I recently wrote a mini-series on Johnson & Johnson (NYSE:JNJ), where I focused on each of its three segments: pharmaceuticals, consumer goods, and medical devices. Now seems like an opportune moment to check out the strengths of J&J as a group, with this article being the first of four that, in turn, will highlight the strengths, weaknesses, opportunities, and threats it is facing.
The pharma segment is a major strength
J&J's biggest strength appears to be its pharma segment. That's because it is currently the most profitable segment by far, with it accounting for 56% of the company's total pre-tax profit in 2013. However, where the pharma segment really provides opportunity for J&J is in its potential to deliver improved profits in future, with a number of drugs in the pharma segment's pipeline having the potential to deliver both top- and bottom-line improvements.
For instance, Imbruvica (a treatment for leukemia that was approved in November 2013) and Invokana (a type 2 diabetes treatment approved just over a year ago) have a combined peak sales estimate of $7 billion -- or possibly more. The great thing about both of these drugs, though, is that they are approved and so, while peak sales numbers are estimates, they could impact the income statement over the short to medium term. In addition, This could be great news for J&J and is a major strength of the business.
As for the present, J&J's pharma segment performed well in the first quarter of 2014. It grew sales by 10.8% when compared to the first quarter of 2013 despite a negative currency impact of 1.4%, with international sales showing particular strength. They grew by 14% and highlight the potential for J&J outside of the US. On the topic of potential, J&J's drug pipeline is strong and it includes multiple late-stage candidates, with the aforementioned Imbruvica currently in Phase 3 trials for further treatments, and other oncology drugs such as Velcade and Yondelis also being in late-stage trials for further applications.
Diversity should not be overlooked
However, J&J isn't all about pharmaceuticals. In fact, it accounts for less than 40% of the group's total revenue and highlights another strength: its diversity. Certainly, the pharma segment offers super-high margins (pre-tax margins were 32.6% in 2013) but it is complemented by the consumer and medical devices segments. Although less profitable than the pharma segment, they provide J&J with increased stability due to lower sales volatility and this helps to smooth out the "boom and bust" nature of pharmaceuticals. For instance, J&J's top-line increased by 3.5% in the first quarter of 2014 when compared to the first quarter of 2013, with the bottom-line increasing by an impressive 6.9% over the same time period. Indeed, increased stability and diversification could be seen as even greater strengths further down the line should generic competition become a bigger factor for J&J's pharma segment.
What about its rivals?
On the topic of generic competition, some of J&J's rivals have been hit hard in recent years. For instance, sector peer Merck (NYSE:MRK) is more focused on pharmaceuticals than J&J (they make up 85% of the company's revenue) and its sales fell by 7.8% in 2013, as sales of respiratory drug Singulair were hit hard by a loss of patent protection and subsequent generic competition. While J&J is not immune from this eventuality, it is far more diversified than Merck and, although a similar event would still hurt J&J, it may not have as great an impact as at Merck.
Of course, Merck, like J&J, has potential in its pipeline, with MK-3475 having a peak sales estimate of $3 billion by 2020. Approval for the drug is not certain, but it could be a catalyst for Merck's top and bottom lines over the medium to long term.
It is a similar picture in terms of generic competition at Pfizer (NYSE:PFE), where the pharma segment accounted for 93% of sales in 2013. The key reason for this was a loss of exclusivity on cholesterol-lowering medication, Lipitor, in developed Europe and Australia as well as further patent losses on other products. Although such events would impact any company, Pfizer's reliance on pharmaceuticals and lack of diversity meant that there was no great "stabilizer" to help counter the effects of loss of exclusivity. However, Pfizer continues to offer strength in its pipeline, with breast cancer treatment palbociclib having peak sales estimates of over $5 billion. Unlike J&J, though, Pfizer's business looks set to be a lot more boom and bust in the future due in large part to its lack of diversity.
Is J&J's valuation a weakness?
The S&P 500 itself trades on a P/E of 17.6 (trailing 12 months), which is relatively high by historical standards, while J&J's P/E of 20.2 is even higher and makes shares in the company look overvalued relative to the wider index.
However, when growth forecasts for the next year are taken into account, J&J's P/E no longer appears unattractive. That's because it falls to 15.4 when looking a year out, which is the same as the S&P 500's forward P/E. So, while the trailing P/E is high relative to the wider market, J&J's valuation in terms of a forward P/E is in line with the market.
Furthermore, when J&J's strengths are taken into account, namely the huge potential and high profitability of the pharma segment, as well as the diversity and stability provided by the consumer and medical devices segments, J&J appears to be a good value when compared to the wider market.
Far from being a weakness, J&J's valuation could, I believe, be its hidden (and third) strength. In other words, paying the same price as that of the wider market for a company as high quality as J&J could be the strongest reason, in my view, why the stock could be a top future performer.
Peter Stephens has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.