Johnson & Johnson's Earnings: What You Need to Know

Healthcare giant Johnson & Johnson (JNJ -1.05%) is one of the first multinationals to report earnings this quarter. While clearly instructive for current and potential J&J investors, the report also offers some insight into the broader sector and the issues faced by other players on the global stage.

Douglass and Campbell review the highlights of the call, then take a deeper dive to discuss what it all means and how to look beyond the headlines. Is the good really that good? Are the bad and the ugly deal-breakers for the Foolish investor? Tune in to find out.

A full transcript follows the video.

Michael Douglass: Johnson & Johnson earnings -- The good, the bad, and the ugly. This is Industry Focus.

[INTRO]

Hi Fools. Healthcare analyst Michael Douglass here, with our contributor from New Hampshire, Todd Campbell.

We're going to be talking today about Johnson & Johnson's earnings. Johnson & Johnson, for those of you who are not familiar, don't just make baby shampoo and Tylenol. They're also a massive conglomerate within health care, that really spans three large industries.

The first, of course, the one I just talked about; the consumer goods and over-the-counter segment, which is a relatively small percentage of the business, under 20%.

Next up is the medical device segment; things like stents, valves, etc., a lot of stuff that's used by hospitals in procedures. That is a little bit under 40% of the business.

Then the remainder is pharma, so you have these three, in some ways very different, but also somewhat related industries. I think of Johnson & Johnson in some ways as a microcosmos of health care, because you've got these weirdly different things amalgamated together.

They reported earnings and ... well, it was interesting!

We'll go ahead and start off with that. J&J's Q1 sales are $17.4 billion. It was down 4.1%. Their adjusted earnings per share of $1.56 down 4.3%. Not exactly great headline news, but there are definitely some bright spots.

Todd, let's start with the good.

Todd Campbell: Absolutely. Hi, Michael. The thing that I think is really important here about J&J is not only is it the Goliath within health care -- the only thing they're not into, probably, is health insurance.

Douglass: And hospitals. They don't own any hospitals that I know of!

Campbell: This is a Goliath, so it's a great proxy, but it's also important because it's a multinational. It's providing us with a lot of insight because it's one of the first companies to report in the space.

It gives us a lot of insight into what might be happening with some other companies, not just in health care, but in other areas that may be exposed to overseas markets, so I think it's important that we're going over the good, the bad, and the ugly today.

As you said, let's begin with the good. If you look at what the good is in this report, what jumps out at me is that they still have some really fast-growing drugs. You look at the consumer business and you look at the medical device business; these are slow-growing, annuity stream type businesses.

Douglass: At best!

Campbell: These are not going to move the needle significantly, one way or the other. It's the pharmaceutical business that can make a really big impact, and within pharmaceutical segments there were three drugs in particular that jumped out at me as being bright spots.

The first was a 38% jump in year over year sales for their anticoagulant drug, Xarelto. The next was a huge jump in demand and sales for their diabetes medication, Invokana, which works in an entirely new way at helping people achieve glycemic control.

Then the third one was a jump from a mere $10 million in sales, because it had just been approved, to $116 million in quarterly sales for Imbruvica, which is a drug that Johnson co-developed with Pharmacyclics (NASDAQ: PCYC).

You've got three drugs there. You've got an oncology drug in Imbruvica. You've got a diabetes drug in Invokana, and you've got the anticoagulant in Xarelto, that all saw dramatic growth year over year.

Douglass: Obviously that's very good news, but even when you dig down a little bit deeper, Xarelto up 38% -- $441 million in the quarter is, what, a $2.2 billion run rate, something like that? That's really powerful growth.

Given that they are in a head-to-head with Eliquis -- and of course we'll see Eliquis sales soon enough -- but nice to see that they are still definitely growing very quickly. At worst, they and Eliquis are perhaps not crowding each other out. At best, perhaps they're gaining market share. That's a good thing to see there.

Imbruvica -- ImBRUvica, as I usually call it -- has seen some recent approvals. I think they just got one for Waldenström's, which is one of the types of non-Hodgkin lymphomas. We've just seen really explosive growth there.

That's been something that's really been talked about a lot as a growth driver for Johnson & Johnson, so it's nice to see they're delivering on that.

Campbell: Yes. Xarelto, I think what's exciting about that opportunity is that for 50 years it's been warfarin, Coumadin. "You've got to use this as your anticoagulant."

This is the first time we've had next-generation drugs for this indication, so I think what's happening is that those two competing drugs are not necessarily at the point where they're eating into each other's market share. They're more still continuing to win away business from warfarin.

Douglass: Which suits me just fine!

Campbell: Right! You're right, the drug with Pharmacyclics, "Imbruvica" or however you want to pronounce it ...

Douglass: It's a constant problem in health care! Potato/potahto.

Campbell: Yes! Again, like you said, analysts think that that could be a multi-billion dollar drug so it's good to see that that's gaining traction in delivering the goods.

I think those are three bright spots that investors can hang their hats on.

Douglass: All right, let's talk about the bad, then.

Of course, the headline there probably is going to be, "Oh gosh, Zytiga looks like it might have lost some market share." That's their prostate cancer drug. It competes directly with Medivation (MDVN) and Astellas Pharma's Xtandi -- which recently got a pre-chemo approval -- and its growth is slowing as a result.

Campbell: Yes. In the "bad" camp there are two things that I want to highlight. The first was that sales of their oncology drug Velcade fell about 16.9%, to $339 million.

Obviously, you hate to see any drug have their sales fall by double digits, but that's the nature of this business. New competitors are always coming in, patents are always expiring, and as a result you have a limited shelf life for drugs.

I think that, like you said the bigger focus, the headline on the "bad" front, would be the Zytiga numbers. We're not going to complain that sales grew 8.6% year over year.

