JNJ reported Q4 2017 results beating consensus expectations, however most of the beat came from non-operational items (currency and lower tax rate). 2018 revenue guidance came below expectations, and the US appeals court ruled JNJ patent on Remicade invalid, causing the stock to consolidate today. Our long-term thesis is intact and we raise our price target to $163.
Current Price: $142.4 Price Target: $163 (new)
Position size: 3% TTM Performance: +25%
Thesis intact. Key takeaways:
1. 4Q17 revenue: +4.2% excluding acquisitions and divestitures; total operational sales increase of 4.1% in the U.S., 4.3% internationally
a) Pharma (49% of sales): sales were +7.6% ex-FX, Remicade sales (-10.5% y/y) were below expectations due to higher discounts and biosimilar competition, but Zytiga performed well
o There are already several biosimilars to Remicade in the US (Pfizer’s Inflectra launched in 2016 for example)
o Stelara growth +21% ($1.081B in sales in 4Q17 vs Remicade $1.47B)
o Oncology portfolio growth of 36% reaching $2B in sales (Zytiga $755M)
b) Medical devices (34% of sales): sales +2% ex-FX
c) Consumer (17% of sales): sales growth +0.2% ex-FX
d) Gross margin came below consensus but lower SG&A expenses offset some of it. R&D spending is at a historical high, a sign the company is focusing on growth, supportive of our thesis
e) EPS growth of 10% was mostly driven by other income and lower tax (9% vs. 19%)
f) JNJ is recording a $13.6B tax charge related to the new tax legislation
2. Management provided 2018 guidance
a) Sales growth expectations of 3.5-4.5% on a constant currency basis, includes 1% growth from M&A deals. Revenue (including M&A) is expected to be $80.6B to $81.4B, which is what the Street was expecting excluding deals
b) Operating margin improvement from rapid growth of higher margin drugs (Darzalex and Imbruvica)
c) EPS guided to $8.00-$8.20 (+11% y/y at the mid-point), above consensus of $7.86
d) First year of seeing the Actelion accretion
e) Capital allocation priorities are: 1/dividends, 2/M7A and share buyback
3. Valuation: price target increased to $163
a) Stock is supported by a 5% FCF yield and a 2.4% dividend yield
b) Share count was down ~3% y/y this quarter
Thesis on JNJ reiterated:
• High quality company with consistent 20% ROE, 4+% FCF yield,
• 2% buyback and 2.34% yield totals a 4.3% shareholder return
• Investments in the pipeline and moderating patent expirations create a profile for accelerated revenue and earnings growth
• Growth opportunity: Medical Devices and Consumer offer sustainable growth and potential for expansion internationally
• Strong balance sheet that offers opportunities for M&A.