On Tuesday, health care conglomerate Johnson & Johnson (NYSE:JNJ) reported its fourth-quarter and full-year earnings results. To put it mildly, Wall Street and investors weren't thrilled with the outcome, and its shares fell $2.75, or 2.6%. I know that may not sound like much, but when you're talking about one of the market's stalwart stocks, and also one of its least volatile, a move of this magnitude is likely to gain some attention.
The numbers on the surface looked like this: 2014 fourth-quarter sales of $18.3 billion, down 0.6% from the year-ago quarter, with EPS of 0.89. Considering that Johnson & Johnson netted $1.23 in EPS during last year's Q4 it's not hard to see immediately why the Street was so disappointed.
But if you dig beyond the headlines and into the nitty-gritty of Johnson & Johnson's business model, you'll discover that yesterday's sellers are dumping shares of J&J for all the wrong reasons.
"Sales were down year-over-year"
Inclusive of all charges and costs, Johnson & Johnson's Q4 sales did indeed dip 0.6%. But looking beyond the surface, you'll discover the two primary reasons why J&J's sales actually dipped.
First, Johnson & Johnson took a big hit because of currency translation. Put in simple terms, when J&J operates in countries outside the U.S. it needs to translate its foreign revenue received back into dollars. As the dollar has strengthened to multi-year highs against most currencies over the past few months, it's meant that J&J's translation from foreign currency to U.S. dollars has resulted in less revenue. The end result is J&J's revenue suffers, even though its underlying business is perfectly healthy. Its overall sales actually increased 3.9% year-over-year sans currency effects. Although J&J can't control what happens with currency overseas, investors should know better than to penalize J&J for something beyond its control and with no bearing on the actual health of its business.
Yet it's more than just a currency faux pas. J&J has been a busy bee on the acquisition and divestment front, acquiring Alios BioPharma and divesting its Ortho-Clinical Diagnostics business in June. These purchases and sales can create "holes" in J&J's results that aren't actually there. For instance, once Ortho-Clinical was sold J&J could no longer count on its revenue to boost its medical device and diagnostic segment. Does this mean J&J's 1.6% operational decline in its medical device unit for the year is representative of a weak medical device environment? Not quite. If you remove the one-time effects of acquisitions and (in this case) divestitures and compare the apples to the other apples, J&J's medical device segment actually grew by 1.6% globally in 2014.
"Competition is eating away at J&J"
With Johnson & Johnson's pharmaceutical segment packing nearly all of its growth and margin punch in recent years, there's been concern among investors that competition against prostate cancer drug Zytiga and hepatitis C therapy Olysio could dampen J&J's pharma sales. What we saw in Q4 was exactly that, as J&J's pharmaceutical sales growth "slowed" to 13.9% in Q4. It was hit especially hard by the sales drop in Olysio, which dropped to $321 million from $796 million in the sequential third quarter.
But guess what -- this isn't a surprise! Johnson & Johnson has been warning investors for months that the emergence of Gilead Sciences' Sovaldi and Harvoni, as well as AbbVie's Viekira Pak, would result in a substantial drop in Olysio sales. Look beyond Olysio, which is what CEO Alex Gorksy has been trying to get investors to do for months, and you'll see plenty of strong growth prospects.
For instance, Simponi and Stelara delivered currency-adjusted global sales growth of 42% and 34%, respectively. More importantly, Zytiga grew despite strong clinical results by competing drug Xtandi from Medivation and Astellas Pharma in metastatic castration-resistant prostate cancer. Xtandi has moved into direct competition with Zytiga for pre-chemo and post-chemo treatment of mCRPC, and still Zytiga sales grew by a currency-adjusted 26% year-over-year. Xarelto was another solid performer, with sales rising by 58% to $428 million for the quarter.
Although no specific figures were mentioned, investors should also note that "Other Oncology" segment revenue more than doubled to $199 million from $94 million in the year-ago period. This segment is where its collaboration revenue with potential blood cancer blockbuster Imbruvica lies.
Now, did someone say something about competition eating away J&J's sales?
"Johnson & Johnson's 2015 EPS forecast didn't impress"
Looking ahead, Johnson & Johnson issued full-year EPS guidance of $6.12 to $6.27 for fiscal 2015. By comparison, Wall Street had been expecting $6.14 in EPS for fiscal 2015, so J&J didn't exactly impress analysts or investors.
While that may be the case, Johnson and Johnson is notorious for underpromising and overdelivering. Over the past 12 quarters J&J has topped Wall Street's adjusted EPS figures how many times? That's right, 12! The majority of the time J&J absolutely crushed expectations by between $0.04 per share and $0.11 per share. In Q4 J&J "only" beat by $0.02, so are we really going to punish the company for only modestly embarrassing analysts once again?
Additionally, the midpoint of Johnson & Johnson's earnings guidance calls for roughly $6.20 in EPS, or a 9% increase from fiscal 2014, despite challenging sales expectations, tied primarily to a strengthening U.S. dollar. You go find me a handful of $284 billion conglomerates growing their bottom line at 9% per year with major currency headwinds. My inclination is you'll find very, very few!
Here's how I see it
When I look at Johnson & Johnson I see three distinct businesses performing at or well above par.
Its consumer products business delivered 1% currency-adjusted growth, with its over-the-counter products like Tylenol and Motrin carrying the bulk of the weight. This is never going to be a high-growth segment for J&J. But what it does provide is a foundation for strong pricing power and predictable cash flow that's helped J&J to 52 straight annual dividend increases and a three-plus decade streak of increasing year-over-year adjusted EPS.
J&J's medical device segment grew by an aforementioned 1.6% when adjusted for negative currency effects and should continue to benefit from its push into emerging markets. I suspect J&J's medical device segment will really reap some nice benefits when questions and concerns surrounding Obamacare begin to die down in a year or two. Uncertainties surrounding the new law have tightened insurer and hospital budgets, but once we have better clarity on how Obamacare will affect these businesses, we should see a steady and long-term increase in medical device and diagnostic sales.
Lastly, J&J's pharmaceutical segment is on fire. Even with Olysio's sales shrinking (as expected), J&J's oncology and neuroscience products are only strengthening. This is the bread and butter segment for J&J, and once Imbruvica sales really kick into high gear J&J shareholders could see EPS gallop higher.
Long story short, I personally feel sorry for those who let their J&J shares go for $100 or $101 yesterday. This is a fantastic company with a long-term oriented CEO leading the charge, and I suspect it has a pretty good chance of heading even higher.