Johnson & Johnson Earnings: Can Pharma Keep Stoking Growth?

On Tuesday, Johnson & Johnson (JNJ 0.82%) will release its quarterly report, and shareholders have been pleased with the stock's ascent to all-time record levels recently. Despite Johnson & Johnson having a wide array of health-care-related businesses spanning medical devices and consumer over-the-counter products, the company has emphasized the growth potential of its pharmaceutical unit. By doing so, Johnson & Johnson seeks to tap into the same trends that have helped peers Pfizer (PFE 1.00%) and Merck (MRK 0.92%) start reversing the effects of their patent cliffs and bolster their future prospects.

Johnson & Johnson has a global reputation in the health-care space, with well-known products like its Band-Aid and Tylenol brands in millions of household medicine cabinets. Yet the pharmaceutical space has seemed to have the most promise for J&J lately, with a number of high-potential drugs in its pipeline that could help boost revenue for years to come. Let's take an early look at what's been happening with Johnson & Johnson over the past quarter and what we're likely to see in its report.

Source: Johnson & Johnson.

Stats on Johnson & Johnson

Source: Yahoo! Finance.

Can Johnson & Johnson earnings surpass expectations again?
In recent months, investors have boosted their views on Johnson & Johnson earnings, raising estimates for the second quarter by 2% and full-year projections for this year and next by about 1%. The stock has kept up its climb, gaining almost 9% since early April.

Johnson & Johnson's first-quarter earnings report continued the company's recent trend of getting growth primarily from its pharmaceutical division. Pharma sales jumped 11%, compared to relatively flat performance in the medical-device area and a slight decline of 3% in consumer-products sales. In particular, the performances of arthritis and psoriasis treatment Stelara and prostate-cancer drug Zytiga were extremely strong, with sales gains of 32% and 49% respectively compared to year-ago levels. High margins on prescription drugs helped send net income up almost 8%.

Yet one thing that Johnson & Johnson can count on in the pharma arena is competition. J&J's Invokana treatment for diabetes has enjoyed early success, and given the size of the diabetes market, it could easily become a blockbuster in time. Yet Merck and Pfizer have worked to develop their own version of a treatment that inhibits the SGLT2 protein, with ertugliflozin in phase 3 trials. Other companies are working at other diabetes treatments that could potentially endanger Johnson & Johnson's position in the space.

Johnson & Johnson hasn't given up on hopes for growth in other areas, though. In May, the company said that it still sees medical devices as a growth industry, especially in emerging markets around the world. Yet rather than simply expanding for expansion's sake, Johnson & Johnson expects to make targeted forays into areas where it can get the best results, with its current emphasis on surgical instruments and orthopedics likely to continue, combined with some tactical plays in other high-value areas like diabetes insulin-management equipment. In contrast to Merck and Pfizer, though, it seems unlikely that J&J will join the recent string of massive buyout offers just to make its business bigger.

One thing investors need to focus on with Johnson & Johnson is its valuation. J&J has a reputation as being a defensive stock, appropriate for those looking to reduce risk in a choppy market. Yet the stock's record run has pushed its trailing earnings multiple above 20, and even its 2.7% dividend yield won't necessarily provide the same level of downside protection that the health-care stalwart has in past markets when its valuation wasn't quite as high.

In the Johnson & Johnson earnings report, watch to see how much of the company's growth again relies on pharmaceuticals. At some point, if the other businesses can't catch up, then Johnson & Johnson will likely see pressure to restructure itself and possibly spin off underperforming businesses into separate companies. With the share price so high, J&J doesn't have much margin for error in its report.

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