- Pharmaceuticals constitute 48% of the Trefis price estimate for Johnson & Johnson's stock.
- Medical Devices constitute 40% of the Trefis price estimate for Johnson & Johnson's stock.
- Consumer Healthcare constitutes 13% of the Trefis price estimate for Johnson & Johnson's stock.
WHAT HAS CHANGED?
- Q4 2020 Performance
- Johnson & Johnson reported a 8.3% top line growth in Q4 2020, driven by a 16% growth in pharmaceutical sales. The Medical Devices business in particular has taken a hit in the current pandemic, due to deferment of elective surgeries, and it saw 1% drop in sales in Q4. Adjusted EPS declined 1% from $1.88 in Q4 2019 to $1.86 in Q4 2020.
- Impact of Coronavirus On Johnson & Johnson
- The current coronavirus crisis has impacted pharmaceutical companies on two fronts, 1. potential impact from hospitals deferring non-emergency and non-Covid cases, resulting in lower number of prescriptions issued, and 2. on direct sales of Medical Devices due to postponement of elective surgeries. Johnson & Johnson is also busy developing a vaccine for Covid-19, which the company intends to sell on a no-profit basis.
- Loss of Patent Exclusivity
- Over the last few years, several of J&J's drugs including Levaquin, Concerta, Invega, and Aciphex lost their patent protection. Its blockbuster drug Remicade, which generated revenues of close to $7 billion in 2016 lost its patent exclusivity, and now faces competition from Pfizer's biosimilar drug - Inflectra. Remicade sales declined to $4.3 billion in 2019. We forecast a mid-teens decline in the near term, as Inflectra hasn't seen significant uptick since its launch. Over the next few years, about 3-4 drugs are expected to lose their patent and this will impact J&J's overall revenues.
- Oncology Drugs Driving The Growth
- J&J has made some great strides in the pharmaceutical sector over the last few years. The company, traditionally known for medical devices and diagnostics, has now becoming more centered around pharmaceutical business. Within pharmaceuticals, Oncology has led the company's growth in the recent past, and this trend will likely continue. Its key drugs includes Darzalex, Imbruvica, and Zytiga, with combined sales of $9.2 billion in 2019.
- Late Stage Pipeline
- J&J has a robust pharmaceutical pipeline, which will contribute meaningfully to its top line over the next 3-5 years. The top drugs in the phase 3 pipeline include oncology drugs such as Apalutamide, Imetelstat, Erdafitinib and Niraparib, anti-infective drugs such as Lumicitabine and Pimodivir, and neuroscience drugs such as Esketamine and Seltorexant. Peak sales of these drugs is estimated to be north of $8 billion. After a strong run up in the past few years, J&J’s fast growing pharma business has started to slow down, partly due to patent losses. Therefore, the company is banking on these phase 3 pipeline drugs to drive growth going forward.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE
Below are key factors that present opportunities for upside or downside to the current Trefis price estimate for J&J:
Phase 3 Pipeline Fires
- J&J's Oncology Drugs Revenue and J&J's Anti-Infective Drugs Revenue: Despite the fall of J&J's hepatitis C drug Olysio, there still exists some potential in its pharma business that can be unlocked. Its immunology and oncology drugs can do well although Remicade is facing competitive challenge from biosimilar Inflectra. Other immunology drugs such as Simponi and Stelara are growing fast. Stelara has grown at average annual growth rate of 25% over the last 3 years. J&J's new immunology drug Tremfya was approved in 2017, and is expected to garner over $2.5 billion in peak sales. J&J’s oncology division is likely to do very well, primarily led by Imbruvica and Darzalex. Both these drugs combined should generate sales of over $8 billion in 2020. We have factored in these expectations in our price estimate. However, positive data pipeline drug trials could lead to our forecasts being conservative. For instance, there are additional clinical data that could potentially strengthen Imbruvica's sales going forward. Also, the company is likely to file multiple phase 3 drugs for FDA review in the coming years. Our valuation reflects probability adjusted revenues assuming 50% chance of phase 3 drugs reaching commercial stage launch. There are more than 10 drugs in phase 3 pipeline with total estimated peak sales of over $8 billion. If all phase 3 drugs are approved within next 3-4 years, it could add additional $4 billion in total revenues by the end of our forecast period. This could lead to an upswing of over 5% in J&J's stock price.
Phase 3 Pipeline Fails
- J&J's Immunology Drugs Revenue, J&J's Oncology Drugs Revenue and J&J's Anti-Infective Drugs Revenue: Our valuation of phase 3 drugs incorporates 50% probability of phase 3 drugs reaching commercial launch stage and therefore, our revenue forecast includes probability-adjusted revenue for these drugs. Neuroscience, immunology, anti-infective and oncology drugs together account for 40% of our price estimate for Johnson & Johnson. If any issues plague JNJ's phase 3 drugs and the company is unable to achieve FDA approval for them, it could imply 10% downside to our price estimate.
