Johnson & Johnson Deserving Of Its Upgrades

| About: Johnson & (JNJ)

by Darnell Brown

After years of relatively flat earnings growth and stock appreciation, Johnson & Johnson (NYSE:JNJ) has finally moved into the forefront of the big pharmaceutical stocks that investors want to own. Since the beginning of June, the stock price has increased by 7.85% on above average volume. The primary catalyst for Johnson & Johnson's recent surge is its purchase of Synthes. Synthes is "the world's largest maker of implants to mend bone fractures, and also produces surgical power tools and advanced biomaterials."

On June 13th, Johnson & Johnson announced that it had received "U.S. regulatory clearance for its proposed acquisition of Synthes. This completes all regulatory approvals required to close the transaction." On the day of the announcement, Johnson & Johnson's stock price rallied by 2.2% on nine times its daily average volume. Since June 13th, the stock price has continued to move higher partly because of three major upgrades: "JPMorgan (NYSE:JPM) raised its opinion of Johnson & Johnson to overweight from neutral, Raymond James (NYSE:RJF) upgraded it to outperform from market perform, and Jefferies Group (JEF) upgraded it to buy, from hold." It seems to be generally accepted that the acquisition will be accretive to earnings instead of dilutive, as expected earlier. Johnson & Johnson "now expects the acquisition to boost 2012 adjusted earnings by 3-5 cents per share. Meanwhile, 2013 earnings are expected to be boosted by 10-15 cents per share due to the acquisition. Synthes' global sales came in at $3.97 billion in 2011, with US sales coming in at $2.14 billion."

Synthes operates as an international company and Johnson & Johnson had to jump through hoops to get all of the regulatory clearances that it needed to make the purchase. The company had to get regulatory approval from Japan, China, Canada and the European Union. The okay from European regulators came only after Johnson & Johnson agreed to sell its DePuy Orthopedics Trauma business to Biomet in the second quarter of 2012 for $280 million.

Positives for Johnson & Johnson moving forward

Johnson & Johnson increased first quarter net income by 12.5% and increased overseas sales by 4.1%.

The company's biggest new product was Zytiga which treats "asymptomatic or mildly symptomatic patients with metastatic castration-resistant prostate cancer" and had sales of over $200 million in its first quarter of sales. Another one of Johnson & Johnson's new drugs, Intelence, which is administered to HIV patients, had sales of $80 million, which was a 15.9% increase from the prior quarter. XARELTO, another new drug, has already "been approved in the U.S. for the prevention of blood clots following hip and knee replacement surgery and the prevention of stroke as a result of blood clots." Johnson & Johnson's biggest selling drug Remicade had first quarter sales of $1.28 billion, which was an 18.4% increase from the first quarter of 2011. Another widely used drug that Johnson & Johnson markets, Velcade, had first quarter sales of $353 million, which was a 26% increase from the first quarter of 2011. Johnson & Johnson has a number of blockbuster drugs that will be increasing its revenues.

Negatives for Johnson & Johnson moving forward

Johnson & Johnson was sued for "hiding the risks associated with Risperdal, which is approved to treat schizophrenia, bipolar disorder and behavior problems in teenagers and children with autism." On April 11th Arkansas Circuit Court Judge Tim Fox assessed a $1.19 billion penalty against Johnson & Johnson for nearly 240,000 violations of the state's Medicaid fraud law. Mr. Fox also issued an $11 million fine for violations of the state's deceptive practices act. In addition to its legal problems in Arkansas, the company will have to deal with the Justice Department which "rejected a proposed $1 billion settlement for the civil portion of the settlement and is seeking more money." In the first quarter earnings call "Johnson & Johnson says it expects to incur a special charge in Q2 of ~$600M to increase its accrual for the potential settlement of previously disclosed civil litigation matters related to Risperdal, Invega, Natrecor and Omnicare (NYSE:OCR)."

In a second problem area, "Johnson & Johnson entered into a consent decree with the Food and Drug Administration last year in which it promised to overhaul operations at three of its manufacturing plants after quality problems led several over-the-counter products, including Pepcid Complete and Children's Tylenol, to be removed from shelves." The company has been losing revenues due the closure of its three manufacturing operations, and the bleeding will continue, because in the first quarter earnings call Dominic Caruso said "the company had underestimated the time it would take to address the issues raised by the consent decree."

Johnson & Johnson's CEO-in-waiting, Alex Gorsky, plans to turn around the company's consumer products division, which has been plagued with manufacturing issues and massive recalls. However, there is still uncertainty about the incoming CEO.


Johnson & Johnson is a large well diversified company that will able to survive its legal problems and the expiration of some of its patents. The company has a well stocked drug pipeline, which will provide strong revenue growth going forward. I recommend investing in this company now, as it is a relatively safe stock that offers consistent dividend income.

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