We expect the strength in Johnson & Johnson‘s (NYSE:JNJ) pharmaceutical business to continue as the company releases its third quarter earnings on October 15, 2013. J&J, traditionally known for medical devices and diagnostics, is getting increasingly competitive in the drug therapeutics segment. Its immunology and oncology medicines have shown strong growth in recent quarters, and we expect the trend to continue. Given the recent weakness in the US dollar against some key currencies such as euro, yen and yuan, we expect the negative impact of currency movements to ease off this quarter.
As far as the medical devices business is concerned, we don’t see any catalysts that could have spurred growth in the third quarter. Sales from this segment increased by just 0.5% in Q2 2013, excluding the impact of the Synthes acquisition and currency movements. Competition and the resulting pricing pressure have started to take a toll on the company’s growth in this market. In fact, J&J has reportedly started looking for a buyer for its Ortho Clinical Diagnostics unit. 
Our price estimate for Johnson & Johnson stands at $90, implying a premium of about 5% to the market price.
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Immunology Drugs Will Do Well, Protected Till 2015
J&J’s stellar performance in the global pharmaceuticals market can be attributed to the success of its key immunology and oncology drugs such as Remicade, Zytiga and Velcade. In Q1 2013, J&J’s immunology drug sales surged by 16.3% globally. The second quarter was no different as the figure saw 16.8% growth worldwide, amounting to $2.24 billion.  Remicade is J&J’s biggest drug and still managed to post growth of close to 12% in 2012. The overall immunology drug market is increasing and the international markets present large growth potential. We expect the company to benefit from these trends and post strong results in the third quarter. The immunology segment constitutes 10-15% of Johnson & Johnson’s value according to our estimates.
For now, the revenues are well protected. The growth is likely to slow down when Remicade, expected to cross $6.4 billion in sales this year, loses its Europe patent in February 2015. The region accounts for a significant proportion of the drug’s sales. The European Commision has already approved a lower priced version of Remicade for the treatment of rheumatoid arthritis. 
Support From Cancer & Diabetes Drugs
Oncology, or cancer therapeutics, is one of the key growth segments for J&J and for the pharmaceutical industry in general. Primary care areas such as cardiovascular and allergy are already flooded with products, and therefore the focus on oncology could help the company command better pricing. The opportunity comes from the fact that the global incidence of cancer is likely to increase from about 12.7 million in 2008 to 21.3 million in 2030. 
Zytiga, which is now approved to treat both chemo refractory and chemo naïve metastatic castration resistant prostate cancer, has seen its sales jump substantially in the first half of 2013 on strong market growth and share gain. In addition to this, J&J’s acquisition of Aragon Pharmaceuticals will allow it to take ownership and control of Aragon’s androgen receptor antagonist program, which can complement Zytiga’s success. Under this program, Aragon is developing a second generation androgen receptor signaling inhibitor, ARN-509, which is currently in the phase 2 development stage and could potentially become a viable drug for treatment of castration resistant prostate cancer. Prostate cancer is the second most common cancer in men worldwide and is among the leading causes of death. Velcade, J&J’s biggest cancer drug, is also witnessing healthy growth.
According to BMO Capital Markets, the initial three-week prescription data for the third quarter suggested that Merck’s Januvia franchise’s prescriptions declined by 1.7%. The drug’s sales have suffered following Invokana’s launch by J&J in April, and the research firm expects the prescription volume to continue declining in the second half of 2013. It appears that Invokana is taking some volume away from Januvia, and this will contribute to the company’s growth in Q3.
Key Risks For The Third Quarter: Pricing Pressure In Medical Devices & Currency Fluctuation
Despite a strong product portfolio, Johnson & Johnson’s medical devices & diagnostics business is facing some pricing pressure. In the second quarter of 2012, this segment saw growth of only 0.5%, excluding the impact of Synthes’ acquisition and currency movements. Additionally, J&J’s exit from the drug-eluting stents business has also weighed on its growth, although the impact will dilute going forward. The pricing pressure is likely to continue in the near term and will impact the company’s Q3 results.
Besides the aforementioned pricing pressure and the risk of patent expiration, Johnson & Johnson faces currency risk due to its vast global operations. In the last two quarters, the company’s international pharmaceutical sales saw a negative impact of more than 2% due to currency movements. The year 2012 was no different as its total sales witnessed a negative impact of 2.7% due to the strengthening of the dollar. However, this impact is likely to ease off as the dollar has consistently weakened against the euro and yuan over the recent months.
Longer Term Risk: Competition From Generics
Johnson & Johnson has more than compensated for the lull in its devices business by growing its pharmaceutical sales. However, the company faces the risk of competition from generics as several of its major drugs are set to lose their patent protection in the next few years. For instance, its biggest drug Remicade, which accounted for roughly $6.2 billion in revenues in 2012, is expected to lose its Europe patent in 2015. In addition, Risperdal will lose its patent in 2014, Prezista in 2015, and Velcade and Zytiga in 2016. As these major drugs lose their patent protection, J&J’s pharmaceutical sales will suffer significantly due to competition from lower priced generic drugs.
Our price estimate for Johnson & Johnson stands at $90, implying a premium of about 5% to the market price.Notes:
- J&J kicks off $5 billion clinical diagnostics unit sale: sources, Reuters, Sept 6 2013 [↩]
- J&J’s Earnings Transcript [↩]
- European Commission Approves Biosimilar of J&J and Merck’s Remicade, The Wall Street Journal, Sept 10 2013 [↩]
- J&J’s Investor Presentation [↩]