The Non-Consensus

View Original

Johnson and Johnson: Pharma Segment Key to JNJ Performance in 2017

A former Wall Street analyst discloses the topics that equity analysts and hedge fund managers are currently talking about. 

Johnson and Johnson stumbled a bit in the second half of 2016. The stock declined slightly 11% from July to late January as investors began to focus in on the Pharmaceutical segment and its growth trajectory. The segment, which represents 47% of sales, has driven much of JNJ's top-line growth over the last four years with over 10% organic growth each year. However, growth in this segment began to slow noticeably to 2% in 4Q16. Additionally, management gave segment guidance that implied growth of just 2-3% in 2017. In turn, street estimates were lowered. 

What has been driving the growth moderation and the investor concerns? In late 2016, Pfizer announced a new biosimilar, Inflectra, which would compete with JNJ's top-selling drug, Remicade, and announced that it would be sold at a 15% discount. Additionally, with increased political scrutiny and what looked like a guaranteed win for Hillary Clinton (who had a history of criticizing pharma companies), drug pricing looked to be under attack as well. Growth concerns grew and the stock declined.

 

 

On top of these concerns, Johnson and Johnson also announced the acquisition of Swiss drugmaker Actelion for $30B on January 26, receiving lukewarm responses from investors. Investors were primarily concerned about the valuation (which had elevated sales and EBITDA multiples, hurting expected returns for the acquisition) as well as the complexity of the deal (the acquisition involves a spinout of the R&D division, which JNJ would hold a minority stake in).

 

Prospects Brightening in 2017 as Growth Concerns Appear Overblown

Since the Actelion announcement, the stock is now up 13% versus the S&P 500's 3% return.

Why are investors suddenly much more bullish? Well, we know what happened with Hillary Clinton.

And more importantly, growth concerns around the Pharmaceuticals segment appear to be overblown. Johnson and Johnson's head of Pharma, Joaquin Duato, has been communicating management's sources of bullishness to investors. And investors appear to be increasingly convinced.

The message to investors: The non-Remicade drugs are still performing well. Xarelto and the Immunology drugs Simponi and Stelra have been growing strongly, and show signs that this could accelerate even further. And new upcoming drugs are showing promising results as well. Specifically, Imbruvica and Darzalex are showing accelerating growth and now make up 3% of sales. The acquisition of Actelion is also expected to drive synergies and add to growth within the Pharma segment. Furthermore, beyond 2017, Duato believes that growth could reaccelerate as their newer drugs (mentioned previously) mature and other drugs in the pipeline progress (management has a goal of 10 new drug filings by 2019). 

Recent data points further support the idea that the Pharmaceuticals segment can withstand the threat from competition. Recent scrip data (real-time data on prescription trends from industry data provider QuintilesIMS) for January suggests that JNJ's Pharmaceuticals segment is performing better than the Street's estimates. And JNJ management noted on their 4Q conference call in late January that they had not yet seen any Remicade impact from Inflectra. As a result, growth concerns were quickly reduced and JNJ stock appears to be back on track.

 

Concerns Remain

But the segment is still not out of the woods. It is still early days for the Remicade competition, and JNJ could see an impact in the coming quarters. And if results slip at any point during the year, bears will pounce now that expectations have been recalibrated upwards. Until then, keep your eyes on the Pharma segment as the stock's future will depend on its ability to grow above the segment's low-single digit outlook.