Johnson & Johnson (NYSE:JNJ) is a healthcare giant that sells over-the-counter products, pharmaceuticals, and medical devices. Its diversification makes it a core holding for many investors, including income investors who love its long track record of dividend increases. Recently, the company reported financial results for 2017 that caused its share price to slip. Is Johnson & Johnson becoming a risky stock to buy?
What's the news?
Johnson & Johnson overdelivered on both revenue and adjusted earnings in the fourth quarter. Its sales were $20.2 billion, which was slightly ahead of $20.1 billion estimates, and its adjusted earnings per share were $1.74, which beat industry watchers' outlook by $0.02.
On an operational basis, consumer goods revenue in the quarter was essentially flat, medical device sales grew 6.5%, and pharmaceuticals sales grew 15.5% from last year. The pharmaceuticals growth was due in large part to growing demand for Darzalex, a multiple myeloma drug, Zytiga, a prostate cancer drug, and Imbruvica, a chronic lymphocytic leukemia drug.
On the surface, the quarterly results were solid; however, there are some reasons for caution when you dig deeper.
For example, while the $20.2 billion in total revenue last quarter represents an 11.5% year-over-year increase, that growth was mostly due to Johnson & Johnson's acquisition of Actelion last June. If you remove Actelion's sales from the quarter and the positive impact of currency conversion, then revenue only increased 4.2% year over year. Johnson & Johnson's 2.4% adjusted revenue growth for the full year was even less exciting.
With Johnson & Johnson's top line only improving at a low single-digit rate, it becomes even more important to consider the risks that are facing some of its best selling drugs, including Remicade, Zytiga, and Invokana.
Remicade's the company's best-selling drug, but it's already lost its patent protection, so its sales are slipping. Granted, sales didn't drop as much as they might've in 2017, but they still declined 10.5% year over year in Q4, and since Remicade still generates $1.5 billion in quarterly sales and competition is mounting, there's reason to worry that sales will fall more in 2018.
Zytiga's sales could also face headwinds later this year. Previously, Zytiga was insulated against generic competition through 2027; however, a key method of administration patent was invalidated last year. If Johnson & Johnson's appeal of that decision fails, then it would put $755 million in quarterly sales in jeopardy as early as the end of 2018.
Invokana, a diabetes drug, could also see sales fall. Mounting competition from drugs that work similarly to it, including Jardiance, caused Invokana's sales to drop 29% to $267 million in Q4. The FDA approved yet another Invokana competitor in December, so Invokana's sales could fall even further in 2018.
Is the dividend safe?
If you're worried that sale headwinds could take a toll on the company's dividend, rest assured, management's committed to returning money to investors via dividends, and thanks to tax reform, it has more flexibility to do so.
Because corporate tax rates are falling to 21% from 35% in the U.S., management thinks its effective tax rate will decline to between 16.5% and 18% in 2018. The guidance isn't much lower than the 17.2% rate in 2017, but it's significantly lower than the rate Johnson & Johnson has typically been paying. For example, its tax rate was about 20% in 2015 and 2016.
Tax reform also frees up more cash overseas that can be used by Johnson & Johnson to support its dividend. The company plans to repatriate about $12 billion from overseas accounts this year, and that should improve its cash flow because it will reduce the need for it to take on debt to finance U.S. operations.
Between Johnson & Johnson's lower corporate tax rate and savings associated with repatriation, management should have plenty of wiggle room for its dividend payments.
The big question is: How will Johnson & Johnson spark organic top-line growth again? One way it could is through acquiring companies with late-stage drugs in development. A better way, however, would be gaining approval of new drugs that are developed internally. The company's past acquisitions and a recent increase in its R&D spending suggest both of these options remain on the table.
In the short term, however, Johnson & Johnson may struggle to offset any worsening in demand for Remicade, Zytiga (if it loses its patent appeal), and Invokana. Given Johnson & Johnson's shares were recently trading near 52-week highs and its forward P/E ratio is nearly at a 10-year high, there's reason to think 2018 might not reward investors as nicely as 2017.