Wednesday, June 20, 2012

Johnson & Johnson Stock, A Good Defensive Play

Johnson & Johnson $JNJ gave results recently and underperformed the broader market on what was a strong up day. There wasn't anything inherently wrong in the numbers, but there wasn't anything sexy about them either. Revenues were slightly down, with a negative currency effect of 1.2% not helping matters. However, top line growth is not the key for JNJ.

JNJ’s attraction is of the kind that sends accountants hearts racing. Its prospects are all about execution, execution, execution.

First, consider the integration of the largest acquisition in JNJ’s history (Synthes) which brought the company 50% market share of the skeletal fixation products market. Second, consider the successful resolution of the manufacturing problems which have dogged the company in recent years and kept some highly popular OTC consumer products off the market. For example, Tylenol and Simply Sleep are not yet back in production. Third, consider the ever-present issue of dealing with generic challenges and launching new drugs. Lastly, JNJ probably still needs to restructure the huge portfolio of products.

Johnson & Johnson Delivers a Mixed Prognosis

Operations in the US saw revenues down 5.1% as JNJ suffered from generic competition to Levaquin (anti-bacterial) which saw a US sales decline of 96%. Similarly, Concerta which treats attention deficit hyperactivity disorder (ADHD) also saw generic competition that caused US sales to fall 22%. This reads across well for Watson Pharma $WPI which has successfully launched a generic version of Concerta, as well as a generic version of Pfizer’s $PFE cholesterol fighting blockbuster Lipitor. In fact, Watson has been busy applying for FDA approval for a generic version of Bystolic (hypertension) of which, Janssen- a JNJ subsidiary- sold its rights to Forest Labs.

By way of contrast, international operations saw a 6.4% rise in constant currency sales but much of this came from the pharmaceutical segment. In fact, it was the only segment to report more than 1% growth in the quarter.

Weak Consumer Segment Results

As mentioned earlier, JNJ has had production problems which led them promise to overhaul operations at three plants, and kept key products off the market. That said, these results were still weak. Reported sales declined, both in the US and internationally, with women’s health, nutritionals and baby care looking particularly poor.

The market wasted no time in marking down rival baby nutrition company Mead Johnson  $MJN) in sympathy. Moreover, market rumours hit that Pfizer is close to divesting its nutrition unit to Nestle. If true, this could create future problems for both JNJ and Mead Johnson, as I would expect Nestle to start using its financial muscle to aggressively compete with them in the future.

Pfizer is keen to divest its nutrional and animal health divisions as part of its ongoing restructuring plans.

The two bright spots in the consumer division were in skin care and wound care in the US. Skin care is a hot sector right now and JNJ has always been very strong in wound care. Internationally, every part of the consumer segment, bar a 1.8% increase for oral care, was in decline.

International Pharma Growth Strong but US Challenged by Generics

JNJ splits its pharma segment into immunology, infectious diseases, neuroscience and oncology. The star was immunology with a 20% reported increase in global sales, followed by oncology with a 36% increase. JNJ saw strength across the board in immunology, whilst oncology saw strong gains from the international release of Velcade (multiple myeloma). Internationally, infectious diseases did well but couldn’t counteract the $404m lost in US sales from Levaquin going generic. Perhaps the most interesting part of JNJ’s pharma division is in Neuroscience.

Invega Sustenna (schizophrenia) appears to be cannibalizing sales from Invega, but I note that the total global sales of $282m are not more than declining Risperdal Consta (schizophrenia) which chalked up $361m in sales. The latter is an older drug which is seen as being inferior to Invega and/or Invega Sustenna. However, if you add the three drugs together, sales rose over 9% to $643m. Now, given that Concerta (ADHD) is facing generic competition its sales will decline, but the gains from the Invega franchise could counteract Concerta losses for the Neuroscience segment in future.
Oncology should see a pick up as Doxil/Caelyx (ovarian cancer) hopefully comes back into production in late 2012 after manufacturing problems. In addition, JNJ has new drug launches so prospects are looking brighter for its pharma business.

Medical Devices and Diagnostics

Global sales were basically flat, but US Diabetes care saw strong results. Diabetes is a strong ailment to be focused on and, there is a detailed article on it linked here. However, it was not enough to offset global weakness in cardiovascular and, flat results in general surgery.
Furthermore, US diagnostics and orthopaedics gave negative results. These results are somewhat puzzling as with an improving economy, visits to the doctor and, elective surgeries should be on the increase.

We will get more colour on the diagnostics space when the likes of Gen-Probe $GPRO and Alere, give results. Similarly, with surgeries I would look to Covidien to provide more background information on the underlying conditions. Gen-Probe, in particular, is a good barometer of conditions in the diagnostics and surgical industries in the US.

The Investment Case for Johnson & Johnson?

In conclusion, this is a mixed bag of results, but this is to be expected from such a large company. JNJ generates huge bundles of cash and, it has a stable- if not growing- collection of businesses. In other words, JNJ can invest, acquire and restructure in order to generate growth.

Going forward, the key driver will be execution. JNJ needs to sort out its manufacturing issues and, compete better within consumer health. New drug launches will help pharma and, an improving economy should help the discretionary element of medical devices and diagnostics.

In short, it is a value play orientated at dividend seeking investors. JNJ also offers upside potential from resolution of issues that are primarily outside of the economy. On that basis, it will attract risk adverse investors who would rather hold JNJ yielding 3.6% than a ten year note yielding 2%.

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