Johnson & Johnson - Solid Earnings, But Momentum Has Pushed Up Expectations

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Shares of Johnson & Johnson (NYSE:JNJ) hardly moved on the back of a solid third-quarter earnings report on Monday.

After shares have seen significant momentum so far this year, expectations for earnings and the valuation at large have risen.

I would consider shares to be fairly valued at this point in time, seeing few triggers for significant outperformance in the short- to medium-term. That being said, I cannot rule out that momentum could push shares toward $100 per share in the coming months.

Third-Quarter Results

Johnson & Johnson generated third-quarter revenues of $17.58 billion, up 3.1% on the year before, and ahead of consensus estimates at $17.46 billion.

Net earnings came in at $3.0 billion, as diluted earnings per share came in at $1.04 per share. Note that earnings were depressed due to a $0.9 billion accrual for litigation expenses, in-process R&D expenses and transaction costs related to the Synthes acquisition.

Non-GAAP earnings came in at $3.9 billion, up 11.3% on the year before. Non-GAAP earnings rose by 8.8% to $1.36 per share, comfortably beating consensus estimates, which stood at $1.32 per share. CEO and Chairman Alex Gorsky commented on the third quarter developments:

Our third-quarter results reflect the solid, demonstrable results in achieving our near-term priorities while also advancing our longer term strategic growth drivers.

Looking Into The Results

Johnson & Johnson saw solid operational growth, as revenues in local currencies rose by 4.7%, while foreign exchange translation shaved off 1.6% from revenue growth. Domestic revenues were up by 1.7%, while international sales rose by 7.1% in constant currencies.

Consumer sales rose by 0.8% to $3.6 billion, while worldwide pharmaceutical rose by 9.9% to $7.0 billion, being the bright spot in this report. Besides showing rapid growth, the company saw approval by the European Commission for SIMPONI and STELARA. Worldwide Medical Devices and Diagnostics sales fell by 2.0% to $6.9 billion.

Johnson & Johnson made good progress in boosting gross margins as cost of goods sold fell by 240 basis points to 30.4% of total sales. These margin gains combined with lower in-house R&D expenses were offset by $943 million in one-off expenses.

All in all, GAAP earnings came in essentially unchanged at around $2.98 billion.


Unfortunately, Johnson & Johnson did not provide a balance sheet yet with its quarterly earnings report. Note that the company ended the second quarter with $25.1 billion in cash and equivalents. Total debt stood at $15.0 billion at the time, for a solid net cash position of $10.1 billion.

Revenues for the first nine months of the year came in at $53.0 billion, up 6.6% on the year before. Net earnings rose by 24.5% to $10.3 billion, as diluted earnings per share came in at $3.58 per share. At this pace annual revenues could come in around $70 billion, as net earnings could approach the $14 billion mark. Johnson & Johnson increased its full-year non-GAAP earnings estimate to $5.44-$5.49 per share.

Trading around $90 per share, the market values Johnson & Johnson at $255 billion. This values operating assets of the firm at $245 billion, the equivalent of 3.5 times annual revenues and roughly 17-18 times annual earnings.

Johnson & Johnson currently pays a quarterly dividend of $0.66 per share, for an annual dividend yield of 2.9%.

Some Historical Perspective

For most of the past decade, shares of Johnson & Johnson have moved in a $50-$70 trading range. After witnessing very solid returns of nearly 30% so far this year, shares are currently exchanging hands around $90 per share, close to their all-time highs.

Between the calendar year of 2009 and 2012, the company has managed to increase its annual revenues by a cumulative 9% to $67.2 billion. Net earnings fell by nearly 12% to $10.9 billion in the meantime. Both revenues and earnings are expected to show some meaningful growth again this year.

Investment Thesis

After years of stagnation, although investors continued to receive nice dividends in the meantime, shares of Johnson & Johnson have finally moved significantly higher. Shares saw steady gains throughout the first half of the year, advancing from $70 in January to highs around $94 in July, after which shares have retreated a little bit.

The pharmaceutical division performed relatively well, as the company is not facing many patent expirations while new drug launches are starting to make a contribution at the moment, and in the coming quarters.

The disappointment within the report was the relative weakness stemming from the medical device business. Apparently health is even elastic, as patients are reducing the number of elective surgeries in a weaker economy. CFO Caruso also noted that there was some sort of pickup in economic activity, but far below levels expected. After, closing the $20 billion deal of Swiss-based Synthes last year, Johnson & Johnson became a leader in the market for devices that treat trauma victims. As it appears now, relative weakness is spread throughout the entire medical device unit.

Despite the weakness in the field, Caruso indicates J&J is willing to acquire more medical device companies, if they can be bought at reasonable prices. Other than that, J&J is also looking to make acquisitions or license new prescription drugs, to continue to show impressive growth.

Back in June, I looked at Johnson & Johnson's prospects after it bought Aragon Pharmaceuticals to boost its Pharmaceutical business. The bolt-on acquisition announced at the time, only cost about a month in earnings, but adds nicely to J&J's pipeline. I concluded to stay on the sidelines given the significant momentum so far in 2013.

So overall, the company is moving along just fine, having plenty of cash to make bolt-on acquisitions to grow operations across the range of its activities. And it was about time that J&J started to show some revenue and earnings growth, after a few years of relative stagnation. Yet I think the market has already priced in these positive developments of 2013 and 2014, with shares trading around 18 times expected earnings.

At these levels, the most compelling upside has already gone for the short- to medium-term, although I cannot rule out shares will move toward $100 per share in the coming year. Trading around 18 times earnings and paying a 2.9% dividend yield, current levels seems fair, even if the balance sheet is strong and there are few imminent patents set to expire ahead.

I remain on the sidelines for now.

Disclosure: I 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.

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Tagged: , Drug Manufacturers - Major, Earnings
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