It's been a few weeks since healthcare conglomerate Johnson & Johnson (NYSE:JNJ) reported its third-quarter earnings results, handily surpassing Wall Street's profit estimates once again, and investors have now had a little time to digest what Johnson & Johnson's management had to say.
For the quarter, Johnson & Johnson recorded $17.1 billion in sales, a 7% decline from the prior-year quarter, and delivered $1.49 in EPS, a nearly 8% decline from Q3 2014. Although J&J's sales fell short of Street forecasts, the company's quarterly profit topped projections by $0.05 per share. Following its better-than-expected results, Johnson & Johnson also upped the lower end of its full-year adjusted EPS guidance to a fresh range of $6.15-$6.20.
Five things Johnson & Johnson wants you to know
But as long-term investors know, you can't judge the health of any company's business by its performance in a single quarter. In order to get a broader picture you need to be willing to dig beyond a few paragraphs in a quarterly press release and listen closely to what its management team has to say about its near- and long-term outlook.
With that being said, here are five things Johnson & Johnson's management wants you to know.
Don't let our headline numbers fool you: we're growing
"Excluding the net impact of acquisitions and divestitures and hepatitis C sales, underlying operational growth was 5.6% worldwide, 7.7% in the U.S. and 3.8% outside the U.S." -- Louise Mehrotra, VP of Investor Relations
One of the key points that J&J's management honed in on during its conference call with Wall Street was that the company, on an apples-to-apples basis, is actually growing.
It's not uncommon for a U.S. multinational like J&J, which is comprised of around 250 subsidiaries, to be hit by foreign currency translation or divestments. In the most recent quarter a 90% global decline in sales of Olysio/Incivo, the company's hepatitis C therapy, single-handedly pushed the company's sales lower. Of course, this sales decline was no shock for J&J's management team, which had been warning that next-generation therapies would push Olysio to the wayside in 2015. If we exclude the negative effect of Olysio and look at operating businesses that J&J still has, the company actually delivered nearly 8% growth in the U.S. and close to 6% worldwide in the third quarter.
Translation: J&J's operating model is as healthy as ever.
"Strong momentum in market share increases drove results for INVOKANA/INVOKAMET. In the U.S., INVOKANA/INVOKAMET achieved 6.3% total prescription share or TRx within the defined market of type 2 diabetes excluding insulin and metformin, up from 6% in the second quarter of 2015." -- Louise Mehrotra
Another interesting nugget unleashed during J&J's conference call was that Invokana, the leading SGLT-2 inhibitor in the United States for the treatment of type 2 diabetics, actually gained prescription share (exclusive of insulin and metformin) in the third quarter.
Why is this notable? During the third quarter Eli Lilly and partner Boehringer Ingelheim released data from their long-term cardiovascular outcomes study on SGLT-2 inhibitor Jardiance. The study, known as EMPA-REG OUTCOME, demonstrated that Jardiance was superior to the current standard of care in lowering the risk of a cardiovascular event or death in patients who are at a high risk of having a CV event. There was obvious concern on the part of J&J investors that Eli Lilly's and Boehringer Ingelheim's Jardiance would devour some of Invokana's market share; however, that didn't happen.
In fact, Dominic Caruso, CFO of J&J, commented when fielding questions from analysts that he believes the positive benefits observed from the EMPA-REG OUTCOME trial will be a "class effect for SGLT2." Take notice that J&J's long-term CV outcomes study for Invokana should be released in 2017.
Our medical device growth strategy, laid out
"Going forward, we are shifting more of our focus and resources to deliver new innovative products and target faster-growing categories within the market such as elective foot and ankle... We also continue to strengthen the trauma franchise capabilities in high-growth markets such as the U.S. and China... Through portfolio discipline, we will continue to exit categories that do not fit our strategy and evaluate our portfolio to identify those growth categories for heavier R&D investment, external partnerships and L&A. " -- Gary Pruden, Chairman of Global Surgery Group
Despite the company's status as a global medical device giant, Wall Street and investors have been largely disappointed with the lack of growth from this operating segment. Whether you blame cautious spending as a result of the Obamacare rollout in the U.S., increasing global competition putting pressure on device prices, or weakness in European markets, it doesn't matter. All investors want to know is how J&J planned to fix its lack of growth. Thankfully, we got some answers during the conference call.
