Johnson & Johnson - Strong Results, Driven By Pharma Sales At Large And Hepatitis C In Particular

Jul.15.14 | About: Johnson & (JNJ)

Summary

Johnson & Johnson reported a strong set of second quarter results, easily beating consensus estimates.

Growth was driven by pharmaceutical sales and hepatitis C combination drug Olysio/Sovriad in particular.

The valuation is in line with the market, while the strong growth and track record warrants a premium valuation.

Investors in Johnson & Johnson (NYSE:JNJ) are pleased with the company's second quarter results, which were better than anticipated. Strength in the pharmaceutical segment of the company and in its hepatitis C drugs in particular fueled the strong results.

Despite significant momentum in recent years, there is still appeal at current levels. Johnson & Johnson trades at similar valuation multiples as the overall market, despite an impressive growth track record, a strong financial position, appealing dividends, and continued growth prospects.

Headline Numbers

Johnson & Johnson posted second quarter sales of $19.50 billion for the quarter, up 9.1% as reported. Revenues came in far ahead of consensus estimates at $18.86 billion.

The company posted net earnings of $4.33 billion which is a 12.9% improvement compared to last year. GAAP earnings per share advanced by 13.5% to $1.51 per share.

Non-GAAP earnings rose to $1.66 per share, comfortably beating consensus estimates at $1.54 per share.

Looking Into The Quarter

Total sales growth of 9.1% was impressive and was actually held back by adverse currency movements, which shaved off 30 basis points from reported revenue growth.

Growth was driven by the pharmaceutical business of the company, which posted a 21.1% increase in revenues to $8.51 billion. Within the segment, the US operations were the driver behind growth, posting a 36.6% increase in sales towards $4.61 billion.

Consumer sales rose by 2.4% to $3.66 billion, driven by international strength. The slowest growth was reported by the medical devices and diagnostics business, which posted a merely 0.7% increase in sales towards $7.24 billion.

The company did a fine job leveraging sales growth into operational earnings improvements. While gross margins were actually down by 30 basis points to 69.0% of sales, the company reported a 200 basis point reduction in selling, general and administrative expenses, which fell to 28.1% of sales.

R&D expenses fell as well on a relative basis, coming in at 10.3% of sales, which was down 60 basis points compared to last year, although expenses increased in actual dollar terms. Overall, net earnings growth was limited, partially the result of higher taxes, with the effective tax rate increasing by 3.1% to 23.1% of operating earnings.

The other reason was the $0.4 billion charge related to higher litigation accruals as well as integration and transaction costs related to the Synthes acquisition.

Pharmaceutical Business Drives The Results

Of course, growth in Johnson & Johnson's results was driven by the pharmaceutical business, which now markets so many products that it is almost impossible to keep track of.

Within immunology, total sales of Remicade rose by 7.9% to $1.80 billion. Spectacular percentage revenue growth within the business unit has been reported by Simponi, which reported a 61.1% increase in sales towards $282 million. The performance of Stelara was very strong as well.

The infectious disease business saw a strong contribution from debuting hepatitis C drug Olysio/Sovraid, which posted worldwide sales of $831 million. Note that last year this drug did not generate any revenues yet, while it posted sales of $354 million in the first quarter.

Oncology sales have been strong as well, driven by Zytiga. Also noticeable is the $361 million revenue contribution from Xarelto, which was up by 91% on an annual basis.

Valuing The Company

Within the press release, Johnson & Johnson failed to provide a balance sheet. At the end of the first quarter, the company operated with $29.4 billion in cash and equivalents. Total debt stood at $17.3 billion, resulting in a comfortable net cash position of about $12.1 billion.

On a trailing basis, the company has posted sales of $74 billion on which it posted earnings of almost $16 billion. Trading at $103 per share, the equity in the business is valued at around $290 billion. Subtracting the net cash position being held at the end of the first quarter, and operating assets are valued at around $278 billion.

This values equity in the business at 3.8 times annual sales and 17-18 times trailing earnings.

Looking At The History And Future Outlook

Over the past decade, J&J has steadily grown its topline sales, which grew from $47 billion in 2004 to a current run rate approaching $75 billion. Earnings have nearly doubled in the meantime, while the company managed to repurchase about 5% of the total number of shares outstanding.

The company has steadily boosted its balance sheet along the way, building up a solid net cash position. This came after the company witnessed quite some volatility over this time period on the back of the 2010 recalls of OTC children medication, hip replacement prostheses and the Tylenol products. The company did settle lawsuits resulting from this recall, eliminating most of the legal overhang.

Shares have traded in a $50-$70 trading range for most of the decade until shares started an impressive move upwards at the start of 2013. Shares have steadily gained ground to current highs around $105 per share, having returned 15% already this year.

Final Takeaway

What is not to like about the latest results? Topline sales grew at high single digits, which is impressive, given the size of J&J's operations. This combined with the excellent track record, bright prospects for the pharmaceutical business, strong balance sheet and fair valuation still leaves little appeal.

Essentially you can buy J&J at a market-equivalent valuation multiple while it displays solid and predictable growth and has significant upside in the pharma business. At the same time, it has great financial strength and pays out a 2.7% dividend yield.

The latest star within the pharma business is Olysio/Sovraid, a combination treatment for hepatitis C, which reported very strong results in a market which could become crowded. Of course Gilead Sciences (NASDAQ:GILD) is already a big competitor with Sovaldi, while AbbVie (NYSE:ABBV) hopes to become a competitor soon in this area.

On the back of the strong momentum in the second quarter, the company now sees non-GAAP earnings of $5.85 to $5.92 per share, which means that the company hiked the higher end of the guidance by two pennies. This values the business at 17-18 times earnings and offers a more than fair valuation in light of the general market valuation.

Disclosure: The author is long GILD. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.