportunities to support margins. Research and development (R&D) intensity is greatest in its biopharmaceutical business, followed by the medical device segment. The company also pursues collaborations and outright acquisitions to supplement its internal new product development efforts. This strategy has produced a significant number of innovative, value-added medical therapies and products. While the consumer business is not as R&D intensive, innovation is still a key component in defending and advancing JNJ's franchises in this segment.

Broad Portfolio Mitigates Risk: JNJ operates with three business segments and a large diversified product portfolio, reducing its operational and financial reliance on any individual product. It employs a decentralized business model with its various franchises to promote receptivity to their respective markets, while maintaining a strong cultural-centric philosophy driven by its longstanding credo. The company develops and manufactures consumer healthcare-related products, medical devices and pharmaceutical/biologic therapies. Its diverse business model also enables JNJ to pursue a broad array of treatment advancements that offer growth opportunities.

JNJ's largest selling product, Remicade, accounts for roughly 9.6% of sales. It is also a biologic, which typically faces patent slopes as opposed to patent cliffs like traditional, small-molecule drugs. This dynamic mitigates the risk of generic/biosimilar competition. The next three largest products, in total, account for less than 10% of company sales. In addition, Fitch views the company's patent expiration risk as manageable.

Free Cash Flow (FCF) for Growth and Shareholder Returns: Fitch looks for JNJ to produce strong annual FCF (operating cash flow minus capital expenditures minus dividends) during 2016-2017 of $8.5 billion-$9.4 billion. Moderate organic sales growth and incrementally improving margins, aided by an improving sales mix and a continued focus on costs, should support solid cash flow from operations, offset by manageable capital expenditures and dividends. Fitch expects JNJ will prioritize cash deployment for dividends, internal/external growth opportunities and then for share repurchases.

JNJ will likely remain acquisitive, focusing on targets or products that offer innovation and growth in the health care sector. Fitch expects the company to finance its transactions within the context of its 'AAA' credit profile. Shareholder-focused activities, such as dividend increases and share repurchases will presumably continue, and Fitch believes the company will finance these primarily with FCF. As of April 3, 2016, JNJ had repurchased a total of $2.6 billion in shares since the inception of the $10 billion repurchase program was announced on Oct. 13, 2015.

Current Leverage/Limited Flexibility: Fitch believes JNJ will operate with leverage consistent with its 'AAA' rating and with solid liquidity supported by significant cash balances and ample access to credit markets. However, current leverage of 1.0x leaves the company little flexibility to take on additional debt. The company should be able to use some of the roughly $39.9 billion of cash and short-term investments to fund targeted and larger acquisitions. JNJ, however, likely holds the vast majority of cash outside of the U.S.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for JNJ's 'AAA' rating include the following:

--Low- to mid-single-digit revenue growth in 2016 and 2017.

--Margin improvement driven by favorable product mix and an ongoing focus on cost control during the near term.

--Annual FCF of $8.5 billion-$9.4 billion during 2016-2017.

--Leverage to range between 0.8x and 1.0x with moderately increasing levels of debt.

--Capital deployment priorities focused on dividend and then balanced between acquisitions and share repurchases, with the mix depending on the availability and valuation of strategically appropriate targets.

RATING SENSITIVITIES

While Fitch does not anticipate a downgrade during its four-year forecast horizon, a negative rating action could occur if some combination of deteriorating operational performance and leveraging transactions stress the company's credit profile. Fitch believes the company's broadly diversified health care related franchises make it more likely that a negative rating action would be prompted by a leveraging transaction, as opposed to operational stress.

Three of the key rating metrics for JNJ's 'AAA' rating that Fitch believes investors should consider are the following:

--Total debt/FCF of 3.0x (reported April 3, 2016 at 3.7x);

--Total debt/EBITDA of 1.0x reported April 3, 2016 at 1.0x);

--Net debt of $4 billion-$5 billion (reported April 3, 2016 at a net cash position of $16.6 billion).

LIQUIDITY

Solid Liquidity: JNJ has significant liquidity and access to the credit markets. Moderate growth and relatively stable margins enabled the company to generate $6.3 billion of FCF during the latest 12 month (LTM) period ended April 3, 2016. JNJ had approximately $39.9 billion in cash plus short-term marketable securities (STMS) and access to $10 billion in short-term borrowings on Jan. 3, 2016.

Debt Structure: JNJ had approximately $23.3 billion in debt, including $523 million in short-term debt on April 3, 2016, with approximately $3 billion of long-term debt maturing in 2016, $1.7 billion in 2017 and $1.5 billion in 2018. Fitch expects that the company will refinance the vast majority of its upcoming maturities.

FULL LIST OF RATINGS

Fitch has affirmed the following ratings:

Johnson & Johnson

--Issuer Default Rating (IDR) at 'AAA';

--Senior unsecured debt at 'AAA';

--Subordinated debt at 'AAA';

--Short-term IDR at 'F1+';

--Commercial paper at 'F1+'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Historical and projected EBITDA is adjusted to add back non-cash stock based compensation. In 2015, Fitch added back $874 million in non-cash stock based compensation to its EBITDA calculation.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1008232

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008232

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Bob Kirby, CFA
Director
+1-312-368-3147
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gregory Dickerson
Director
+1-212-908-0220
or
Committee Chairperson
Megan Neuburger
Managing Director
+1-212-908-0501
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Bob Kirby, CFA
Director
+1-312-368-3147
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Gregory Dickerson
Director
+1-212-908-0220
or
Committee Chairperson
Megan Neuburger
Managing Director
+1-212-908-0501
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com