Johnson & Johnson: Fourth Quarter Earnings And The Year Ahead

Johnson & Johnson (NYSE:JNJ) will report its Q4 2014 and full year financial results on January 20th. The fourth quarter, and the year ahead, don’t look too good as far as the company’s international sales growth is concerned. However, its U.S. business is likely to remain strong. There are some existing drugs that are doing well but the competition is increasing and Remicade, J&J’s biggest drug, is losing its patent protection. Additionally, the company’s Hepatitis C drug Olysio lost some steam last quarter and it will be interesting to see whether it can carry the company’s weight this time. Here is what we expect for J&J in the upcoming quarter as well as the year 2015.

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

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International Growth May Remain Slow

Johnson & Johnson’s international growth has suffered in recent quarters primarily due to a slowdown in Europe. The situation may not be any different in the fourth quarter and for the year 2015. The slowdown has only worsened and the possibility of austerity measures could further hamper pharmaceutical sales growth, unless ECB’s quantitative easing plan re-ignites the economy.

Declining oil prices and the possibility of Greece exiting Euro has disturbed investor sentiment in Europe. The decline in European stocks is manifestation of these events along with the fear of deflation. A high percentage of healthcare spending in Europe is funded by the government. The faltering economy may pressure the public sector to take strict measures and cut financial corners. While healthcare spending is largely fixed, European governments may try to optimize the variable part of the expenditure which is largely related to drugs. Also, governments use IRP tool (or international reference pricing) to benchmark prices across geographies. For instance,  a host of countries in Europe and other regions of the world reference their pharmaceutical pricing to Greece. (Read about this and the impact of austerity on European pharmaceutical policy and pricing  in a report by Deloitte) If Greece exits Euro currency, its own currency is likely to depreciate which will make its Euro-denominated debt even more expensive, thus resulting in further austerity measures and economic slowdown. The pricing and sales of pharmaceuticals could be impacted too, and this effect can spread to other countries.

Besides the economic slowdown, the competition for some drugs is likely to affect Johnson & Johnson’s international growth. Zytiga, an oncology drug, is seeing strong growth but 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 Commission 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.

Olysio’s Sales Growth Will Be In Focus

Olysio is the new hope for Johnson & Johnson’s pharmaceutical segment amid growing competitive pressure, but the results from the last quarter suggest that even the Olysio’s growth could be at risk. The company received the approval for its this Hepatitis C drug 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.

However the sales declined sequentially in the third quarter. Excluding Olysio, J&J’s pharmaceutical segment growth stood at roughly 6.8% in Q3 2014 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 and will be something that investors will be cautious about. The chart below shows how Olysio’s sales have trended in the past three quarters.

J&J May Continue To Trim 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 2015.

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.

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1. Johnson & Johnson’s R&D Pipeline [↩]