Saturday, September 1, 2012

Johnson & Johnson Powers On

Johnson & Johnson (NYSE: JNJ) in turn demonstrated why investors love and loathe the stock. The results were superficially disappointing and confirmed the company’s weak growth trajectory. Full year guidance was reduced in the face of currency headwinds and there was the usual mix of production problems and generic competition eroding established products. The Synthes acquisition added some growth, but it also demonstrating how difficult it will be to generate top line growth via acquisitions.
On the other hand, the stock barely moved as a consequence. Simply put, Johnson & Johnson represents a relatively high yield play with stable end markets and in this kind if environment that will do fine. Any growth upside comes from execution and new product launches, and that is good news because it offers risk adverse investors some income plus the potential for some non market correlated upside.

Johnson & Johnson reports in three business divisions.

Consumer Products  (22% of Sales)

Investors wouldn’t have had a good night’s sleep with this division’s results in recent quarters, and I am not just talking about the manufacturing problems that have kept Tylenol off the market. On an operational basis US sales fell 1.9% whilst international rose 2% although negative currency effects took them down by 8%. Overall reported sales fell by 4.6%.

Superficially this isn’t great but recall that the loss was due to currency effects and international sales (which are growing organically) are 75% larger than domestic. Essentially JNJ needs to sort out its production problems and continue to expose its products to emerging market growth. Categories like oral and baby care offer good growth prospects internationally. Competitors like Colgate-Palmolive (NYSE: CL) in oral continue to report good numbers and emerging market birth rates remain conducive to longer term growth in baby care. Of a slight concern here would be the wound care division which is seeing very strong competition from the likes of Covidien (NYSE: COV).
Overall it seems that JNJ is halting the decline in this division.

Pharmaceuticals (38.1% of Sales)

Overall sales rose by a paltry .9% but excluding currency effects they were up 5.1% and again, it is a story of strong international growth (organically 15.5%) versus weaker US (down 4.5%); however, I think the underlying picture in the US is quite strong here.

The reduction in sales in the US was almost entirely due to Levaquin (bacterial infections) which lost sales due to generic competition. Of course, this will drop out of future sales comparisons and Levaquin sales are now minimal to results.

On a brighter note, new product launches went well. Zytiga (prostate cancer)sales increased by $183m, moreover JNJ filed with the FDA and EMA to extend the use of Zytiga in patients who haven’t received chemotherapy.

Immunology makes up 30% of pharma sales with Remicade (anti-inflammatory diseases) responsible for 79% of those sales.  Sales grew by 12.7% on a worldwide basis and the potential for international sales growth remains good.

 The second biggest division within pharma is neuroscience which makes up 27.2% of sales. Operational sales were up a meager .5%. I’ll start with the bad news first. Converta which treats attention deficit hyperactivity disorder (ADHD)  saw further generic competition that caused US sales to fall 37.6%. This reads across well for Watson Pharma (NYSE: WPI) which has successfully launched a generic version of Concerta.

More positively I think the underlying picture in schizophrenia (40% of neuroscience) is quite good. Risperdal is an older treatment which is in decline but the improved version of Invega (Sustenna) is more than compensating for any fall.

In summary, the pharma division is now performing well and with new drug marketing applications plus the continued success of Remicade, Invega Sustenna and Zytiga growth looks assured.

Medical Devices & Diagnostics (44.6% of sales)

This division reported a .1% revenue decline but operationally it was up 3.5% and that figure includes contribution from the Snythes acquisition. This is the most cyclically sensitive part of JNJ’s revenues and investors should not expect too much, too soon. Hospital admissions and elective surgeries in North America are coming back but, by most estimates, it is only in line with the kind of revenue growth that JNJ is reporting.

The concern here is that US revenues in cardiovascular (partly due to a decision to exit the drug eluting stent market), diabetes and general surgery all declined. It is reasonable to expect that both Intuitive Surgical (NASDAQ: ISRG) and Covidien (with its energy products) are winning market share in surgery and JNJ’s positioning is a concern.

In Conclusion

Same old same old, I am afraid. A mixed bag of results from a healthcare giant that has low growth and, is a difficult company to jump start growth in. Pharmaceuticals are doing well and have good prospects. Meanwhile consumer products offer some upside from execution and the fixing of production woes and the medical device sector needs some work in its surgery product line.
But so what?
JNJ offers a high yield, huge amounts of cash flow and upside from execution. It offers security and in an insecure market and income where so many other safe havens are very highly priced. It’s worth a look at for any portfolio in this environment.

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