We remain big fans of the steady hand displayed by the venerable Johnson & Johnson as the pharmaceutical bellwether continues to perform admirably. During its second-quarter results, we came away impressed with the continued strength in the Oncology division, which masks the deceleration in growth in Cardiovascular Disease. There continues to be headline risk with respect to talcum powder litigation, but J&J’s underlying business remains solid, in our view.
By Alexander J. Poulos
Examining J&J’s Franchise Strength
We wrote up Johnson & Johnson’s (JNJ) second-quarter results July 19, “Johnson & Johnson Powers Ahead, Litigation Overhang Remains,” but we think a closer examination of the underlying trends of the three largest components of J&J’s pharma division will be helpful to readers. The company remains a stalwart in the high-growth branded pharmaceutical sector, an area that will continue to have an outsize impact on J&J’s overall growth. Though most of the recent news headlines have focused on litigation risk with respect to talcum powder lawsuits, we think this risk is manageable for J&J, even if it may sting a bit. J&J remains one of our favorite ideas, but we’d be much happier if it could put its litigation risk behind it, of course.
Immunology Division
Immunology remains the largest component of J&J’s pharmaceutical division’s revenue, but clear signs of strain are manifesting thanks in large part to the loss of patent exclusivity on J&J’s key product Remicade. We view the 15.4% reported worldwide revenue drop at Remicade during the first six months of 2018 as a harbinger of things to come as Remicade is one of the first biological treatments to face a biosimilar challenge. The erosion of revenue is similar, in our view, to that witnessed when a branded product loses exclusivity.
J&J will attempt to defend some of its market share, but we feel with additional competitor entries imminent, a “race to the bottom” may occur, which will force prices downward, thus necessitating the need for additional innovation to offset the loss in revenue. Thankfully for J&J, its next-gen product Stelara continues to gain traction, but we fear the near-term success will be fleeting as a wide swath of more efficacious products may be in the initial stages of its product ramp.
J&J’s Immunology division remains the largest individual component of the pharmaceutical division, but its continued importance will diminish as Oncology takes on a more prominent role.
Oncology Division
We applaud the foresight J&J displayed with the decision to partner with two of the more innovative Oncology treatments–Darzalex for the treatment of Multiple Myeloma and Imbruvica, which is predominately utilized for the treatment of chronic lymphocytic leukemia. Darzalex remains firmly in its early growth stages as the product continues to gain additional indications, which bode well for further top-line expansion. J&J continues to test the revolutionary product, with the express purpose of expanding the prescribing label. In our view, we think Darzalex is J&J’s premier Oncology asset.
Imbruvica continues to ramp sales, but it suffered a disappointing setback in the lab as the product did not improve outcomes when added to standard therapy for the treatment of non-Germinal Center B cell (non-GCB) subtype of diffuse large B-cell lymphoma (DLBCL). The treatment paradigm has shifted in DLBCL as the CAR-T therapies with Gilead Sciences (GILD) Yescarta poised to revolutionize the way the disease is treated. Though we are disappointed with Imbruvica’s outcome, it may not diminish demand for the product, though we would like to highlight AstraZeneca’s (AZN) Calquence recently gained approval for the treatment of Mantle Cell Lymphoma, an area of previous Imbruvica dominance.
Calquence was approved under the FDA’s accelerated review process based in large part to a stunning 80% response rate, with 40% of the patients treated displaying a complete response to the medication versus 17% for Imbruvica. AstraZeneca is furthering the potential of the product with clinical trials currently underway for the treatment of Chronic Lymphocytic Leukemia, the primary driver of Imbruvica’s sales. If Calquence is proven to be more efficacious, the results may severely diminish the commercial prospects for Imbruvica. At this time, we think it’s premature to speculate in the trial’s ultimate outcome. In any case, we wanted to bring the possibility to readers’ attention as a potential looming risk in the ultra-competitive Oncology space.
