Abbott Labs and Johnson & Johnson: Clash of the Titans

Includes: ABT, JNJ
by: John Putnam, CFA

Two of healthcare's largest companies could not have reported more opposite Q4 2008 results and more polar outlooks for 2009 than if they had tried.

On Tuesday, Johnson & Johnson (NYSE:JNJ) reported results that exceeded analysts' expectations at the EPS line ($0.97, +18% and $0.05 better than expectations) but were disappointing on the revenue line ($15.2 billion, down almost 5%) (Call Transcript).

By contrast, Abbott Laboratories (NYSE:ABT) on Wednesday, reported EPS of $1.06 (+14% and in line with guidance) on a revenue increase of 10% to $8.0 billion (Call Transcript). JNJ lowered its guidance for 2009 (EPS of $4.45 to $4.55 as compared to the $4.55 just reported for 2008 and Wall Street consensus of $4.61) while ABT confirmed its previous guidance (EPS of $3.65 to $3.70 as compared to $3.32 in 2008 from continuing operations excluding specified items.

So, why the big divergence? We believe three factors: the economy; new product cycles; and old problems. We suggested in our 2009 medical device outlook that healthcare spending is not immune to the economy despite secular growth in demand. Loss of jobs translated into loss of health insurance benefits which translates into less per capita spending especially on elective services and procedures.

Although JNJ's consumer franchises have long been viewed as a stable source of growth, its consumer revenues were up only 1.8% in the U.S. and 1.2% world wide in the fourth quarter. For the first nine months, the consumer division's revenues grew 14% Y/Y, so tough economic times have caused consumers to cut back and seek alternatives such as generics or discount brands.

Most surprising in JNJ's business was an 18.4% U.S, and 8% international decline in diabetic care products which could be signaling a sharp shift to generic meters and strips or a shift by patients to to less expensive mail order sources. By contrast, ABT's diabetic care business grew by 7% in the U.S. and 2.4% ex-currency, overseas.

JNJ, along with its competitors, Boston Scientific (NYSE:BSX) and Medtronic (NYSE:MDT), are facing tough competition from ABT's XIENCE drug-eluting stent [DES], which became the market leading DES in the U.S. during the fourth quarter with WW sales of $410 million (U.S. revenues were $267 million). JNJ's Cypher DES booked revenues of $270 million WW, down 34% but U.S. sales were a mere $70 million, down a whopping 63%. Cypher's market share dropped to 15% down from 23% in Q3 and 47% in Q4 2007.

For some time, JNJ has faced increased generic competition in its pharmaceutical portfolio. Contributing to an 11% decline in pharmaceutical revenues (-13% U.S. and –8.6% internationally) was a 67.4% decline in RISPERDAL/ RISPERIDOEN which faced generic competition for the first time in June 2008.

Abbott's pharma sales increased 9.8% on a world wide basis balanced nicely between a 10.2% increase domestically and 9.5% overseas. HUMIRA revenues in the U.S. were up 40% during the quarter with new data demonstrating that 50% of patients with moderate to severe early rheumatoid arthritis [RA] demonstrated no progression of joint damage at five years.

In spite of all its woes, JNJ's stock has held up remarkably well. In 2008, JNJ shares were down around 10% as compared to the Dow which declined over 40% and the stock was the third best performing security in the Dow. Even in the face of a downward revision in 2009 guidance, it has recovered most of its 5% decline.

The company is viewed as defensive because of its widely diversified businesses. While there is some organic growth, JNJ has historically acquired companies related to its existing businesses as a means of growth. We believe it will continue to grow in this manner but the challenge to growing in this way is that the base has become quite large and bolt-on acquisitions have less impact to the company's overall growth rate.

During the quarter, JNJ completed the acquisition of SurgRx, Inc., a privately held developer of the advanced bipolar tissue sealing system used in the ENSEAL family of devices, and the divestiture of Ethicon's Professional Wound Care business to One Equity Partners. In addition, the Company completed the acquisition of Omrix Biopharmaceuticals, Inc., a fully-integrated biopharmaceutical company that develops and markets biosurgical and immunotherapy products.

Also in the quarter, the Company entered into a definitive agreement to acquire Mentor Corporation (MNT), a leading supplier of medical products such as breast implants for the global aesthetic market. While this may prove to be an attractive long term acquisition, we believe in the near term the demand for its products may be negatively affected by economic conditions since they are primarily elective in nature.

ABT's shares actually did a little better, declining only 2% in 2008. It too has pursued a strategy of diversification through acquisition although its pharmaceutical portfolio has fared much better with new product discoveries of late than has JNJ's.

Abbott recently announced an agreement to acquire American Medical Optics (EYE), an established global leader in the large and growing eye care market. This acquisition strengthens and expands Abbott's current medical device business, providing further diversification for the long term. AMO participates in three segments: cataract surgery, refractive surgery, or LASIK laser vision correction, and eye care products, such as contact lens solutions. AMO holds the number-one market position in LASIK, the number-two position in cataract surgery and the number-three position in eye care products.

Clearly the momentum is in ABT's favor and should remain so until the product development cycle in coronary stents shifts to one of the other competitors or some other unforeseen event occurs. Although ABT's shares carry a slight valuation premium to those of JNJ's, about 13.5%, we believe it is justified and at a P/E of 14.2X 2009 guidance, the stock looks very attractive to us.

Disclosure: I have no positions in any of these companies.

About this article:

Tagged: , Drug Manufacturers - Major, Earnings
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here