Johnson & Johnson (JNJ) is in a rut, but at least it happens to be a very profitable rut. What's more, the company has a lot of a game-changing events underway or just on the horizon. Not only has there been a change at the top, but new drug launches, a major acquisition, and annualizing some very bad comparisons should make the business look pretty solid by the end of 2012.
For Now Though, It's Still A Rut
That said, J&J didn't blow anybody away with first quarter results. Revenue was basically flat (though up 1% in constant currency), as pharmaceuticals did alright (up more than 2% cc), devices did alright (up less than 1% cc), and consumer was not alright (down a bit in constant currency). All in all, it was a slightly disappointing topline result with a few weak spots that merit further inquiry.
JNJ did beat on the bottom line, but it was a low-quality beat. Gross margin shrank a bit from last year on ongoing above-trend costs in Consumer and margin pressures from Crucell. Operating income fell about 1%, with the company's lower R&D spending helping boost numbers (though this is likely just a timing artifact).
Certainly Some Good News
As I've been told that I hate J&J, I'll try to accentuate some of the positives first. In the Pharma business, Remicade was a star again and both Stelara and Zytiga are giving every reason to think that they will be big hits for the company. As the company moves past some generics-induced pressure through the year, the drug business should emerge looking pretty strong.
The device and diagnostics business also had its strong points. Diabetes was strong - up 13% in the U.S. and up in Europe in constant currency terms. That makes Roche's (OTCQX:RHHBY) issues look incrementally more company-specific, and JNJ seems to be playing a strong hand in diabetes.
Orthopedics also looks as though its stabilizing. While revenue was down 1% and down 4% in the U.S., this was more or less as expected - JNJ wasn't ever going to achieve the strong print that Biomet produced a week ago. With Stryker's (SYK) earnings on tap tonight, there will be some added context pretty soon, but JNJ's ortho business is looking a little better ahead of the Synthes deal.
But Also Some Bad News
JNJ's consumer health business is still in pretty bad shape, with certain areas like women's health especially weak. This isn't an industry-wide problem either, as Pfizer's (PFE) and Sanofi's (SNY) consumer businesses are doing much better. This is still a fixable situation, but investors are going to have to be patient.
I'm also a little troubled by the results in diagnostics (down 2%) and the flat performance of the surgery business. We'll see how that compares to the reports from the likes of Abbott (ABT), Danaher (DHR), Covidien (COV), and Bard (BCR), but the diagnostic number was pretty weak relative to Roche. As far as the surgery number goes, that's a little troubling given that office visits and admissions have been picking up a bit lately.
The Bottom Line
I have to admit that I'm warming on JNJ stock again. The reported numbers should start getting better later in the year, as businesses like orthopedics should start to recovery and the drug business should put some generic headwinds behind it. I also am cautiously optimistic that the worst is past in the consumer business. In addition to that, the company has some interesting products in the pipeline in both the pharma (an Alzheimer's drug, an HCV program, and a RA/lupus drug) and device (renal denervation) businesses.
I do believe there's a fair chance that Johnson & Johnson can grow its free cash flow at a compound rate approaching 7% over the next decade. That's a big target, I admit, but the improving drug and device businesses will help, as will the company's relatively sizable exposure to growing overseas markets (not that that helped much this time around). While I'm worried a bit about countries trying to solve budget issues on the back of the healthcare industry, that's arguably a bigger threat to smaller companies.
All told, I think fair value for JNJ shares lies in the mid-to-high $70s and it's shaping up as an increasingly interesting option among its peers.