Ahead of the annual shareholder meeting of Johnson & Johnson (NYSE:JNJ) it is important to take stock of where the company is objectively — before top brass gets a chance to put its spin on the narrative, that is. It wouldn’t be surprising for shareholders to come clamoring with questions.
Last week, JNJ announced mixed results for the first quarter and JNJ stock performance to date has lagged the broader Dow Jones Industrial Average. So far, JNJ stock has appreciated just 11% this year, compared to over 17% for the index.
JNJ Stock: The Good
In terms of its first-quarter results, Johnson & Johnson naturally wants investors focused on its adjusted earnings per share beating expectations by 7 cents per share — $2.10 per share, which landed above analyst estimates of $2.03 per share. JNJ also wants investors to note that sales both beat expectations and increased year over year, however slightly.
JNJ is coming off a very successful 2018, in which it delivered growth across its three major categories: consumer sales, pharmaceutical sales and medical-device sales. Indeed, the brand portfolio is incredibly strong, and you would be hard-pressed to not recognize many of the consumer names.
The consumer sales division contains household names that are found in virtually every medicine cabinet, e.g. Motrin and Tylenol (which recently reclaimed the No. 1 spot in the branded adult analgesic position), and every bathroom shelf, e.g. Neutrogena and Aveeno. Pharmaceutical sales, by far the largest absolute contributor to revenue, include Zytiga, imbruvica and Tremfya. Brands like Acuvue (contact lenses) fall under the medical device banner.
This gives readers a sense of the sheer strength of JNJ’s brand portfolio. And on the heels of such a strong 2018, the general market sentiment is that this year should be even better.
JNJ Stock: The Bad
The problem is that the momentum seems to have slowed. The under-performance of JNJ stock reflects investor concerns, even after reasonably good first quarter earnings.
The concern is that on such a strong 2018, cracks have begun to appear across more than one division in the first quarter of 2019. Consumer sales were down 2.4% over the prior year, as were medical device sales (down 4.6%). Pharmaceutical sales increased 4.1% but that has to be discounted given the potential for expensive lawsuits.
JNJ has been increasing its investments in the pharmaceutical business, which makes perfect sense from a profit potential standpoint. However, it’s also a riskier business. In the first quarter, revenue may have gone up slightly, but net income decreased.
The main culprit was soaring legal expenses. According to CNBC, “The company spent $423 million on litigation expenses during the first quarter, on top of $1.29 billion during the fourth quarter.”
It’s not uncommon for healthcare companies to be embroiled in lawsuits, but JNJ is in the midst of defending itself in thousands of them, thanks to its talc baby powder. Plaintiffs allege this product causes cancer. JNJ has also settled over 25,000 lawsuits relating to the blockbuster blood thinner Xarelto.
Some might counter that this is just the nature of the business: high-risk, high-reward. After all, JNJ had a couple big wins on the pharma side with anti-inflammatory treatment, Stelara, and the multiple myeloma drug, Darzalex.
However, if JNJ can’t keep legal costs from spiking, this is a meaningful risk to future cash flow and earnings.
The Bottom Line on JNJ Stock
Looking ahead, with JNJ stock trading around the $140 mark and sporting a price-to-earnings ratio of 25, caution is advised. Valuation doesn’t look cheap, but a pullback, coupled with better visibility on the pharmaceutical front, could convince the market that better things lie ahead for the $379-million-market-cap company.
Additionally, an enhanced strategy for material growth in consumer sales and medical device sales could reignite confidence in JNJ and juice JNJ stock upwards some more.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.
