Monday, April 22, 2013

Johnson & Johnson Remains Good Value

Earnings season is in full swing now and Johnson & Johnson $JNJ was the first of the major health care and consumer products companies to give results. In summary, the numbers were pretty good, but the commentary contained some negatives about the health care industry with regards the medical devices and the volume of surgical procedures. On the whole, it was a net positive for the company and despite the great run, I think there is still a bit of upside left in the stock.

The story of 2013 is really about integrating the Synthes acquisition with the medical devices segment, developing sales for some of its new pharmaceuticals, and getting most of the key brands (affected by production difficulties) back on the market.

Consumer products making a comeback? (21% of sales) 

Within consumer products, management confirmed that 75% of the brands (if not necessarily the volumes) of those affected should be back on the market by the end of 2013. Indeed, a build up of these sales is expected throughout 2013.

On the whole, I thought it was one of the most positive earnings reports I’ve seen in a while for this segment. Okay, overall sales up 3.3% (operationally) doesn’t sound great, but the underlying trends are positive and investors can expect better things going forward.

Its two biggest categories are OTC/Nutritionals and Skin Care, which together make up over 56% of the segment's sales. Sales in both categories have been weak in recent quarters, but the former is benefiting from having products back on the market (analgesics were particularly strong) while the latter appears to be stabilizing in the face of strong competition. The good news didn’t stop there as baby care sales grew 7% operationally, with oral care also doing well with a 5.1% increase.

Colgate-Palmolive $CL shareholders should note that Listerine mouthwash was cited as a notable positive in these results. Frankly, I think that Colgate has had it a bit easy in the past, with being able to aggressively launch new mouthwash products in the U.S.

It is obviously not a core activity for Johnson & Johnson (indeed it has divested some toothbrush products), but it has learnt from Colgate’s execution and the new Listerine products appear to be working well. I see no reason why this can’t continue, so investors need to think about the assumptions they are making over Colgate’s valuation and earnings.Moreover, Colgate already has a strong position within emerging markets and it will have to defend it against competitors.

Pharmaceuticals still going strong (39% of sales) 

This segment has seen the most impressive improvement in performance over the last year and it looks set to continue this year. Overall, sales grew 11.4% operationally and many of the drugs that contributed to this growth are still in the early innings of their sales progression. Meanwhile, its biggest treatment is still Remicade (rheumatoid arthritis), which represents nearly 24% of total pharma sales and it is still growing nicely with 5.5% operational growth in the quarter.  

Other highlights from the segment included

  • Immunology (including Remicade) grew 16.7% operationally, with Stelara (psoriasis) and Simponi growing sales by 72% on a combined basis. As they are both relatively new drugs, it is reasonable to expect strong growth to continue within this category

  • Neuroscience revenue grew 7.7% operationally, with Invega and Invega Sustenna sales now totaling $416 million and managing to replace declining sales of its older schizophrenia drug Risperdal Consta, which contributed $335 million, albeit after a 6% decline.

  • Oncology represents less than 12% of pharma sales, but it contributed over 31% of the growth in the quarter. Zytiga (castration resistant prostate cancer) sales grew over 72% and the intent is to try and get its usage extended for other indications. 

  • Xarelto (anti coagulant) and Incivo (hepatitis C) contributed $158 million and $162 million in the quarter, and both are likely to grow strongly in the future.

In summary, new drug sales are expanding rapidly and it’s hard not to see continued strength here.

Medical devices and diagnostics (40% of sales)

This proved to be the most interesting segment as the company outlined how within the U.S., hospitals had been commenting that procedures were running at levels below what they had previously predicted for 2013. Moreover, within general surgery and orthopedics, it declared that the acceleration that it had seen in Q4 did not carry on into Q1, and suggested that this was a sign of seasonality creeping into these elements' performance.

All of this would appear to be disappointing news for a company like Covidien $COV. Covidien’s surgical activities rely on growing procedures, but elsewhere, I thought there were some good takeaways for Covidien.

For example Johnson & Johnson’s cardiovascular results were good, with endovascular cited as generating double-digit growth. Meanwhile, its international energy results were strong outside the U.S. This bodes well for Covidien, because expanding in energy and vascular within emerging markets is one of its key growth drivers for the next few years.

So, it appears that Covidien will report good results from its existing growth businesses, but there could be some pressure elsewhere. We shall see soon enough when it reports on April 26.

There was no new news on the future of the diagnostics unit after it had been put under review at the time of the last set of results.

The bottom line

This was probably a better set of results for the company than it was for the health care market on the whole. The more negative outlook with regards surgical procedures is likely to cause some concerns among the higher rated companies within this sector of health care.

However, for Johnson & Johnson, its pharma sales are expanding well and look set to continue. There is still upside from a return of the affected brands within consumer products and its plans remain on track.

The stock remains the sort of high cash generating, decent yielding defensive type that the market is in love with at the moment, and I wouldn’t be surprised to see the stock appreciate in the future.