Market Reaction To Johnson & Johnson’s Earnings Is Justified

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JNJ: Johnson & Johnson logo
JNJ
Johnson & Johnson

Johnson & Johnson’s (NYSE:JNJ) stock price fell sightly following its Q3 2014 earnings announcement despite the company beating consensus estimates and keeping the full year outlook the same. This can be attributed to a slowdown in sales of its new blockbuster drug Olysio which could be due to increased competition from Sovaldi, a similar drug from Gilead Sciences. This, along with a slight improvement in sales of diabetes drugs, was perhaps the most important takeaway from Johnson & Johnson’s third quarter earnings. Why is the market placing so much value on one drug? To answer this question, we’ll have to look at Olysio’s contribution to the company’s growth in recent quarters, and the outlook for its other key drugs. The ramifications of a sharp halt in Olysio’s growth can be significant considering that Johnson & Johnson is likely to face generic competition for its several other key drugs in the near future. In such a situation, Olysio is its primary hope for sustaining growth in the pharmaceutical business, which has been the key driver behind its stock price increase in the last two years.

Our price estimate for Johnson & Johnson stands at $101, implying a premium of little under 5% to the market price.

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See our complete analysis for Johnson & Johnson

Olysio Has Been Prime Driver Of J&J’s Growth In The Last Three Quarters

Johnson & Johnson received the approval for its Hepatitis C drug Olysio in the U.S. in November 2013 and in Europe in May 2014. [1] Olysio’s sales doubled sequentially in the second quarter of 2014, amounting to $831 million. The impact of European approval further strengthened the effect. The drug is already a blockbuster as its has reigned in more than $1.98 billion in sales in the first nine months of this year. Let’s consider only the third quarter for a moment. Excluding Olysio, J&J’s pharmaceutical segment growth stood at roughly 6.8% whereas including the drug, the figure jumped to 18.1%. The situation was more or less the same for the first and the second quarters too. Olysio single-handedly lifted Johnson & Johnson’s pharmaceutical segment growth to 16.7% during the first 9 months of 2014. Without the drug, the figure would have been somewhere around 7.2%. Therefore, a slowdown in the drug’s growth is certainly a cause of concern. The chart below shows how Olysio’s sales have trended in the past three quarters.

The Market Is Too Lucrative To Lose Out On

The combination of strong demand and steep pricing suggests that effective Hepatitis C drugs such as Olysio and Sovaldi can earn billions of dollars in revenues in the coming years. The demand stems from the drug’s high efficacy and short treatment window as compared to traditional therapies. Close to 150 million people suffer from Hepatitis C globally. [2] Sovaldi’s sales in the second quarter of 2014 reached $3.5 billion and the drug is on track to earn in excess of $10 billion in 2014. Building upon this success, Gilead Sciences launched a new drug that combines Sovaldi with another agent so that the patients only have to take one pill instead of a combination. The competition for Johnson & Johnson’s Olysio is likely to be stiff, but the market is too tempting to ignore. Strong pricing and high margins can boost J&J’s cash flows.

Competition For Other Drugs Will Increase, Which Makes Olysio Even More Critical

Johnson & Johnson’s cancer drugs are experiencing strong growth, especially Zytiga. The drug’s sales jumped 36.5% in the first nine months of 2014 as the drug continued to gain market share globally. However, there is a new potent rival Xtandi, which was approved for the treatment of chemo-naive patients suffering from prostate cancer in September. The drug was previously being administered to those who had already received some form of chemotherapy, and thus did not directly compete with Zytiga. Considering Xtandi’s impressive trial results, Johnson & Johnson’s fastest growing cancer drug could lose its steam. Additionally, J&J’s biggest drug Remicade is expected to lose patent protection in Europe in 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. Remicade accounts for roughly 25% of J&J’s pharmaceutical revenues.

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2009

2010

2011

2012

Streaming Content Costs as % of Revenue

3%

7%

22%

44%

Total Content Costs as % of Revenue

13%

14%

25%

46%

Streaming Content Obligations as % of Revenue

60%

122%

156%

Total Streaming Content Obligations ($ Million)

1,299

3,907

5,634

Notes:
  1. Johnson & Johnson’s R&D Pipeline []
  2. Gilead offers Egypt new hepatitis C drug at 99 percent discount, Reuters, Mar 21 2014 []