Led by Drug Sales, J&J Posts Solid Third Quarter
New drug launches are helping offset tepid consumer and device growth, but competition will likely weigh on the health-care giant next year.
Commentary
Led by strength in the drug unit, Johnson & Johnson (JNJ) posted solid third-quarter results, slightly exceeding our expectations and those of consensus. While both the device and consumer segments continue to generate tepid growth, new drug launches are buoying overall results, leading to 6% overall top-line growth and a faster 10% earnings growth rate as the drug division carries stronger margins.
However, we don't expect any changes to our $99 fair value estimate or wide moat rating. Part of the outperformance was attributable to strong sales of hepatitis C drug Olysio (4% of the quarter's sales), which will likely decline significantly in late 2014, since Gilead's Harvoni was recently approved in the U.S. and carries a best-in-class profile. Nevertheless, J&J has several other recently launched drugs that should support solid drug division growth in 2015, albeit decelerating growth. Potential risks to growth in 2015 are sales declines for Risperdal Consta and Invega Sustenna because of generic competition, but we don't project generics until 2016 and 2018, respectively, because of the complexity in manufacturing the drugs.
The brand power in the consumer business and power of switching costs in the device segment showed signs of weakness in the quarter. While product divestitures and manufacturing issues make comparisons more complex, we believe the flat growth in these divisions in the first nine months of the year is signaling a minor deterioration in the competitive positioning of J&J. This is more acute within the hip business, where prices fell 5% in the quarter.
J&J's strong drug sales boosted overall margins. While the company reinvested some of the gains, a good portion fell to the bottom line as shown by operating costs as a percentage of sales falling 180 basis points year over year. We expect margins to fall slightly in 2015 as the drug division's sales growth decelerates and the high-margin U.S. sales from Olysio decline rapidly.
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