Medical Devices Business Crumbles Under Competitive Pressure
- J&J's Orthopedics Devices Revenue and J&J's Surgical Devices Revenue: The revenues from J&J's medical devices & diagnostics segment have declined at a CAGR of 1% over the last 5 years. It remains to be seen if J&J can sustain the revival that initiated in 2016 after falling from peak in 2013. Competition from new players has led to pricing pressure, which has brought down incremental growth despite increased shipments. We currently expect low growth in medical devices and diagnostics business. However, if the competition intensifies and J&J fails to find new growth drivers, its revenues can dip further by $5-$6 billion leading to approximately 10% downside.
Johnson & Johnson (NYSE:JNJ) is an American multinational pharmaceutical, medical devices and consumer packaged goods manufacturer founded in 1886. The company (also called J&J) and its subsidiaries are engaged in the research and development, manufacture and sale of a range of products in the health care field. It has more than 250 operating companies conducting business worldwide.
J&J is an industry bellwether and therefore its shares generally reflect the overall performance in healthcare products at any given point in time. It also reflects investor appeal for “defensive” securities, as during periods of economic or market uncertainty investors have generally sought haven in J&J shares as its earnings are less cyclical.
SOURCES OF VALUE
We believe that both pharmaceuticals and medical devices business are important to J&J's value.
Pharmaceuticals Business Has Grown Significantly In The Past Few Years
J&J's pharmaceutical business accounted for nearly 51% of its revenues and EBITDA (earnings before interest, taxes, depreciation and amortization) in 2019. These percentages have increased over the last few years, thanks to the growth in immunology, anti-infective and oncology drugs. Besides, the division has significantly higher EBITDA margin (~ 50%) as compared to consumer business, and medical devices segment. J&J also acquired a Swiss Pharma company - Actelion - in 2017 for $30 billion. This has further improved its top and bottom line.
Strong Market Position In Medical Devices Industry
J&J has leading market position in several sub-segments of the medical devices market due to its diversified product offerings, established brand, R&D focus, and strong sales and marketing capabilities. Medical devices business constituted roughly 32% of total revenues and EBITDA in 2019. Furthermore, J&J acquired Synthes in 2012, which is a global manufacturer of medical devices for orthopaedics market including trauma and spine. The combined DePuy/Synthes orthopaedic division has the broadest orthopaedic portfolio globally and will help J&J expand its leadership.
Pharmaceutical Business Becoming Increasingly Important
J&J has made some great strides in the pharmaceutical sector in the last few years. The company, traditionally known for medical devices and diagnostics, is now becoming more centered around pharmaceutical business. The segment saw strong growth driven by increasing sales of Remicade, Zytiga, Simponi and Stelara. However, there are near term challenges as Remicade faces competition from Inflectra and Invokana and Xarelto face pricing pressure. Much of the future growth is likely to come from oncology drugs such as Imbruvica and Darzalex. In addition to this, J&J's pipeline will contribute meaningfully in the next 5 years.
Loss of Patents Impacting Sales
Over the last few years, several of J&J's drugs including Levaquin, Concerta, Invega & Aciphex lost their patent protection. Over the next few years, about 3-4 drugs are expected to lose their patent and J&J will need to develop new drugs to offset these losses.
Growing Threat of Generic Products
The fast growing pharma market in emerging economies or referred to as the 'Pharmerging' economies have the capability and technical prowess to manufacture generic versions of blockbuster drugs. These generic drugs are often sold at prices that substantially cheaper then their branded counterparts, thereby severely affecting big pharma's ability to generate profits in the long run. Remicade faces potential threat from biosimilars, which are generic versions of biologics. The drug is already witnessing significant sales decline in Europe where its biosimilar versions have been approved. However, J&J holds marketing rights for Americas, Japan and other regions. If a biosimilar version of Remicade is approved in the U.S., Remicade's sales, attributable to J&J, will suffer.
Globalization of Healthcare Reforms
Governments around the world are trying to rein in fiscal spending in order to manage their budget deficits
Since healthcare costs are one of the biggest components of any national budget, increased healthcare legislation and reforms around the world will hurt revenues for the entire pharmaceutical sector.
Piling Lawsuits Against Consumer Healthcare Products
Johnson & Johnson was recently ordered by a jury in Missouri to pay $550 million in compensation and an additional $4.14 billion in punitive damages, in a case related to its talc products. The company was previously able to get a relief in a similar case last year, where a woman alleged that she developed ovarian cancer after using J&J’s talc products, and the company's management in its Q2 2018 earnings conference call stated that it is positive to get the verdict reversed. However, the amount of $4.7 billion set by the jury is very high, and pertains only to this case of 22 women. There are over 9,000 lawsuits against J&J for its talc products, including the baby products. The company on an average has spent $1.5 billion dollar on litigation expenses between 2015 and 2018. The company spent $4.3 billion in litigation expenses in 2019, primarily to settle opioid lawsuits. If these expenses were to increase, it could hurt the company's earnings growth.