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Steady Growth at J&J Reinforces Wide Moat, But Shares Overpriced

An anticipated slowdown in pharma giant’s drug business gives us some pause on the firm’s current valuation, but its long-term competitive advantages are intact.

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Buoyed by strong immunology and oncology sales,

As J&J ended the quarter with close to $17 billion in net cash, we expect it to make a large acquisition. With healthcare valuations down from their mid-2015 peak, we believe J&J is in a better position to create value through acquisitions. However, with several other large healthcare companies also looking to redeploy capital, we don't expect any good deals for J&J. The specialty pharmaceutical area looks most undervalued, but this is an area where J&J hasn't shown much interest recently. Therefore, we believe innovative biotechnology and medical device companies are the most likely targets.

J&J reiterated its commitment to increase operating margins by over 200 basis points, which looks achievable and is critical for the company to hit its 2016 outlook. We expect all expense lines to improve, although when generic competition intensifies in the drug group through 2018, margins are likely to reverse this trend as these older drugs carry hefty margins.

Lastly, recently launched cancer drug Darzalex is off to a strong start with sales likely approaching $100 million in the quarter, well above our expectations. Darzalex's early-stage data looks excellent in multiple myeloma and should easily top $1 billion in peak sales.

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About the Authors

Damien Conover

Director of Equity Strategy
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Damien Conover, CFA, is the director of healthcare equity research for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is also director of equity strategy, responsible for helping to shape, package, and surface research based on Morningstar’s investment philosophy by working closely with the firm’s sector strategists and directors.

Before joining Morningstar in 2007, Conover was an equity research analyst covering the healthcare sector for Raymond James, Bank of Montreal, and Tucker Anthony.

Conover holds bachelor’s and master’s degrees in finance from the University of Wisconsin and was a member of its Applied Security Analysis Program. He also holds the Chartered Financial Analyst® designation.

Damien Conover, CFA, is the director of healthcare equity research for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is also director of equity strategy, responsible for helping to shape, package, and surface research based on Morningstar’s investment philosophy by working closely with the firm’s sector strategists and directors.

Before joining Morningstar in 2007, Conover was an equity research analyst covering the healthcare sector for Raymond James, Bank of Montreal, and Tucker Anthony.

Conover holds bachelor’s and master’s degrees in finance from the University of Wisconsin and was a member of its Applied Security Analysis Program. He also holds the Chartered Financial Analyst® designation.

Debbie Wang

Senior Equity Analyst
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Debbie Wang is a senior equity analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. She covers the medical-device, diagnostics, and animal health industries. Previously, she was an associate director of equity analysis for Morningstar, leading the healthcare team.

Before joining Morningstar in 2002, Wang was a vice president and senior brand strategist for Leo Burnett. During her tenure at Leo Burnett, she led brand strategy on a variety of accounts, including Allstate, Amoco, McDonald's, Heinz, Smucker’s, Pepto-Bismol, and Celebrex.

Wang holds a bachelor’s degree in anthropology from Colgate University and a master’s degree in business administration from the University of Chicago Booth School of Business.

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