Friday, January 31, 2014

Johnson & Johnson in 2014

The recent earnings results from Johnson & Johnson  $JNJ were met with a near 2% sell-off on the day. As ever, a lot of journalists and commentators immediately searched for a negative in the results or guidance in order to justify the drop. There was nothing significantly wrong with the results. However, the company's stock looks fairly valued and it probably needs to surprise the investment community on the upside in order to move significantly higher in 2014.

The running story with its divisions in 2013 was one of strong pharmaceutical sales, weakening medical device & diagnostics, and moderately growing consumer products. The fourth quarter results stuck to the script, and it's hard to see how things will change much in 2014.

Pharmaceuticals (39.4% of 2013 sales)
Johnson & Johnson's pharmaceutical performance stood out because it had a number of new drugs in early marketing stages, while continuing to generate strong growth with its Remicade (rheumatoid arthritis) treatment.

Remicade sales grew by nearly 14% in the fourth quarter, and generated more than 23% of pharmaceutical sales and over 9% of total company sales in the quarter. Meanwhile, some of its newer drugs achieved very strong growth:

Drug Treatment Fourth Quarter Sales ($m) Fourth Quarter Growth
Stelara psoriais 417 55%
Simponi rheumatoid arthritis 254 40%
Invega Sustenna anti-psychotic 350 54%
Xarelto anti-coagulant 271 n/a
Zytiga castration-resistant prostate cancer 495 87.5%

Source: Company Presentations

Together, these fast-growing drugs generated 24.4% of total pharmaceutical sales in the fourth quarter. Growth should continue at a strong pace in 2014 as the company's sales reach is expanded.

However, one potential problem could be Hospira's (NYSE: HSP  )  biosimilar for Remicade, called Inflectra. Hospira's drug was approved by the European Commission in late 2013, and has proved to be comparable to Remicade in a large-scale trial.   Johnson & Johnson's patent protection for Remicade will run out in most countries in Europe in February 2015, and in February 2018 in the United States. Given the importance of Remicade, Hospira's Inflectra could turn out to be a challenge to Johnson & Johnson in future.

Medical Device & Diagnostics (40% of 2013 sales)
Pharmaceuticals did well, but the medical device & diagnostics division is facing another difficult year. The whole indusrtry has found it tough. Medical device sales are not often seen as economically sensitive, but when the economy is slow patients tend to make fewer visits to the physician. Ultimately, this results in fewer surgical procedures. Throw in a climate of austerity in hospital spending, and the outlook for medical devices looks moderate in mature markets. Indeed, Johnson & Johnson's management outlined on the conference call that surgical lab procedures were "flat over the last 12 months" in the United States.

Consumer Products (20.6% of 2013 sales)The 2.8% increase in consumer products sales for the fourth quarter was disappointing to some, but Foolish investors should note four things about the division.

First, the consumer products division is probably the most visible of its operations, though it's actually the least important in terms of sales. Second, it's also the division with the largest reliance on international markets, and currency effects reduced sales by a significant amount. In fact, on a constant currency basis, consumer products sales were up 4.4% in the fourth quarter.  Third, the company achieved its aim of getting 75% of its over-the-counter brands (previously affected by production problems) back onto the shelves. Indeed, its U.S. OTC sales rose 21.6% in the fourth quarter. Finally, if you exclude the effects of the sales of the manual toothbrush (oral care) and women's sanitary protection (women's health) businesses then U.S. sales were actually up 10%, with global operational sales growth up 6%. 

Johnson & Johnson in 2014
Looking into 2014, investors should focus on three things:

  • Acceleration in the economic recovery so medical device sales can pick up inline with an increase in surgical procedures.

  • Ongoing development of pharmaceutical sales, and activity to protect future market share for Remicade in Europe.

  • An improvement in its international consumer products sales, as they only grew 3.1% operationally in 2013.

Achieving two of the three things should provide for some upside surprise, and Johnson & Johnson needs it. On current analyst estimates, it trades on a valuation of 16 times forward earnings. The company also has only 6% and 7.4% earnings-per-share growth estimated in the next two years. This makes it look like a fairly valued stock.

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