Johnson & Johnson's (JNJ, 63.02) strong first quarter result underscores why we continue to argue the merits of this diversified, blue chip, Dow Industrial for which value is emerging into growth.

Last April, with valuations at historical lows, we said this120-year-old health care products giant was a value proposition ripe for the picking for the long-term investor. We added the name as a suggested holding in the Briefing.com Active Portfolio in March based on JNJ's earnings growth potential, valuation, consistent returns, defensive status, and attractive shareholder value.  

Shares have rebounded over the last month, in part driven by a rotation into defensive stocks as investors have grown uneasy about the economic outlook and expectations for decelerating profit growth as the year progresses.

Today, shares are rising materially in early trading, trading up over 3% on big volume following a material earnings upside surprise driven by impressive topline growth and expense control. 

JNJ's broad-based business and global footprint produced a strong start to the fiscal year. The world's largest health products company by sales posted record first quarter sales of $15.0 billion. The topline came in ahead of expectations of $14.4 billion piloted by its consumer and pharmaceutical businesses.

JNJ has been in an acquisitive mode over the last year, a trend we expect to continue. The only question is the size of its next deal. JNJ has the balance sheet to support a large acquisition, but we don't think a major deal is in the cards at this time. Instead, JNJ will likely continue to execute on existing initiatives to streamline costs and drive faster earnings growth that will include making strategic acquisitions to enhance overall market position and long-term growth.

Excluding the impact from acquisitions, JNJ produced an organic growth rate of 6% in the quarter. Net earnings, excluding a number of charges and gains related to this activity, were $3.4 billion with earnings per share of $1.16, up 14.0% and 17.2%, respectively. This represented a 12 cent beat compared to the Reuters Estimate consensus of $1.04.

Interim Revenue Breakdown

The leader this quarter was the Pharmaceutical business, which represents 41% of total sales. Pharma sales grew 10.6% over the prior year's period to $6.2 billion. International sales grew 14%, compared to a 9% gain domestically. Key product lines included Topomax, Levaquin, Floxin, and its antipsychotic franchise which includes Risperdal, Risperdal Consta and Invega.

The Medical Devices & Diagnostics unit also posted an impressive quarter, led by growth outside the US. Segment sales rose 6.2% from the prior year to $5.3 billion including 10% international sales growth and 2.5% domestic sales growth. Key drivers included Vistakon's disposable contact lenses, Ethicon Endo-Surgery's minimally invasive products, wound care and joint reconstruction, and sports medicine and trauma businesses. These areas offset ongoing challenges facing Cordis in the drug-eluting stent market.

Through the purchase of Pfizer's (PFE, 26.88) healthcare products business, JNJ greatly expanded its consumer segment. This quarter, sales grew  48.5% or 6.7% organically to $3.5 billion. Again, international growth outpaced growth in the US, led by strong sales of its reformulated Tylenol OTC upper respiratory products, Listerine, Aveeno, Benadryl, and Rogaine product lines.

The Bottom Line

JNJ's first quarter results are a testament to the broad-based nature of its product portfolio. As such, we recommend investors continue to add to positions. We remain confident in the company's overall strategy driving earnings leverage and top line growth, led by several new product launches and the new Consumer Health unit, in addition to the opportunity for share repurchases.

Management raised its FY07 cash EPS guidance from $3.93-$3.98 to $4.02-$4.07, which reflects the strong Q1 topline performance. In addition, management noted it was comfortable with the consensus in the mid-point of this range. 

The stock trades at 16.5x FY07 and 15.2x FY08 estimates. This is a discount to all three of its comparative groups: the S&P 500 Pharma Index (22.4x), Health Care Equipment (46.2x), and the Household Products Index (21.9x).

--Kimberly DuBord, Briefing.com