Don't Forget About Pharma's Stepchild

We talk a lot about prescription drugs when measuring the performance of pharmaceutical companies. And for good reason. With sales that can top $1 billion, prescription drugs drive the revenue needle.

But quite a few pharmas also sell over-the-counter drugs and other products such as sunscreen that shouldn't be forgotten.

Company

2012 Consumer Health Sales (in millions)

Fraction of Total Revenue

Year-Over-Year Growth (Decline)

Johnson & Johnson (NYSE: JNJ  )

$14,447

21.5%

(2.9%)

Novartis (NYSE: NVS  )

$3,735

6.6%

(19%)

Merck (NYSE: MRK  )

$3,399

7.1%

4%

Sanofi (NYSE: SNY  )

$3,946

8.6%

9.9%

GlaxoSmithKline (NYSE: GSK  )

$7,762

19.3%

0%

Source: Company releases.

Manufacturing issues
Novartis' massive decline in sales last year is due to issues at its manufacturing facility in Lincoln, Nebraska. Before that, Johnson & Johnson had issues with the manufacturing of its over-the-counter drugs.

As best I can tell, the problems stem from a lack of oversight. It's like management was following investors' lead and ignoring the groups. Or maybe the companies were cutting corners to eke out profits from the lower-margin business.

Whatever the case, it's been costly for Novartis and Johnson & Johnson. Novartis' consumer health division posted an operating loss of $12 million in the fourth quarter.

Profits
Pharmas don't generally break out margins by division; the one exception that I know of is Novartis, which links its animal health and consumer health together. In 2011, before the company ran into manufacturing issues, operating income was 15.7% of sales for the division compared to operating income of 25.5% of sales for its pharmaceutical division in the same time period.

If we assume that the animal health products aren't affecting the division's profits all that much, it seems likely that drugmakers aren't making nearly as much from their consumer health care divisions as they do from their drugs that are kept behind the pharmacy counter. That makes empirical sense as well given the lower costs of over-the-counter products relative to branded prescription drugs.

Spin out?
It's all the rage with pharmas these days. Bristol-Myers Squibb spun out its nutrition business Mead Johnson Nutrition. Abbott Labs separated out its pharmaceuticals AbbVie from the rest of its business. Pfizer sold its nutrition business to Nestle and spun out its animal health business Zoetis.

I don't see the same strategy working very well for the consumer health divisions mainly because the divisions are so dependent on the pharmaceutical branded drugs for success; many over-the-counter drugs started as prescription drugs. Allergy pills such as Johnson & Johnson's Zyrtec and Merck's Claritin were both pharmaceutical drugs before the FDA cleared them for OTC status, as were heartburn medications Procter & Gamble's Prilosec OTC and Takeda's Prevacid.

Pharmas could just license their drug to a consumer health company and let them sell it, but it's a lot easier to do brand lifecycle management if it's kept in house. One of the main driving forces in Sanofi's purchase of Chattem was the ability to convert its prescription allergy medication, Allegra, into an over-the-counter product.

A blended family
As long as the pharmaceutical companies can supervise their consumer-health children sufficiently, I think keeping the divisions together with pharmaceutical drugs can work. For consumer products like Pfizer's and Abbott's nutrition businesses, it makes more sense to part ways. It's hard to see how having baby formula and prescription drugs under the same roof helps companies sell more of either.

Although their profits aren't particularly massive, consumer health offers some stability, which can help balance out the high-risk, high-reward nature of drug development.

Is bigger really better?
Involved in everything from baby powder to biotech, Johnson & Johnson's critics are convinced that the company is spread way too thin. If you want to know if J&J is nothing but a bloated corporate whale -- or a well-diversified giant that's perfect for your portfolio -- check out The Fool's new premium report outlining the Johnson & Johnson story in terms that any investor can understand. Claim your copy, and a year of free analyst updates, by clicking here now.


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