Based on Pruden's responses, it's clear that acquisitions and/or divestments are still on the table. Even after jettisoning Cordis and Ortho-Clinical Diagnostics, it's still possible that J&J moves to sell slower-growth or highly competitive businesses that don't align with its growth strategy. We also learned that trauma, as well as elective foot and ankle procedures, are going to be J&J's primary focus moving forward. Markets and Markets has estimated that the foot and ankle device market could grow at a compound annual rate of 7.2% between 2015 and 2020, ultimately generating $5.4 billion in sales by 2020, so you can certainly understand why J&J sees this indication as a strong growth opportunity.
R&D is important, but we're still looking for the right acquisition(s)
"Our investment in research and development as a percent of sales was 12.6% in the quarter and 160 basis points higher than the prior year as we continue to make important investments in our pipeline for future growth... At the end of the quarter, we had approximately $17 billion of net cash, which consists of approximately $37 billion of cash and marketable securities and approximately $20 billion of debt. This is a higher level of cash than we typically hold and we are actively looking for the right opportunities to use that capital to create greater value for our shareholders." -- Dominic Caruso, CFO
Caruso's commentary regarding Johnson & Johnson's spending going forward is a bit tricky on the surface, but it ultimately makes a lot of sense.
On one hand, Caruso is quick to point out that research and development expenses as a percentage of sales grew from 11% to 12.6% from the prior-year quarter. This would imply that J&J is freely spending more capital on its pipeline, which bodes well for the long-term. It also aligns with the company's efforts to file for approval of up to 10 novel blockbusters before the end of the decade. Of course, the downside of this spending is that it could weigh on margins in the coming quarters.
However, Caruso also suggests that J&J is still very much on the hunt for an earnings-accretive deal, but just hasn't found what it's looking for as of yet. Investors would much prefer to see organic growth, but a balanced growth approach that involves R&D investment and acquisitions should help J&J grow its top- and bottom-lines over the long run.
We're not worried about prescription drug reform
"There's been a lot of rhetoric about pharmaceutical drug pricing. And despite significant media attention on drug pricing, there really isn't a consensus on policy solutions that would lower prices without negatively impacting innovation." -- Dominic Caruso
Finally, J&J tried its best to calm concerns that Wall Street and investors may have over calls for prescription drug reform. There are plenty of therapies within Johnson & Johnson's pipeline that carry hefty price tags and could draw the ire of lawmakers. These include relatively new blood cancer drug Imbruvica, which has an annual wholesale cost ranging between $98,000 and $132,000 annually, depending on the indication, and Zytiga, a mature advanced prostate cancer drug that has a wholesale cost in excess of $60,000 annually.
Caruso's commentary suggests that J&J doesn't anticipate drug price reform getting off the ground on a broader level. He also points out the primary argument against capping drug prices, which is that it could discourage innovation and send jobs to overseas markets where labor and research costs are lower.
Johnson & Johnson: still a buy?
Now that we have a better idea of how healthy J&J's business model truly is, we can ask the $64,000 question: is Johnson & Johnson still a buy?
Although its 31-year adjusted EPS growth streak will likely end in 2015 (mostly due to a one-time sales pop from Olysio in 2014), there still appear to be plenty of reasons to own Johnson & Johnson. Pharmaceutical growth is still strong, medical devices demonstrated better growth than in recent quarters in Q3 (and the company now has a plan to spur growth in the segment), and consumer health continues to chug along at its usual steady pace. For their patience, shareholders are being rewarded with a 3% yield, a 53-year dividend growth streak, and a recently announced $10 billion share repurchase program. All in all, I'd call J&J a pretty safe long-term investment.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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