Last month healthcare giant Johnson & Johnson (NYSE:JNJ) reported its second-quarter earnings results, which, for the most part, exceeded Wall Street's expectations.
As a quick refresher, Johnson & Johnson delivered $17.79 billion in revenue, down 8.8% from the year-ago quarter, with adjusted EPS of $1.71, a 3.9% decrease from the prior-year period. Comparatively speaking, Wall Street had been looking for J&J to deliver just $1.69 in EPS. Johnson and Johnson also slightly increased its full-year EPS forecast to a range of $6.10-$6.20 from its prior-quarter projection of $6.04-$6.19.
However, these top- and bottom-line numbers don't tell you much about how Johnson & Johnson arrived at its quarter-end results. To get a better understanding of what's really going on at J&J, and to get a better feel for the health of the business, we need to take a closer look at management's commentary for the quarter.
With that in mind, here are five things that Johnson & Johnson's management wants investors to know.
We're still growing whether you realize it or not
"[E]xcluding the net impact of currency translation, our operational earnings per share was $1.90 or up 6.7%." -- Dominic Caruso, VP of Finance
One key point to Johnson & Johnson's quarterly results that was easy to overlook if you didn't dig below the surface is that it actually grew.
Although J&J's revenue declined 8.8%, it was dealt a 7.9% reduction solely because of negative currency translation. J&J reports in dollars, and since the U.S. dollar has been strong against most global currencies J&J has been losing a percentage when translating back into dollars. It was also affected by business divestments which don't allow for apples-to-apples comparisons to the previous year.
When currency fluctuations are removed, and one-time benefits and costs are excluded, J&J actually grew its adjusted EPS by close to 7% and its global sales by a modest 1.7%. This isn't mind-numbing growth by any means, but it goes to show that J&J's business model is still healthy and working.
We realize Remicade is a concern, but we're in good shape
"[M]ore than 2.2 million people have been treated with REMICADE and about 70% of the current patients are receiving sustained and effective treatment, so we believe their doctors are very unlikely to switch them off with that level of success. And we also have a patent for the REMICADE antibody that doesn't expire until September 2018 that you can be sure we'll continue to vigorously defend."
-- Alex Gorsky, CEO
Johnson & Johnson's pharmaceutical segment is its primary growth and margin driver, but it's not immune to the adverse effects of patent expirations.
Johnson & Johnson's top-selling pharmaceutical product is arthritis drug Remicade, which brought in $1.67 billion during the second quarter and $3.27 billion through the first-half of 2015. J&J is facing a highly competitive anti-inflammatory market and expected patent losses by 2018. In other words, there's fear that J&J could be looking at billions in lost revenue once biosimilars of Remicade hit the market.
However, J&J wants investors to realize that biosimilars are an entirely different boat than generics. They'll be discounted from the innovator drug price, but their discount is nowhere near what consumers would see with a generic. Given that and Remicade's established physician and customer base, J&J believes it can extend Remicade's revenue stream for years to come.
Our medical device segment isn't gaining any traction, but it could soon
"[T]he ongoing consolidation among health systems and within the insurance industry is continuing to create pressure on pricing. We've been encouraged though by data showing that healthcare utilization trends in the U.S. have continued to improve for the fourth consecutive quarter with growth in both hospital admissions and hospital surgical procedures."
One segment that's been a regular disappointment for J&J and investors in recent quarters has been medical devices. The purchase of Synthes for nearly $20 billion, announced in 2011, was designed to bolster J&J's orthopedic business, while introducing the company to rapidly growing emerging markets. Unfortunately, the deal hasn't paid the dividends that investors had been expecting -- at least not yet.
As CEO Alex Gorsky describes above, two factors have been holding back its medical device and diagnostic segment. The implementation of the Affordable Care Act had, for many quarters, caused hospitals and consumers to hold back on elective procedures and large equipment purchases. The good news is that healthcare utilization rates appear to be rising, which could signal an end to hospitals and consumers being afraid of ACA-related pricing uncertainty.
The more interesting headwind noted by Gorsky is the consolidation in the insurance sector. As insurers combine forces, it's possible they'll be able to exert more pricing pressure on pharmaceutical and device makers like J&J. It doesn't appear that J&J has any answers for this possible headwind as of yet, but it remains to be seen if industry-wide consolidation will truly be a negative for J&J.
We remain on the hunt for an earnings-accretive deal
"We have a good balance of internal and externally sourced innovations. And acquisitions have accounted for just under half of sales growth over the last decade. And we're always actively looking for new value-creating acquisitions and deals to continue that success."
One of the more intriguing developments from J&J's conference call was Gorsky's commentary on future deal-making.
Gorsky noted that acquisitions have accounted for about half of J&J's growth over the last decade. Remember, a good chunk of its revenue comes from the slow growing consumer health segment, while medical device growth has also been weaker than expected. Acquisitions are thus a critical component to J&J's three-decade-plus streak of adjusted EPS growth -- and, with more than $15 billion in cash on hand, who can blame J&J for wanting to shop around?
It's not clear what businesses might be on J&J's radar, but management has made it apparent that it wants to focus on complementary products or services to existing areas of focus. With pharmaceuticals being its major growth driver, my belief is this would be the most logical segment where J&J could look to make a purchase.
By the way, our internal pipeline is enormous
"[Y]ou can see the impact reflected in our portfolio and robust development pipeline, which includes 25 active late-stage development programs, 160-plus early stage programs and over 70 venture investments."
-- Alex Gorsky
Lastly, J&J's management also wants its investors to understand that while it's actively looking for acquisition opportunities, they aren't entirely necessary.
Per Gorsky, J&J's pipeline has a mammoth supply of early stage drug hopefuls, and more importantly more than two dozen late-stage therapies that could make an impact within the next couple of years. If you recall, J&J has plans to file for approval of 10 new blockbuster drugs by the end of the decade after witnessing seven of its 14 new molecular entities since 2009 become blockbusters.
The first of those possible 10 blockbusters is daratumumab, a drug designed to treat late-stage multiple myeloma. With a surprisingly high overall response rate of 29% in patients that had taken and progressed on an average of five prior therapies, it looks as if it could have a good shot at approval by the Food and Drug Administration.
What's next for J&J?
The real question that needs to be asked here is "what's next for J&J?"
I'm looking for more of what we've come to expect: solid execution, a growing dividend, and perhaps slower pharmaceutical growth as some of its drugs mature, but nonetheless substantial gross margins. This isn't to say that Johnson & Johnson won't face ongoing concerns, such as increased medical device competition, or perhaps a slow bleed in Remicade sales leading up to 2018. However, it would appear that J&J's segment diversity and size will continue to give investors practically unrivaled peace of mind within the healthcare sector.
Long story short, I see no reason why Johnson & Johnson's stock can't head even higher over the long run.
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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