Douglass: Right.

Campbell: But that is a massive deceleration. This is a drug that was growing double digits, double digits, double digits, quarter after quarter after quarter. This was the first real test of how it would hold up once Medivation and Astellas' Xtandi got the nod for use in the pre-chemotherapy indication.

In Johnson & Johnson's conference call, I just finished listening to it, they said that they lost about 1.2% market share in the quarter.

Douglass: So they're at 30% of the market.

Campbell: Yes. I think that shows you that the competition is heating up in that space. This is still going to be a massively successful drug. You're going to have enough room for both players, but it's going to have much less of an impact going forward than, say Xarelto, Invokana, and Imbruvica.

Douglass: Yes. This is probably one of the reasons, and I think it's underappreciated, why Johnson & Johnson has stayed in this conglomerate model with your slow-growing -- or sometimes slow-falling -- OTC and medical device segments.

Pharma is by nature a roller coaster, so having those steadier cash-throwing-off businesses is a good thing particularly if you are, like Johnson & Johnson, a dividend aristocrat. I think that highlights some of the importance there.

Finally, let's talk about the ugly.

Campbell: I think that the ugliest part of this is not just what you're going to see here in J&J, but what you're going to see across all of these multinationals. It's the impact of currency. Currency, currency, currency. This is going to be what people are focusing on as all of these big companies with large international exposure roll out their first quarter earnings.

I think it also shows you just how important it is for investors to do their due diligence and not just rely on the headline that's being reported.

You have to dig in, because you don't want to make an investment decision on a company that's a core holding like a J&J solely because you see, "The revenue on the top line started to slip," or "The bottom line earnings started to slip."

You need to also consider how they're doing operationally. If they're selling more of their product and they're generating more money that's a very different situation, losing those sales to currency exchange, than it is if they're selling less of those products and generating less money overall.

Douglass: Right.

Campbell: You look at what happened in the first quarter. I think the place to focus on is Europe. Europe counted for more than $4 billion in J&J's sales, so a pretty big chunk of the $17 billion.

Douglass: Yes. Call it a quarter or something like that.

Campbell: Yes. Once you factor in the effects of the stronger dollar, they reported essentially flat operational sales. The reported sales actually fell 17.3%, so you went from "Okay, everything is going steadily, we're OK," to "Wow, we just saw our sales fall 17% year over year in this market?" You have to dig in a little bit deeper here and see what's going on.

A similar situation played out in the Western Hemisphere. If you look outside of the U.S., they had a reported basis that the sales were down 3.3%, but that mass in operational sales growth of 9.9%. Huge swings!

In pharmaceuticals, across all of the drugs that J&J sells, on an operational basis sales were actually up 10%. But when you back out all of the currency exchange headwinds, it ends up growing just 3%, which is obviously very uninspiring.

Douglass: Right, and this is one of those things where a lot of investors are going to see the headline numbers and say, "Oh my gosh J&J, what's going on?"

This is one of those moments that I think really highlights the opportunity for long-term investors -- Fools even, one might say! -- to look at, "Okay, what about the underlying business?"

Okay, sure. Currency moves. That happens. This is what happens when you're a multinational, and frankly as you mentioned we always talk about being a multinational as kind of a good thing because that means that you're not just tied to one market.

If Europe's in a recession, you don't want to be a Europe-only business. If the U.S. is in a recession, you don't want to be a U.S.-only business.

It's nice to have some of those other opportunities, especially when you have some of these growing markets like China -- less so like Japan, although somewhat in health care spending -- but like the BRIC countries where you really have that opportunity with growing middle classes and with just so much economic expansion, to make a lot of money for shareholders.

This is the cost of doing that business. For what it's worth, I think it's always important to take that long-term view on it.

Todd, here's my question. Final thoughts on J&J; you've dug into the earnings call and we've both looked through the numbers. What do you think about the stock today?

Campbell: If you're a long-term investor you have to look at J&J and say, "This is going to be a company I am just going to sock away for 20-30 years."

If your time horizon is much shorter than that, you're going to have to recognize that over the course of the next couple quarters, these currency headwinds are going to take a little while to shake out. Until then, it's going to be rocky. It's going to be a rocky sea for the shares.

But again, if you're a long-term investor, go ahead and feel comfortable. This is obviously a big conglomerate. They've got their hands in all aspects of health care, pretty much, and this is going to be one that you want to stick with.

Douglass: Yes, I'm definitely long-term bullish on J&J, if for no other reason than because it's got that emerging market exposure, it's got other markets outside the U.S. exposure, it's huge, and because it operates in those very different segments of health care -- med devices, OTC and consumer-facing, and then finally pharma for the growth.

It's a holding in my portfolio. Todd, I think it's a holding in yours, isn't it?

Campbell: I'm actually not in it, currently.

Douglass: Oh OK, you're not in it? Fair enough!

Campbell: But if we get to a point where these currency headwinds cause people to sell down, it's definitely on the top of my list.

Douglass: Got you! Cool, good to hear. I think that's solid commentary. Again, obviously I'm a J&J bull because I own it, but I think it definitely does highlight a lot we'll be wanting to watch in health care, today and for the rest of this quarter.

Then, also, the fact that a lot of folks can be very myopic about this, and about other companies. They're going to look at it for the short term, ignoring what the 3, and 4, and 5, and 10, and 20-year opportunities look like with some of these companies.

As well, keep in mind -- Todd and I both disclosed about J&J -- but folks who are on the show may have positions in stocks that are mentioned on the show, and The Motley Fool may have positions or recommendations, active or not, on stocks that are mentioned in the show.

As always, it's always important to do your own research and think things through. If you ever want to have more dialogue, just shoot us an email at [email protected].

Todd, thank you as always. For The Motley Fool, I'm Michael Douglass, and Fool on!