Month: June 2020

Starbucks purchases and roasts high-quality whole coffee beans, which it sells along with cold beverages and complementary food. The company was founded in 1971 by two teachers and a writer. It is the largest coffee chain in the world by far and the second-most valuable convenience food brand, surpassed only by McDonald’s. The company has a footprint of 30,000 stores in over 77 countries, with the average customer going to Starbucks six times a month. Their well-known logo is a siren, which is a mythological mermaid seductress. It is supposed to symbolise the seductive power of coffee. Indeed, while coffee is not quite essential, many people have a hard time getting through the day without their caffeine boost.

Starbucks’ shares were among the first to be hit by the coronavirus pandemic. The company was forced to close the majority of its stores in China, then across the world. Yet it faced the challenges head-on, implementing tight measures to control costs to protect its bottom line. It suspended share repurchases, cut discretionary spending and deferred certain capital expenditures. The locations that remained open became hubs for takeaway and delivery orders. As a result, the company’s second-quarter results were better than many investors feared. They were able to generate a profit, even in the face of a significant global disruption. Having faced the brunt of the COVID-19 closures, the third quarter results will likely be worse than the second.

Starbucks is among the faster-growing companies in the consumer segment. It invests relentlessly in digital development, social media, mobile payment and loyalty programmes. Seventy percent of sales are derived from the United States where it commands a 40 percent market share. Starbucks’ global growth prospects recently improved after its biggest competitor in China, Luckin Coffee was embroiled in vast-scale accounting fraud. Legal implications and funding concerns will likely render Luckin Coffee unable to compete with Starbucks in China. This leaves the door wide open for Starbucks to gain even more market share in an increasingly affluent country where growth in coffee demand is underpinned by the brew being regarded as an exhibition of social status and cosmopolitanism.

In times of economic uncertainty, going with industry leaders can help mitigate downside investment risk. Significant scale advantage offers Starbucks unmatched flexibility in supply negotiations and product pricing, which leads to durability. Simply put, they can afford to make less money per cup than individual coffee shops that have lower sales volume. While the cost to switch product is minimal, Starbucks has a strong brand name and loyal customer base. As lockdown restrictions are eased, people will return to their daily routine, which will no doubt include a stop at their nearest Starbucks outlet. However, this recovery seems to be priced into the current valuation, with the share price already 35 percent up from its low in March.

Frants Preis, CFA is a portfolio manager at VEGA Asset Management based in Pretoria.

Johnson & Johnson began as a small company that created surgical dressings in 1886. It has grown to become the largest, most resourceful healthcare company on earth. The company manufactures healthcare products for the pharmaceutical, consumer and medical devices markets. Johnson & Johnson has over 250 subsidiary companies that sell products in over 175 countries. It has increased its annual dividend for 58 consecutive years and is one of only two companies with a higher credit rating than the United States government. Shareholders have benefited from stable and consistent returns over the years.

A quarter of its sales come from products launched in the past five years; testament to Johnson & Johnson’s ability to innovate. It was the first company to release prescription contraceptives and invented the coronary stent. Will it be able to add yet another first to the list? Johnson & Johnson has committed over $1 billion to develop a COVID-19 vaccine and it is scheduled to advance to clinical trials by September. If all goes well, it could be available for emergency use early next year. The company is also revving up production capacity for such a vaccine, irrespective of whether they are the first to develop it.

Unfortunately, it is the company’s legal battles that have been making recent headlines. It has faced lawsuits relating to its role in the opioid crisis and talc baby powder products. The cost of litigation cut into about 6 percent of revenue during 2019 and 3 percent in 2018. Although not currently consequential, the risk is that these lawsuits get larger and materially impact its financials. The company has lost quite a number of lawsuits, although it has had many of the verdicts reduced or nullified on appeal. A potential agreement in principle to settle opioid litigation could likely remove an overhang on the share price.

Johnson & Johnson’s pharmaceutical segment represents half of its revenue. It is also its most profitable business and largest sales growth driver. The medicines focus on the therapeutic areas of immunology, neuroscience, cardiology and oncology. Its medical device segment sells a wide range of products including contact lenses, hip and knee replacement devices and surgical equipment. Well-known brands such as Listerine, Neutrogena, Savlon, Band-Aid and Clean & Clear are included in its consumer segment stable.

Johnson & Johnson will almost certainly remain a global force for years to come. It has a diverse business mix, with leading positions in various health markets. The company has the massive research and development infrastructure required to remain relevant over the long run. Its solid balance sheet and cash flow generation allow for further dividend growth, share repurchases and acquisitions. For these reasons Johnson & Johnson is a quality, defensive core holding in many investment portfolios.

Frants Preis, CFA is a portfolio manager at VEGA Asset Management based in Pretoria.