Tuesday, December 4, 2012

Johnson & Johnson Resarch Analysis

Johnson & Johnson (NYSE: JNJ) reported market pleasing results, but many questions remain unanswered. This quarter’s star was the pharmaceutical division that performed well with particular strength in immunology and oncology. Moreover, underlying conditions in neuroscience are positive. The cause for doubt relates to ongoing disappointing results within consumer products, and if we exclude the contribution of orthopedics (much if which was due to the Synthes acquisition), revenues were actually down in medical devices and diagnostics.  However, the question that remains is that of evaluation. JNJ is not doing much, but it’s enough to see the stock appreciate, given its cheap evaluation.

Consumer Products (21% of Sales)

The US makes up only 34% of divisional sales, and that’s a good thing because operational sales were down .4%, with ongoing production problems having their affect. Operational results from international increased a paltry 1.8%, but this was more than wiped out by negative currency effects, which resulted in reported sales dropping 6.1%.  Overall, sales dropped 4.3%, and there were some particular areas of concern.

OTC/Nutritionals are doing well and are in line with the sector, but there is ongoing weakness in baby and oral care in the US. I suspect the latter is partly due to Colgate Palmolive (NYSE: CL) stepping up competition with mouthwash in the US. As for baby care it was also down internationally where others have reported pretty good growth.  In general, Colgate is generating growth via innovation and JNJ needs to respond or continue to lose market share. The other surprise was the negative result in international skin care. This is another category where rivals have been giving good numbers.

At the last set of results I had thought that the decline in the division was beginning to slow but it seems that there is much more work to do.

Pharmaceuticals (37.5% of Sales)

Pharma outperformed for JNJ in this quarter as a combination of new drugs accelerated sales and a hefty $183m contribution from Remicade helped overall revenues rise 7% to $6.4bn. In fact, Remicade made up nearly 25% of total pharma sales, although the drug is part of a class of drugs (TNF Blockers) for Rheumatoid Arthritis that may face competition in future from Janus Kinase Inhibitors (JAK) . In fact, Pfizer’s (NYSE: PFE) tafocitinib may receive FDA approval quite soon. Long term this may prove to be an issue, but most observers think that JAK inhibitors will initially be marketed to TNF non responders, and (like the TNFs) there are some safety concerns with Pfizer’s drug. We shall see. However, the issue does hang over Remicade. It should also interest Abbott Labs shareholders because after the forthcoming split its TNF-Blocker (Humira) will make up a large part of revenues and profits for Abbvie (the future pharma and biologics part).

Elsewhere reported Neuroscience revenues were down 1%, but I expect Invega and Invega Sustenna will gradually takeover lost revenues from Risperdal and Concerta. The launch of Zytiga (prostate cancer) has gone very well and reported Oncology sales were up 27.1% in the quarter.

In conclusion, it was a strong quarter for Pharma but keep an eye out for developments with RA treatments.

Medical Devices and Diagnostics (41.4% of Sales)

Frankly it was a mixed bag and I want to demonstrate this by splitting orthopedics from the rest of the division.

Much of the orthopedics growth is due to the Synthes acquisition and without it this wasn’t a strong quarter. Diabetes care was weak and diagnostics reported negative sales growth in the US and international, although this may turn around in future with improvements in hospital visits.

Moreover, surgical care was weak with reported sales down 4.4% and it is hard to conclude that JNJ isn’t losing market share to the strongly performing Covidien, whose mix of endomechanical, vascular, and energy devices and is generating close to double digit growth for the company. It will be interesting to hear what Covidien has to say about conditions in surgery because hospital admissions are up but JNJ does not seem to be able to generate growth.

The Bottom Line

In conclusion, it’s the usual mixed bag of results from JNJ.  There is an obvious need for the company to turn around the poorly performing consumer division and there are longer term concerns with Remicade and some parts of medical devices.

On the other hand, the stock remains cheap on every single value metric that you might care to consider. Cash flow generation is substantial and the company has the capacity to increase dividends significantly. Moreover, more acquisitions are possible given the strong cash flow and investors should applaud the successful integration of Synthes.

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