How Sensitive Is Johnson & Johnson To Changes In Its Operating Margins?

by Trefis Team
Johnson & Johnson
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We estimate that Johnson & Johnson’s (NYSE:JNJ) operating profit will grow in high single digits in 2018, primarily led by the company’s Pharmaceuticals business, which accounts for roughly 60% of its overall profits, according to our estimates.  We have created an interactive dashboard on J&J’s sensitivity to changes in its operating profit margin. Note that you can adjust the margin drivers, and see the impact on J&J’s overall valuation and price estimate. Below are some of the charts and data from the interactive dashboard.

Our price estimate of $149 for Johnson & Johnson implies a premium of over 15% to the market.

Expect Pharma Operating Profit Margin To See Steady Growth In 2018

We forecast JNJ’s operating profit margin separately for its Pharmaceuticals, Consumer Health, and Medical Devices segments. Pharmaceuticals operating profit margin, on average, has been around 32% over the last few years. However, the figure has declined from the recent highs of 38% in 2016 to 31% in 2017. This can primarily be attributed to an increase in overall expenses due to the Actelion acquisition. We forecast the figure to improve to 32% in 2018. New drug launches increase revenues and profits for firms due to lower competition in the early stages of market introduction. J&J expects to launch multiple new drugs over the next 18 months, each having $1 billion+ in sales potential. Having said that, we don’t expect the figure to reach its recent highs in the near term, primarily due to loss of exclusivity for several drugs. For instance, J&J lost patent exclusivity for Remicade in 2016, and the company will start seeing increased competition from Pfizer’s biosimilar Inflectra. It should be noted that Remicade is a blockbuster drug for J&J, with peak sales of over $6 billion. Additionally, Zytiga lost a patent and four more drugs will lose patent exclusivity over the next few years. This will put some pressure on margins and keep a check on the company’s overall growth. Looking at J&J’s Consumer Health, and Medical Devices segments, we estimate the operating profit margins to be around 19% and 20%, respectively, in 2018. We don’t expect any significant changes from 2017 levels.

Impact of Changes In Operating Profit Margins On J&J’s Valuation

Over the past few years, J&J has launched a number of new molecular entities and significant line extensions that we expect to drive growth and partly offset upcoming patent expirations and generic competition. As of January 2018, J&J’s phase 3 pipeline included over 20 key line extensions for existing drugs. These line extensions, along with new drug launches, will likely aid the company’s profitability. A 3% increase in J&J’s operating profit margin for its pharmaceuticals segment would translate into an approximately 5% increase in the company’s valuation and stock price estimate (assuming other factors being constant), as shown in the scenario on our interactive dashboard.

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