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Stock Analyst Update

We View J&J's Litigation Concerns as Manageable

We don't see any major impact to our fair value estimate based on the quarter's outperformance.

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Johnson & Johnson (JNJ) reported third-quarter results that were slightly ahead of both our and consensus expectations, but we don’t see any major impact to our fair value estimate based on the outperformance. We continue to view the stock as fairly valued. Also, the firm’s wide moat looks intact, as shown by the steady results across J&J’s key divisions.

While the fundamentals in the quarter look solid, J&J continues to face increasing litigation concerns, but we see these lawsuits as manageable. We have factored in over $5 billion of costs related to litigation over the next five years. In particular, we believe the litigation around the side effects of opioids and talc will represent the larger settlements, with legal challenges to neuroscience drug Risperdal and the company’s pelvic mesh likely to lead to smaller settlements. Overall, our projected legal costs over the next five years are similar to those of the previous five years. Both from a discounted cash flow valuation perspective and a market sentiment perspective, the actual payouts on legal challenges in the past haven’t significantly affected J&J’s stock price over the long term. However, we expect continued short-term volatility surrounding legal cases, especially where initial rulings are significant.

Turning to the quarter, the drug division continues to lead overall growth, but the device and consumer groups are improving. Despite generic competition, the drug group’s recent launches continue to offset the patent losses (especially in oncology and immunology) and we expect continued steady growth for the drug unit over the next five years. We expect steady growth in the device segment, with potential room for upside based on new robotic devices that should reach the market over the next two years. In consumer, we don’t expect much acceleration of growth based on the more competitive Internet distribution channel, where brand strength looks less powerful.

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Damien Conover, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.