Johnson & Johnson Earnings: Don't Expect An Investment Surge

(Bloomberg Gadfly) -- Johnson & Johnson kicked off Big Pharma's earnings/what-will-you-do with-your-tax-cut-proceeds season Monday morning. It managed to disappoint on both fronts.

The company met or beat analyst expectations for both fourth-quarter earnings and 2018 guidance. But there were enough areas of concern within the results that shares fell 2 percent Tuesday morning. And J&J's detail-light promise to use its tax windfall to invest more in "innovation" is likely to frustrate as well.   

The midpoint of J&J's adjusted-earnings growth guidance for 2018 is 8.2 percent, about double its projected operational sales growth. That difference will be driven partly by consequences of the tax law and the growing impact of some higher-margin medicines. But the gap still suggests a trickle of new spending rather than a flood. 

For one thing, the company faces real sales-growth headwinds. Its aging blockbuster inflammation drug Remicade -- its best-selling product -- has held up relatively well to new biosimilar competition in the U.S. But sales are still declining and will likely fall more steeply in the year to come, now that there are two competing options available. Sales of several other prominent drugs, including Stelara and Invokana, didn't meet analyst expectations for the quarter.

J&J doesn't believe this will be a big year for new generic competition for other drugs, but there may be negative surprises on that front. The most likely source is the prostate-cancer blockbuster Zytiga, which is under greater threat after a successful patent challenge from competitors.

What's more, J&J is already spending plenty. Last year marked its biggest reported annual increase in R&D spending in a decade.

J&J has one of the biggest R&D budgets in the industry. It has spent more than other large pharma firms on M&A since 2015, most of it coming in the past year with the $30 billion purchase of Actelion. And the company has done almost twice as many drug-licensing deals as its nearest large pharma competitor over that same period, according to Bloomberg Intelligence. 

Much of the firm's cash flow and tax windfall will go to the sector's biggest dividend and substantial share buybacks, which ate up $19 billion in 2017. J&J also suggested on Tuesday's call that it will likely pay down more debt this year. J&J has spending obligations to match its size, and it has raised an unnatural amount of debt to fund them because it didn't want to pay high taxes on overseas cash. That's no longer an issue.

J&J still has a strong balance sheet and cash flow, and even slower growth is highly impressive for the health-care behemoth. Adding tax-cut benefits to that solid base may let J&J substantially increase investment while maintaining earnings growth.

My guess? Fabulous 2018 earnings numbers, but only very modest spending increases. 

Corrects date in second and eighth paragraphs

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Max Nisen is a Bloomberg Gadfly columnist covering biotech, pharma and health care. He previously wrote about management and corporate strategy for Quartz and Business Insider.

©2018 Bloomberg L.P.

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