How Sensitive Is Johnson & Johnson To Its R&D Expense Change?

by Trefis Team
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We estimate that Johnson & Johnson’s (NYSE:JNJ) R&D expenses will more or less be flat at around $10.5 billion in 2018, as compared to the prior year. However, we expect a slight decline in R&D expenditure as a percentage of J&J’s revenues. Of late, many large pharmaceutical firms are becoming more financially disciplined in order to protect their earnings, which are under threat due to patent expiries for key drugs. For instance, J&J has lost its patent exclusivity for its top selling oncology drug Remicade. The drug sales were over $6 billion annually over the last few years. While J&J has a promising portfolio of new drugs, which will likely offset the revenue declines that are expected from the loss of patent exclusivity for drugs, we expect the company to be prudent about its R&D spending. We have created an interactive dashboard on J&J’s sensitivity to changes in its R&D expenses. Note that you can adjust the R&D 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.

Expect R&D Expenses To See Modest Decline In 2018

J&J’s R&D expenditures as a percentage of revenues have increased from around 11% in 2010 to a little under 14% in 2017. However, for most of the years the figure remained around 11%. The jump in 2017 can be attributed to the company’s continued expansion of its pharmaceuticals portfolio, and its collaborative agreements with Idorsia Ltd. and Legend Biotech. We believe that R&D expenditure as a percentage of revenues will come back to its historical range of 11% to 12% in the coming years. In 2018, we forecast the figure to be around 13%. Given that we forecast an increase in J&J’s overall revenues for 2018, led by its pharmaceuticals segment, this should translate into overall R&D expenditures of nearly $10.5 billion, reflecting a modest decline over the prior year period.

Of late, several pharmaceutical companies, including J&J, have been focusing on a few specific therapeutic areas such as oncology. This is expected to streamline expenses and optimize R&D spending. However, developing and bringing a new drug to the market is a long process involving several phases including identifying the compound and clinical trials, which is costly and can last for several years. With many drugs, such as Zytiga, Prezista, and Invega Sustena, facing patent expiry over the next few years, J&J has been investing prudently to grow its pharmaceutical pipeline, and this trend is likely to continue, at least in the near term. The company has around 10 new drugs under its phase 3 pipeline. This could result in higher R&D spending as well. A 2.5% increase in R&D expenditures as a percentage of revenue would translate into an approximately 8% decline in J&J’s valuation and stock price estimate, as shown in the scenario on our interactive dashboard.

We currently have a $154 price estimate for Johnson & Johnson, which is roughly 20% ahead of the current market price.

 

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