Johnson & Johnson Upgraded On Synthes Approval
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Staid, predictable Johnson & Johnson (NYSE: JNJ) has received a slew of analyst upgrades in recent days. Specifically, JPMorgan (JPM) raised its opinion of Johnson & Johnson to overweight from neutral, Raymond James (RJF) upgraded it to outperform from market perform, and Jefferies Group (JEF) upgraded it to buy, from hold.
The reason for the raised opinions of the big drug and health care equipment maker is its acquisition of Synthes, a large Swiss maker of orthopedic surgical supplies. When first announced, this roughly $20 billion deal was expected to be dilutive to Johnson & Johnson shareholders. Now, the deal seems to be more accretive initially, and what is more, it seems to have taken attention off of the reasons why Johnson & Johnson has underperformed the market lately.
Since 2007, four of five of Johnson & Johnson's leading drugs have experienced expirations of their patent protection. More recently, its wholly owned McNeil Labs subsidiary went through a devastating series of recalls of numerous brand names over the counter medicines. Through it all, however, full year 2011 marked the 29th consecutive year that Johnson & Johnson reported increased year over year earnings, and the 50th consecutive year of a dividend increase. I know of no companies that can match that record of bottom line consistency.
The downside is that in return for the unmatched consistency there has been very limited growth in either revenues or stock price of late. First quarter 2012 revenues for Johnson & Johnson grew just 1%, assuming stable currencies. Currency fluctuations drove revenues down by 0.2% to $16.1 billion. Absent special factors, the company sees 2012 earnings overall of within five cents of $5.12 per share. In 2011, earnings came to an even $5 per share.
Growth help is on the way. The FDA has recently given final approvals for several drugs, including anti prostate cancer drug Zytiga, anti HIV drug Edurant, and anti-hepatitis C medicine Incivo. On the strength of these new, high priced medications, analysts foresee meaningful “organic” revenue growth going forward of 5% annually, the highest revenue growth pace since the mid 2000's.
This brings us to the recent European approval of Johnson & Johnson’s plan to acquire Synthes. The growth from orthopedic expertise is apparent worldwide as the population of increasing affluence ages. But in order to make it immediately accretive, certain hoops had to be jumped through to avoid the U.S. Internal Revenue Service. That involved a wholly owned Irish subsidiary becoming the actual buyer of Synthes, with help from JPMorgan and Goldman Sachs (GS). The rather elaborate lengths done to deprive the IRS and the American Taxpayers can be found here. I understand fully that management owes a fiduciary duty to shareholders. But the lengths Johnson & Johnson, along with many other American companies, go to reduce their domestic tax burdens is appalling.
Johnson & Johnson is trading now at a price to earnings ratio of about 11.8, based upon management's earnings estimate. I am optimistically looking for earnings of about $5.75 per share in 2013, and at today's price level, there is definitely room for upward movement in the stock price. Analysts' 12 month price target is about $73, implying about a 14% one year total return including the current 3.7% dividend yield. For a company as financially healthy and predictable as Johnson & Johnson, a 14% return is nothing to sneeze at it. There are few better choices for conservative or income oriented investors than Johnson & Johnson.
Eli Lilly (NYSE: LLY) is also in the news due to a new drug. It, like most other large pharmaceuticals, is struggling to make up for blockbuster drugs with expired patents. Zyprexa and Gemzar both recently lost patent protection, sending Eli Lilly revenues, profits, and the stock price down for the full year 2011, and then again in the first quarter of 2012. Eli Lilly has a true blockbuster still in Cymbalta, and is on the cutting edge of Type II diabetes treatments, for which there is a booming worldwide increase in incidence. It will take a year or more for these drugs to receive approvals and gain traction worldwide, but when accomplished, I expect a worldwide blockbuster. This may be enough to carry Eli Lilly earnings far beyond today's levels. But even today it is hardly expensive at just 11 times earnings. The company has an excellent balance sheet and offers a current dividend yield of 4.7%. For these reasons, I see Eli Lilly as a winner for the long term investor.
On the other hand big drug maker Pfizer (NYSE: PFE) received some bad news when, despite being approved by European authorities, Pfizer's new treatment for a rare neural condition was denied by the FDA which ordered a second efficacy study. This medication though would never be a blockbuster, but still it was assumed that the FDA would follow the European lead. Not so fast.
Pfizer, along with most other major domestic drug manufacturers, is in Phase Three testing of a drug designed to slow the progress of Alzheimer’s disease. Several different drugs are under investigation, and the first one to market in this rapidly growing disease segment will be a sure winner.
Pfizer has been struggling with the loss of its best selling drug ever, Lipitor, to patent expiration. It is also selling its vaunted animal products division. But the fact is, unless or until Pfizer can bring several billion-dollar drugs to market, it will be a shrinking company. There are candidates that have recently been released or are in Phase 3 testing, but replacing a $10 billion per year franchise is not easy and Pfizer's planned reduction in research and development spending is not going to help its pipeline situation.
Pfizer has too many issues for my taste right now, and it is a fine case study on the dangers of being too dependent upon a single product. I would not be a buyer of Pfizer for now.
jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend Johnson & Johnson and Pfizer. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.