The Year 2014 In Review: How Johnson & Johnson Became More Pharma Focused

The year 2014 has been a fairly good one for Johnson & Johnson (NYSE:JNJ). The company’s stock gradually gained 10% on the back of its growing pharmaceutical business. Additionally, the divestitures of flat or declining businesses showcased J&J’s commitment to increasing shareholder value. Overall, the company went through a significant transformation as far as its image is concerned, and is now being seen as pharma-centric as opposed to medical devices focused. Its existing and new drugs saw good adoption both in the U.S. and international markets. In this note, we’ll review key developments that shaped Johnson & Johnson’s business in 2014 and will follow it up with another note shortly in the future discussing what 2015 holds for the company.

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

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Existing Pharmaceutical Products Saw Good Adoption

J&J’s pharmaceutical business grew strongly due to the continued uptake in its current products. While the growth in the company’s consumer and medical devices & diagnostics segments flattened out, the surge in the sale of its drugs catering to immunology, oncology and infectious diseases kept the wheel spinning this year. Johnson & Johnson performed better than many of its peers in terms of topline growth. The company’s pharmaceutical revenues jumped by almost 17% in the first nine months of 2014, and we expect a growth of just under 16.4% for the full year. While the pricing pressure continues, some specific drugs are fueling the growth.

J&J’s immunology drug sales increased 12.2% globally during the first nine months of 2014. While Remicade, J&J’s biggest drug, grew by 4.7%, Simponi and Stelara saw a growth of 24% and 40.5% respectively. Considering the slowdown in Remicade’s sales growth and its expected patent expiry next year, Simpony and Stelara are becoming increasingly important. These two drugs together accounted for about 31% of Johnson & Johnson’s immunology revenues in the first three quarters of this year. We expect this percentage to increase going forward. The overall immunology drug market is growing and the international markets present large potential.

Oncology, or cancer therapeutics, also did well for J&J. Zytiga has surpassed Velcade to become Johnson & Johnson’s biggest oncology drug. While Velcade’s sales grew by 5.6% in the first nine months of 2014 amounting to $1.2 billion, Zytiga’s revenue surged by 36.5% to $1.64 billion. Together, these two drugs constitute roughly 87.5% of the company’s oncology revenues and continue to gain market share. In the U.S., Zytiga has increased its share in the metastatic castration resistant prostate cancer market to more than 30%, besides benefiting from the overall market growth.

Olysio’s Launch Was A Showstealer, But Concerns Emerged

Johnson & Johnson received the approval for its Hepatitis C drug Olysio in the U.S. in November 2013 and in Europe in May 2014. Oysio’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. However, there is a flip side. Let us 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.

While Johnson & Johnson’s cancer drugs are experiencing strong growth, there is a new potent rival Xtandi, which was approved for the treatment of chemo-naive patients suffering from prostate cancer in September 2014. 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. These potential risks make Olysio even more critical to J&J’s future growth.

The Company Trimmed Its Medical Devices And Consumer Operations

J&J has traditionally been known for its medical devices and diagnostics equipment, but that is slowly changing. Given the slowdown in the segment’s growth, the company has been looking at ways to downsize its medical devices business so as to operate more efficiently and free up money to fund its fast growing pharmaceutical business. We believe this is the right move because, despite being the global leader in medical devices and diagnostics market, J&J hasn’t been able to grow much. Stiff pricing pressure and competition from lesser known names seems to be taking a toll on its operations. In early 2014, it announced the sale of its diagnostics unit, Ortho-Clinical Diagnostics, to the Carlyle group for around $4 billion. Ortho-Clinical Diagnostics manufactures and markets donor screening and blood typing products, besides being involved in information management, testing technologies, and automation and interpretation tools. The unit’s revenues have declined in the last two years, and have also come down as a percentage of total medical devices revenues. This can be attributed to certain inventory issues and pricing pressure due to growing competition. It won’t be surprising if we see more such divestitures in future.

In March 2014, J&J entered a definitive agreement with Reckitt Benckiser to sell global rights to its K-Y brand. The move was hardly surprising from Johnson & Johnson’s perspective, as its consumer business holds little value for its stock due to low margins. The essence is that there is a good chance that the company will continue to downsize its consumer and medical devices businesses and focus more on the growing pharmaceutical segment.

It must be noted that despite J&J’s gradual exit from drug-eluting stents business, its cardiovascular medical devices segment recovered in 2014. Biosense Webster is gaining market share and J&J’s endovascular products are seeing good growth, driven by the re-launch of the S.M.A.R.T. vascular stent system and the EXOSEAL Vascular Closure Device.

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