Johnson & Johnson Stock Valuation - Part 2

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 |  About: Johnson & Johnson (JNJ)
by: Bio Vantage

Part 2: Sales growth from existing products and the Synthes acquisition

This is a 4-part series for Johnson & Johnson (NYSE:JNJ) report. Please refer to Part 1 for an overview of JNJ's business strategy, its three product segments, drug pipelines, company specific issues, and our strategy to analyze this company as a whole (JNJ stock valuation part 1).

In Part 2 of our JNJ report, we will focus on the profit margins of existing products and their anticipated revenue growth over the next 5 years. For example, some products have seen declining sales over the last few years due to generic competition. These are offset by new products introduced or approved in 2010-2011. We will also discuss ongoing litigation lawsuits and product liability expenses that would affect the company's earnings. At the end of Part 2, we will derive revenue projections for the next 5 years based on existing products.

According to JNJ's 2011 annual report (JNJ 2011 annual report), its 10-year compound annual growth rates (OTCPK:CAGR) for worldwide product sales was 7.2%, whereas its 5-year CAGR was 4%. The decline is partly attributable to the global financial crisis and the economic slowdown since 2008. However, by looking at sales for each of JNJ's segments, we can better assess the sources of growth and decline for purposes of deriving accurate financial projections.

Pharmaceuticals

JNJ's pharmaceutical operational sales increased by 8.8% in 2011. Its best-selling drugs, REMICADE and VELCADE, had sales growth of over 18%, whereas Prezista had 41% growth over 2010. The gains in these drugs are offset by other drugs that have experienced declined sales. For example, PROCRIT/EPREX (erythropoiesis stimulating agents) had a decline of 16% in sales due to a declining market and increased competition. LEVAQUIN sales decreased 54% versus the prior year due to the loss of market exclusivity in the U.S. in 2011.

In 2011 alone, JNJ received regulatory approval for 6 products. These include U.S. approval for XARELTO® (rivaroxaban) for two indications, an anti-coagulant co-developed with Bayer HealthCare. The first indication is for the prevention of deep vein thrombosis (DVT), which may lead to pulmonary embolisms (NYSE:PE) in people undergoing knee or hip replacement surgery. The second approved indication was for reducing the risk of stroke and systemic embolism in patients with atrial fibrillation.

EDURANT® (rilpivirine) was approved in both the U.S. and the European Union (NYSEARCA:EU) for HIV in treatment-naïve patients. INCIVO® (telaprevir), a new direct-acting antiviral protease inhibitor for the treatment of hepatitis C virus (HCV) infection in combination with pegylated interferon and ribavirin, was approved in European Member States in September 2011.

ZYTIGA® (abiraterone acetate) is an oral, once-daily medication for use in combination with prednisone for the treatment of men with metastatic castration-resistant prostate cancer (CRPC) who have received prior chemotherapy containing docetaxel. It was approved by the U.S. FDA and European Commission in 2011.

The FDA also approved REMICADE® (infliximab) for the treatment of moderately to severely active ulcerative colitis in pediatric patients, and NUCYNTA®ER (tapentadol), an oral analgesic, for the management of moderate to severe chronic pain in adults.

The sales of new drugs launched in recent years, including STELARA, SIMPONI, ZYTIGA, INCIVO, and INVEGA SUSTENNA, were reported in the Other Pharmaceuticals category. This category has impressive 18% sales growth that brings revenue to $10.3B in 2011. This emphasizes again JNJ's strategy to sustain revenue growth through innovative products that have competitive advantage in the marketplace. We believe that JNJ's recently-launched products will continue to generate double-digit growth over the next few years, and so we factored their growth into our financial projections.

Consumer and Medical Devices

Sales of consumer and medical devices increased in 2011 by 2% and 4.8%, respectively. The lower growth rate in the consumer business was partly due to remediation and supply issues associated with the McNeil Consumer Healthcare over-the-counter (OTC) business. JNJ has signed a Consent Decree with the FDA and several product lines have already returned to the market. The company expects these products to be reintroduced throughout 2012, with an attendant increase in sales.

JNJ's medical devices segment faced several challenges in 2011. These included the DePuy ASR™ Hip System recall, European austerity measures, pricing pressures, and a slowdown in elective surgeries driven by continued economic pressures. These challenges were offset by strong double-digit growth in emerging markets.

One important factor that will impact future growth in medical devices is the acquisition of Synthes, completed in 2012. Synthes reported $4B sales in 2011, and its sales will be added to JNJ's topline this year (Synthes 2011 annual report). We will factor in this revenue in our financial projections.

Conclusion

We believe that JNJ's sales will increase at greater than its current five-year compound annual growth rate (OTCPK:CAGR) of 4%. Factors that will contribute include newly launched drugs and products, the Synthes acquisition, the resolution of the McNeil issue, and the gradual economic recovery. Overall, we estimate that Synthes will contribute at least $4B sales and newly launched drugs will contribute $1.85B sales (based on an 18% increase in $10.3B sales in Other pharmaceutical category in 2011).

We assume the sustainable sales growth rate for JNJ to be 5%, slightly above its 5-yr CAGR (4%), but less than its 10-yr CAGR (7.2%). This assumption is based upon the fact that 7.2% annual growth appears unrealistic while the global economy continues to slow down, but that the low 5-yr CAGR is also skewed by the global financial crisis and setbacks for JNJ in recent years. As these conditions improve, JNJ should be able to restore a higher growth rate.

JNJ also has multiple pending litigations. For example, in 2011 alone, JNJ had $2.7B in Other Expenses, which includes litigation expenses and product liability issues. In 2010, however, it reported a gain of $768M on this line item. As product liability charges, litigation, and write-downs are simply part of the pharmaceutical business model, we accounted for $1B in Other Expenses for these unpredictable liabilities in our 5-year financial projection.

Disclosure: I am long JNJ. 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.