J&J faces an imminent generic risk to its prostate cancer treatment Zytiga, which continues to take share from Pfizer’s (PFE) Xtandi. Zytiga posted astounding sales growth of over 60% for the first six months of 2018 with a worldwide sales tally of $1.75 billion, underscoring the importance of the treatment for the overall growth of the Oncology division. One of the most pressing issues for J&J remains the patent estate protecting Zytiga with a trial underway challenging the validity of the patents covering Zytiga. To say the least, a generic challenge would irreversibly alter the growth trajectory of the product. The solid oral dosage form would leave the product vulnerable to a generic challenge, in our view, as the process to bring a generic of solid-dosage form such as tablets is well-established, with little J&J can do to stymie the challengers from stealing significant share.
Cardiovascular/Metabolism
The once-vaunted Cardio division has hit a proverbial speed bump as more-efficacious products with a cleaner side-effect profile have hurt growth for this once-formidable division. We warned last year that we expected sales of Invokana would fall off a cliff following the addition of a black-box label, and unfortunately for J&J, our fears have come to pass with Invokana posting sales of $463 million during the first six months of 2018 versus $579 million for the comparable six-month period in 2017. The 20% sales drop may not be “correctable,” as we feel at this juncture, Invokana will be managed as if it has lost patent protection.
The picture for Xarelto, J&J’s treatment for blood clots, is rapidly losing share to Eliquis due to a combination of a more aggressive marketing push coupled with a few key efficacious claims vaulting Eliquis to the pole position in the category. Sales of Xeralto in the US perked up to the tune of an 8.8% gain for the first six months of 2018, but the sales gain could not offset the decline in Invokana. At this juncture, we do not expect the Cardio division to return to growth anytime soon.
Corporate Divestitures
There have been two notable divestitures undertaken by J&J to streamline the offerings of the healthcare giant. We continue to view J&J as a healthcare conglomerate with a wide swath of healthcare-related businesses, all housed under one corporate umbrella. We find it notable the rest of the industry, however, is undergoing a “simplification process’’ where all non-core research-based products are divested to focus on drug discovery.
The first divestiture centers on the LifeScan division, which is best known for its home diabetes monitoring products sold under the One Touch brand. We agree with the move to divest the business as reimbursements remain challenging, as the US government looks to rein in costs. The division is slated to be sold to Platinum Equity for $2.1 billion with the transaction expected to close by year-end 2018.
J&J is exiting the sterilization business as it looks to shed its Advanced Sterilization Products (ASP business) for $2.7 billion in cash to Fortive (FTV). The ASP business is far from a household name as it specializes in products such as the Evotech endoscopy cleaner and reprocessor. The business can be termed a stable low growth entity with the overall addressable market expected to grow to $5.5 billion by 2022 (4-6% annual growth), far from the stellar growth typically seen in newly-patented pharmaceuticals. The transaction is expected to close by the early part of 2019 at the latest.
We suspect J&J is undergoing a healthy examination of its product suite, with an eye towards divesting slower-growing products to free up capital for higher valued added products such as the audacious purchase of Actelion for its Pulmonary Hypertension products. We do not believe J&J will become a pharma pure-play by divesting its iconic Consumer Care division with such household staples as J&J baby shampoo, powder, etc.
Concluding Thoughts
We continue to maintain the view the J&J healthcare conglomerate is the optimal structure to ensure a healthy dose of equity stability coupled with consistent annual dividend hikes. The drawback of such a sprawling empire is the lack of eye-popping revenue expansion and earnings growth, as the sheer size of J&J precludes it from posting a sudden acceleration in revenue. Instead, we view J&J in terms of the “meticulous gardener” who expertly prunes its “garden” of underperforming assets while selectively adding new entities with faster growth prospects as its replacement. We believe J&J’s litigation risk is manageable, “Johnson & Johnson’s Litigation Risk Manageable.”
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Heathcare and biotech contributor Alexander J. Poulos is long Gilead Sciences. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.