J&J is not the first company to take such an initiative. Pharmaceutical giants Pfizer and Merck both over the recent years resorted to spin-offs of their less profitable businesses, while industrial giant General Electric recently announced its plans to split into three different companies to unlock shareholder value.
This move to split its Consumer Healthcare business appears to be a step in the right direction for J&J. The company’s earnings have been weighed down over the recent years due to its Consumer Healthcare business. The segment sales have hovered in the range of $13.5 billion and $14.5 billion for the better part of the last decade. Operating profit from the segment also hovered in a range of $2.0 and $2.5 billion between 2011 and 2019, before plunging to an operating loss of $1.1 billion in 2020, owing to litigation expenses of $3.9 billion for its talc related products.
Although the company has taken multiple initiatives, including the Dr. CI. LABO acquisition in 2019, and ongoing portfolio optimization, to strengthen its Consumer Healthcare business, the margins have been much lower than the company’s other businesses. The average operating margin for the Consumer Healthcare business between 2016 and 2020 stood at 12.2%, compared to 30.9% for Pharmaceuticals and 20.0% for the Medical Devices business. Now, after the split, the Consumer Healthcare business will have its own management, while J&J will focus on its more profitable segments – Pharmaceuticals and Medical Devices. Overall, this move is largely a positive for the company, unlocking more value for shareholders, in our view.
However, J&J has made some progress with its international rollout. The single-dose vaccine was authorized for emergency use by the U.K. regulator in late May and the U.K has ordered 20 million doses of the shot. J&J will also be supplying the doses to Japan by 2022. The company is also looking to expand the vaccine’s availability to India, working with manufacturer Biological E. to produce its shot locally.
Overall, we think the J&J shot has some room for growth globally, as it could do much of the heavy lifting in getting the global population inoculated against Covid-19, considering its single-dose requirement and relatively easy storage.
Now while J&J’s vaccine has dominated the headlines for the company, there is not much upside from a stock price appreciation point of view, given that it is a not-for-profit product, at least for the period of the pandemic.
Below are key factors that present opportunities for upside or downside to the current Trefis price estimate for J&J:
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.
We believe that both pharmaceuticals and medical devices business are important to J&J's value.
J&J's pharmaceutical business accounted for nearly 55% of its revenues in 2020. The contribution of pharmaceuticals has 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.
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 28% of total revenues and 21% of total EBITDA in 2020. Furthermore, J&J acquired Synthes in 2012, which is a global manufacturer of medical devices for orthopedics market including trauma and spine. The combined DePuy/Synthes orthopedic division has the broadest orthopedic portfolio globally and will help J&J expand its leadership.
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.
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.
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 than 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.
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.
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. In 2020, the company spent $5.1 billion in litigation expenses. If these expenses were to increase, it could hurt the company's earnings growth.