After their latest quarterly report on the 20th of July, Johnson & Johnson (NYSE: JNJ) prescribed investors a hefty dose of excitement as they delivered a double beat for the second quarter of fiscal 2023. Investors reacted with an immense influx of buying volume, pushing the share price up a staggering 6%. As we advance, can the pharmaceutical giant continue treating its investors with its healthy financial performance?
The quarter’s earnings per share (EPS) came to $2.80, up from the second quarter of the prior year’s $2.59, exceeding the forecasts of $2.62. Similarly, the company generated revenue of $25.53Bn, showing steady growth from the previous $24.02Bn, while shattering the $24.67Bn consensus. After adjusting its full-year guidance upward, CEO Joaquin Duato reiterated the company’s position by stating that they are entering the second half of the year with multiple tailwinds, most notably its drive toward a two-sector company which focuses on Pharmaceuticals and its fast-growing MedTech innovation segment.
Technical
On the 1D chart, an ascending triangle has formed, where a breakout occurred following the earnings release. Since then, the bulls have sustained the rally, breaking through the Fibonacci golden ratio from the late-March bottom at $169.02.
If the daily pivot support at $169.73 holds in the upcoming session, the bullish trend could continue, with resistance established at $175.10. In the longer term, a breakout above this resistance could open a pathway to complete the retracement at $179.95. From there, the estimated fair value of $182.69 is within reach, providing a 7% potential upside from current levels.
However, if the daily pivot support fails, a retracement toward the $169.02 golden ratio is on the cards, where the breakout point of the triangle could offer support at $166.51. Sustained downward momentum could break down the Fibonacci midpoint at $165.53 before looking for buyers at lower support, around $161.01 and $156.77.
Fundamental
The graph below shows Johnson & Johnson’s revenue positioning relative to earnings compared to its industry peers. They generate the most revenue while creating healthy earnings above all their closest competitors. In the latest quarter, the company enjoyed growth across the board, with Pharmaceutical revenue growing 3.1% year over year to $13.73Bn, and MedTech revenue realizing double-digit growth, up 13% to $7.79Bn. Consumer Health sales were also up, rising 5.4% to $4.01Bn. As we advance, the company will focus on Pharmaceuticals and MedTech innovation.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
In terms of their MedTech segment, most of the revenue is generated through surgical equipment, which grew 5.9% to $2.6Bn. Orthopaedics was up 5%, mainly driven by a 6.1% expansion in the trauma segment, while spine and sports injuries saw a 5.8% rise to $766M. Solid growth was also realized in the Vision segment, which saw a 5.4% rise to $1.31Bn. As we advance, this segment is set up to be their high-growth segment, which could be topical in future earnings releases.
Source: FairMarkets Australia – Johnson & Johnson, Tiaan van Aswegen
However, their largest segment remains Pharmaceuticals. With immunology and Oncology as the main drivers, this segment benefitted from their new cancer drug, Carvykti, which brought in $117M in revenue, up 388% from the prior year’s quarter. The company aims to continue organically growing its existing assets in this segment, with the likes of Concerta and Spravato already realizing 28.6% and 98.2% growth in the recent quarter.
Source: FairMarkets Australia – Johnson & Johnson, Tiaan van Aswegen
The company’s performance over the last three years has been somewhat less than optimistic. While the healthcare sector is considered defensive, Johnson & Johnson’s 14.35% return is less than half that of the S&P 500, which returned 40.76% over the same period. Similarly, the broader healthcare sector has returned 27.92%, with competitors like Merck & Co and AbbVie Inc. driving the sector upward with returns of 39.37% and 46.06%, respectively. The lack of catalysts to unlock share price appreciation could cause concern, but the company’s recent strategy focus might be the catalyst needed to propel it toward its former glory.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
One of the focal points that stood out in the earnings release was management’s decision to engage in a share exchange with Kenvue, the consumer health spin-off that Johnson & Johnson decided to separate from their core operations. Kenvue went public through an IPO in May 2023, and Johnson & Johnson is now taking the next step toward segregation by offering 80.1% of its 89.6% ownership of Kenvue to its shareholders in exchange for Johnson & Johnson stock. This segregation reflects the company’s current strategy toward creating meaningful value for shareholders by focusing on its Pharmaceutical segment, its most significant revenue driver, by growing its existing assets and continuing the uptake of newly launched products. Additional focus will also be placed on their MedTech segment, which offers them exposure to higher-growth markets, as accelerating volumes in medical procedures provide a tailwind for growth in this segment.
Along with their shift toward a two-segment company, Johnson & Johnson also engages in growing Research and Development (R&D) costs. The graph below depicts the consistent year-over-year growth in R&D expenses as the company attempts to continue growing organically. However, when focusing on their free cash flow (FCF) generation, it becomes evident that the growth rate in FCF is slowing down. To continue sustainably increasing its R&D, the company may need to find ways to expand its FCF growth to make additional cash flow streams available for investment to prevent becoming more levered and taking on additional debt in the current interest rate environment.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
While the earnings release was positive, there are some inherent risks that investors should be aware of. Recently, Johnson & Johnson has been sued by tens of thousands of individuals over their Baby Powder and other talc products that allegedly contain asbestos that causes ovarian cancer and mesothelioma. On Tuesday, A jury decided that the company must pay $18.8M to Emory Hernandez Valadez, who developed mesothelioma due to longstanding exposure to the company’s talc from a young age. However, Johnson & Johnson’s vice president of litigation, Erik Haas, said that the company would appeal the verdict, denying that the Baby Powder is unsafe, claiming that scientific evaluations confirm that their product does not contain asbestos or cause cancer. Additional clarity on their litigation could be useful, as investors remain cautious about the financial effects these accusations could have on the company’s performance.
Summary
Johnson & Johnson reported stellar earnings last week, which fueled a rally in its stock price, as investors reacted favourably to a top and bottom line beat. With a solid runway to continue its consistent top-line growth in upcoming quarters, the company looks well-poised for further upside. However, the risk surrounding their current litigation clouds the outlook, sparking uncertainty that could cap the upside. If the trend continues, the estimated fair value of $182.69 provides a 7% potential upside from current levels.
Sources: Koyfin, Tradingview, Reuters, Yahoo Finance, Investor’s Business Daily, Johnson & Johnson