VALUATION HIGHLIGHTS

1. Pharmaceuticals constitute 73% of the Trefis price estimate for Johnson & Johnson's stock.
2. Medical Devices constitute 27% of the Trefis price estimate for Johnson & Johnson's stock.

WHAT HAS CHANGED?

1. JNJ Stock Performance
   • JNJ stock has seen little change, moving slightly from levels of $155 in early January 2021 to around $160 now (ending February 2024), vs. an increase of about 35% for the S&P 500 over this roughly 3-year period.

     Overall, the performance of JNJ stock with respect to the index has been quite volatile. Returns for the stock were 9% in 2021, 3% in 2022, and -11% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 - indicating that JNJ underperformed the S&P in 2021 and 2023.

2. Q4 2023 Performance
   • Johnson & Johnson reported a 7.3% top-line expansion in Q4 2023, with both segments - Pharmaceuticals and MedTech seeing growth. Adjusted EPS rose 11.7% y-o-y to $2.29 during the quarter. The company expects its full-year 2024 sales to rise in mid-single-digits and the adjusted EPS is estimated to be in the range of $10.55 and $10.75.

3. J&J Has Spun-off Its Consumer Healthcare Business
   • J&J, in late 2021, announced its plans to spin off its Consumer Health business into a separately listed company. The Consumer Healthcare business garnered $15 billion in 2022 sales, while the rest of J&J's revenues were $80 billion ($53 billion in Pharmaceuticals and $27 billion in Medical Devices sales). Our dashboard on Johnson & Johnson Revenues offers more details on the company's segments.

     J&J is not the first company to take such an initiative. Pharmaceutical giants Pfizer and Merck both in recent years resorted to spin-offs of their less profitable businesses.

     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 recent years due to its Consumer Healthcare business. The segment sales have hovered in the range of $13 billion and $15 billion for the better part of the last decade. Operating profit from the segment also hasn't seen any meaningful growth.

     Although the company has taken multiple initiatives, including the Dr. CI. LABO acquisition in 2019 and portfolio optimization in 2022, 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 2018 and 2022 stood at 11%, compared to 30% for Pharmaceuticals and 18% 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 positive for the company, unlocking more value for shareholders, in our view.

4. J&J Covid-19 Vaccine
   • The rollout of J&J's Covid-19 vaccine had a rocky start amid concerns of extremely rare but potentially deadly side effects of blood clots and manufacturing and quality issues at a plant run by a contractor in Baltimore. Demand for the shot has also been tepid in the United States, where Pfizer and Moderna have come to dominate the Covid-19 vaccine market.

     However, J&J made some progress with its international rollout. The single-dose vaccine was authorized for emergency use by the U.K. regulator in late May 2021, and the U.K. ordered 20 million doses of the shot. J&J's Covid-19 vaccine garnered $2.4 billion in 2021 sales and $2.2 billion in 2022. We don't expect any meaningful contribution from this vaccine to the company's sales going forward.

5. Impact of Coronavirus On Johnson & Johnson
   • The 2020 coronavirus crisis impacted J&J on two fronts, 1. impact from hospitals deferring non-emergency and non-Covid cases, resulting in a lower number of prescriptions issued, and 2. on direct sales of Medical Devices due to the postponement of elective surgeries.

6. 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 $2 billion in 2022 from around $7 billion in 2016.

7. 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 become more centered around the pharmaceutical business. Within pharmaceuticals, Oncology has led the company's growth in the recent past, and this trend will likely continue. Its key drugs include Darzalex, which alone garnered $8 billion in 2022 sales.

8. 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 Amivantamab and Lazertinib, and neuroscience drugs such as Aticaprant and Seltorexant. Peak sales of the drugs in the late-stage pipeline are estimated to be north of $20 billion, according to our estimates. 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 the late-stage 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 Is Successful

• 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 challenges from biosimilar Inflectra. Other immunology drugs such as Simponi and Stelara are growing fast. Stelara has grown at an average annual growth rate of 20% over the last five years. J&J's immunology drug Tremfya was approved in 2017 and is expected to garner over $3.5 billion in peak sales. J&J's oncology division is likely to do very well, primarily led by Darzalex, with estimated peak sales of over $12 billion. 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 Darzalex'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 a 50% chance of phase 3 drugs reaching commercial-stage launch. There are more than a dozen drugs in the phase 3 pipeline with total estimated peak sales of over $20 billion. If all phase 3 drugs are approved within the next 3-4 years, it could add an additional $10 billion in total revenues in the coming years. This could lead to an upswing of over 10% 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. If any issues plague JNJ's late-stage pipeline drugs and the company is unable to achieve FDA approval for them, it could imply a 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 risen just 3% in the last five years. Competition from new players has led to pricing pressure, which has brought down incremental growth despite increased shipments. We currently expect strong growth in the 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 an approximately 5% downside.

BUSINESS SUMMARY

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 healthcare 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 of 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 businesses 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 55% of its revenues in 2022. 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 a significantly higher EBITDA margin (>60%) as compared to the 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 a 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. The medical devices business constituted roughly 29% of total revenues and 23% of total EBITDA in 2022.

KEY TRENDS

Pharmaceutical Business Becoming Increasingly Important

J&J has made some great strides in the pharmaceutical sector over the last decade. 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 Darzalex, 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. In addition to this, J&J's pipeline will contribute meaningfully in the next five years.

Loss of Patents Impacting Sales

Over the last few years, several of J&J's drugs including Levaquin, Concerta, Invega, and 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 are 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 the 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.