Johnson & Johnson (JNJ) – Prevent Defense

by Dan July 15, 2016 12:36 pm • Commentary• Trade Ideas

I know why investors have been flocking to stocks like Johnson & Johnson (JNJ), the defensive nature of the products that they sell, massive commitment to cash return (existing $10 billion share repurchase) and current dividend yield of 2.6%. But with that the trade is becoming crowded. The stock trades at 18.6x expected 2016 eps, and about 20x trailing, both at 10 year highs. And that comes after posting its first annual sales decline in 2015 (-6%) in five years, with only 2% expected sales growth in 2016:

From Bloomberg
From Bloomberg

JNJ is expected to get about 50% of their sales from outside the U.S., and the nearly 2.5% bounce in the U.S. Dollar Index (DXY) could pose a bit of a headwind, especially relative to the revenue guidance the company gave on April 19th that called for 2% sales growth in 2016 when they reported their Q1 results.  

JNJ’s breakout in April to new all time highs doesn’t reflect a meaningful fundamental improvement, but rather a sense of investor concern about growth and a search for defensive yielding stocks.

That said, from purely a technical perspective the breakout is impressive, yielding a nearly 20% gain on the year, with the stock now up 30% from its January lows and up 50% from its August 24th 2015 flash crash lows:

[caption id="attachment_65040" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

Event: JNJ reports Q2 results on July 19th before the open, and the options market is implying a 2% one day post earnings move in either direction. With the stock at $123, the July 22nd weekly 123 straddle (the call + the put premium) is offered at $2.40, if you bought that, and thus the implied move you would need a move above $125.40 or below $120.60 to make money, or about 2%.  The stock is generally not a big mover on earnings, as the 4 qtr avg one day earnings move is only about 1.9%. That average is heavily skewed by the 5% rally in January, after the stock was down 6% to start the year.

My View: Options are cheap with 30 day at the money implied volatility 12.5%, down more than 50% from its 52 week highs in February, and up only 1.5 points from its 2016 lows made in late May.  While the conditions that make the stock attractive might persist, cheap options, and the stock’s unusual strength make contrarian defined risk bets attractive.

If I thought the stock could get hit hard following earnings, if I thought there was a strong chance of an earnings miss and or guide down then you could look at weekly puts.

Trade: JNJ ($123) Buy July 22nd weekly 123 put for 1.25

Break-even on next Friday’s close:

Gains: below $121.75, down about 1%.

Losses: up to $1.25 between $121.75 and $123, max loss of $1.25 above $123

Would look to take a quick profit down near $120.