Johnson & Johnson's Q2 Is Not As Strong As It Looks

| About: Johnson & (JNJ)

Summary

JNJ beat estimates, driven by 9% growth in the pharma segment.

But currency is the main reason for growth, and sales are lower than last year after adjusting for FX.

Competition from generics is a headwind, and JNJ is too expensive to invest at these levels.

The market reacted positively to Johnson & Johnson's (NYSE:JNJ) second quarter results. Sales increased 3.9%, beating analyst estimates, and EPS beat by $0.06. Once again, JNJ's Pharmaceuticals segment carried the day, growing 9%, which offset weakness in Medical Devices (0.8% growth) and Consumer Products (1.8% decline). Management raised its full year revenue forecast by 300 million, and guided EPS higher by $0.05 - $0.10. JNJ stock has climbed higher on the continued success of the pharmacy business, the firm's largest segment at 40% of sales. But this segment faces more headwinds than any other, and a closer look and the company's results will reveal the JNJ's most recent quarter was not all that great. As long as interest rates stay low JNJ's dividend will remain attractive and the stock will likely climb higher in 2016. But JNJ is expensive based on historical metrics and now is not the time to invest.

Competitive pressures in JNJ's drug division have been rising. After the company lost patent protection for its hepatitis C drug, Olysio, Olysio sales declined 86.3% in the first quarter. Gilead's (NASDAQ:GILD) Harvoni and Solvaldi hep-c drugs have proven to be blockbusters, and GILD just had Epclusa approved, a drug that can treat all-six hep-C genotypes and reduce patient testing costs. JNJ faces generic or biosimilar competition in Concerta, Invega, Risperdal, Consta, and Remicade, which together account for $10 billion in annual sales, almost 15% of 2015 revenues. In the latest quarter, increased competition in hep-C weighed on growth, and Invega declined due to generic competition. Remicade is expected to face its first biosimilar (Celltrion's Inflectra) this year, and growth slowed to 8% versus 11.2% in the first quarter.

Despite patent losses and increased competition, JNJ's pharma segment continues to outperform peers. We attribute this to a number of factors. Thanks to a massive R&D budget and expertise in drug development, JNJ maintains a robust product pipeline. Many of the firm's specialty drugs treat rare conditions, making them easier to get approved, and their complexity often makes it difficult for competitors to replicate them. But JNJ's performance was not that great after factoring in the impact of currency. In the comparable period last year, FX dragged down sales by 14.8%, making for an easy comp. In the latest quarter, currency reduced sales by just 1.4%. Adjusting for currency, JNJ's sales are actually lower than they were last year. On a sequential basis, sales grew at the same rate as they did in Q1 after taking currency into account (the same quarter in which Olysio sales fell 86.3%). Because the US accounts for just 50% of sales, currency has a big impact on results. FX is predominately responsible for JNJ's "strong" quarter, and competition from generics is weighing on performance.

Conclusion:

JNJ is a great company and in spite of increased competition, growth in the Pharmaceuticals segment continues to drive the stock higher. But FX is the main reason for the improvement, and JNJ's Medical Devices and Consumer Products businesses are struggling. JNJ trades at a trailing P/E of 22.4, a 20% premium to its 5-year average of 18.6. While JNJ is growing at a faster rate than its 5-year average of 2.6%, the premium is not justified when you consider that much of the growth is due to currency. As long as rates stay low, demand for yield can drive JNJ higher in 2016. But now is not the time to take a position in Johnson & Johnson.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.