What Johnson & Johnson Needs to Take the Stock Higher

The investment case for Johnson & Johnson (NYSE: JNJ  ) in the past few years has focused on a combination of two things: its ability to generate growth through internal execution, and a "growth kicker" from a potential improvement in the more cyclical parts of its heath-care portfolio. By the look of its recent second-quarter results, the company continues to do well with the former but is finding the latter harder to come by. Is Johnson & Johnson still a buy?

Johnson & Johnson's consumer segment (19.2% of sales)
The company's management has certainly executed on most of the things it has set out to do in the past few years. In consumer products, after some well-documented product recalls and production difficulties, Johnson & Johnson has been steadily bringing the affected over-the-counter, or OTC, brands back into the marketplace. In fact, its U.S. OTC sales increased 9% in the quarter. Moreover, excluding the women's health category in the U.S., where a divestiture was made, would see U.S. consumer product sales rising 5%, instead of the reported 0.5% decline.

Moreover, management declared that its strategy to focus on its "mega brands" within consumer products was "working." Indeed, its international consumer product sales grew 5.8% on a constant currency basis, with its international baby care, oral care, and OTC categories, all growing above 7%. Clearly, it was a good quarter for its consumer products segment, and Fools can look forward to a good contribution from the segment going forward.

Johnson & Johnson's pharmaceutical segment (43.6% of sales)
The pharmaceutical segment has provided the most successful element of Johnson & Johnson's execution in recent years. Simply put, the company had an opportunity to rapidly expand sales of a host of new pharmaceutical products, while mitigating declines with off-patent drugs like Concerta, an ADHD treatment that saw sales falling 67% to just $28 million in the United States.

A look at some of its fastest-growing drug sales confirms how well Johnson & Johnson is executing. Fools should note that, excluding Remicade, the drugs in the table made up $2.96 billion in revenue, representing 34.7% of total pharma sales in the quarter.

Drug Treatment Second-Quarter Sales
(in Millions)
Sales Growth
Stelara psoriasis $528 41.3%
Simponi rheumatoid arthritis $282 61.5%
Invega Sustenna anti-psychotic $394 34.4%
Xarelto anti-coagulant $361 91%
Zytiga castration-resistant prostate cancer $562 40.7
Olysio hepatitis C $831 n/a
Remicade rheumatoid arthritis $1,804 8.7%

Source: Johnson & Johnson presentations.

Total pharma sales increased by an impressive 21.1%, but there are a couple of notes of caution. First, management pointed out that Olysio, whose sales contributed 56% of the growth in overall pharma sales in the quarter, would "face significant competition from new hepatitis C products later in the year, the full impact of which is difficult for us to predict at this point." Management continued: "And while we're not providing guidance for 2015, this will certainly pose a headwind next year."

Second, its biggest-selling drug, Remicade, made up 21.2% of total pharma sales (and 9% of the total growth), but with Hospira's (NYSE: HSP  ) partner, Alvogen, launching a bio-similar, called Inflectra, in certain markets in Europe this year, it's possible that Remicade sales could falter in the future.

When questioned on the subject on the conference call, Johnson & Johnson's management outlined that "the price erosion has also been limited" and suggested that with bio-similars, "the discount in which these products have been launched averaged about 25% to the branded price, so that's the situation today as far as the bio-similar to Remicade." Indeed, Remicade's international sales increased 6.3% operationally in the quarter, so no immediate impact seen there. Furthermore, management confirmed that it believed its Remicade patent would not expire until the latter half of 2018.

On the other hand, Hospira's partner has only, thus far, launched the drug in countries including Bulgaria, Croatia, Hungary, Poland, and Romania, so it's not surprising that a big impact hasn't been seen. A far bigger test will come in early 2015, when Western European countries are likely to see Inflectra.

Johnson & Johnson's medical devices and diagnostics (37.1% of sales)
Here again, management has been active in recent years. The acquisition of Synthes, and the recent sale of its ortho-clinical diagnostics unit to the Carlyle Group for $4 billion, signals its intent to restructure the segment toward growth. Unfortunately, the problem here is that end-market demand hasn't picked up in line with economic growth. The segment's overall sales grew a paltry 0.9% on an operational basis in the second quarter. Moreover, management outlined that it saw key metrics such as hospital utilization, surgical procedures, and primary-care physician visits as remaining "somewhat subdued" -- not good news.

Where next for Johnson & Johnson?
All told, this was a good report for its consumer-products segment, and an excellent one for pharmaceuticals. Johnson & Johnson still has growth prospects in pharma, but investors should be mindful of possible headwinds with Olysio, and potential competition from Hospira's Inflectra. Moreover, there are still no real signs of end-market improvement for its medical devices and diagnostics segment, and this doesn't augur well for the rest of the industry, either. Johnson & Johnson's execution has been excellent in the past couple of years, but it will need to be in the future as well, for the stock to move significantly higher.

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