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Announcement on 26 February, 2024
Growth Above Expectations Can Continue With A Timely Acquisition
- The company reported solid Q4 earnings, scoring 7.3% Y/Y revenue, led by the Med Tech segment.
- Ambrx Biopharma's acquisition for $2b could serve as a positive catalyst, as Antibody Drug Conjugates (ADCs) are the current ”hot thing“ in the pharmaceutical sector. Ambrx acquisition would help JNJ to develop a quality product pipeline in that segment.
Talc Case Remains a Storm Cloud Across The Horizon
- JNJ confirmed the company has agreed to pay $700 million to settle a probe by over 40 state attorney general offices into the marketing of its controversial talcum powder product.
- This settlement only involves state attorneys, while the company still faces more than 50,000 lawsuits filed by users of the product. JNJ has offered to settle for around $8.9 billion, but this sum might be as high as $10-12 billion.
I am leaving my Neutral thesis unchanged for a moment's notice but monitoring the situation as the situation remains unclear until the lawsuit gets resolved.
Key Takeaways
- I expect JNJ to remain an established and mature market performer in a relatively stable sector.
- Some short-term company-related headwinds are cancelled out by long-term industry-related tailwinds
- Two main risks come from the talc-related litigation issue and patent expiration
- Most promising revenue growth opportunities are from cancer therapy drugs, with a TAM of $21.6b.
Catalysts
Industry Catalysts
Implementation of Artificial Intelligence (AI) lowers overheads, improving profitability
AI has been the most prominent financial market tailwind in 2023, and its broad influence didn't miss the healthcare & pharmaceutical sectors. Naturally, these sectors have very expensive research & development processes, which take years due to the vast amounts of data for processing.
For example, during a drug discovery experiment, cells representing a specific disease are exposed to various compounds, and each following reaction creates a microscopy snapshot.
A single experiment might generate as many as 500k snapshots. While scientists already use AI to sort through them, researchers are now developing AI to predict the likely reaction of different types of cells to the same compounds – cutting short the research process when starting a new study. Hugo Ceulemans, Director of Janssen R&D, believes this AI method is up to 250 times more efficient than the traditional drug discovery method.
With this new technology, we could see JNJ's research and development expenses decrease as a percentage of revenues (not in dollar amount) (currently R&D is 15% of revenues)
Increasing Cancer Rates Create Opportunity to Fill the Gap in Therapeutic Market
As our lifespans get longer, the odds of developing cancer also rise. While the average age at diagnosis is around 68, a new study shows a dramatic increase in cancer among adults younger than 50. Scientists attribute this to various reasons, mainly tied up to lifestyle. Stress, dietary habits, smoking, alcohol consumption, and even sunbathing – are all factors in the ”emerging cancer epidemic.“
Unfortunately, this means that the global cancer drug market is growing. It is currently projected to be worth around $151.55b in 2023, with an estimated CAGR of 11.43% that will double the market to $306.1b by 2030. JNJ provides Darzakex, Carvykti and Tecvayli , which are currently widely used for existing cancer treatment. While it’s sad to acknowledge the underlying cause of the market growth, this means JNJ is well positioned to continue serving this need from patients.
Personalized Healthcare Improves Patient Outcomes
The concept of precision medicine avoids a one-size-fits-all approach and specifically tailors the treatment to a group of patients based on factors like age, genetics, and risk factors. The most advanced approaches consider a person's genetic information, which also serves as an early warning system.
Classifying individuals into high-risk groups and conducting preventive tests leads to earlier diagnosis, earlier treatment, and better odds of recovery. The global personalized healthcare market was worth $538b in 2022 (48.1% of that is the U.S.), with a projected compound annual growth rate (CAGR) of 7.20% from 2023 to 2030.
29% of JNJ’s revenue comes from its Medtech offerings and alongside Medtronic it is the leader in personalized healthcare space. This means it’s a beneficiary of this continued trend of personalized healthcare. Its Medtech products include joint reconstruction, devices for treating orthopedic trauma, spinal care and sports medicine. MedTech is a $570b market, growing at 4.7%, with a projection to reach $720b by 2028.
Company Catalysts
New Product Potential Could Enhance Revenue Streams
JNJ has several promising drugs in its pipeline, including Erleada, Imbruvica, Stelara, Zarelto, and Zytiga. However, the cancer therapy drug Carvytki has one of the largest sales potential. It is a chimeric antigen receptor (CAR)-T- cell therapy - a type of immunotherapy treatment that uses genetically altered immune cells for locating and destroying cancer cells.
Carvykti has already received FDA approval as a 5-th-line treatment for Multiple Myeloma (MM) patients. Yet, JNJ is now looking for a supplemental biologic licensing application approval to treat MM patients much earlier potentially. The MM market was valued at $21.6b in 2022, and it is expected to grow at 6.3%, reaching $33.1b by 2030.
This Carvytki drug could help increase its Pharmaceutical revenue streams given it’s the best drug on the market for this disease.
As for the other drugs in the pipeline (Erleada, Imbruvica, Stelara, Zarelto, and Zytiga), they’re still in various stages of clinical trials, so it’s hard to have any certainty about their contribution to revenues.
High Portfolio Concentration
JNJ has the majority of its income coming from the pharmaceutical division. Yet, that division itself is rather concentrated, with most sales coming from the top 4 drugs. In 2021, approximately half of the revenues came from Stelara, Darzalex, Imbruvica, and Invega. Such concentration comes with high risks, particularly due to patent expirations when generic drugs could take their market share.
While Invega, Imbruvica, and Darzalex expire in the 2030s, Stelara's patent expires in September 2023. Stelara has been one of JNJ's more lucrative assets, bringing $9.7b in revenue in 2022 (10% of total revenues). Still, the change won't be immediate, as JNJ has signed settlement agreements with Alvotech and Teva, who won't launch their biosimilars on the U.S. market before 2025.
Complications From Talc-related Litigation
JNJ is facing an extensive class-action lawsuit related to cancer-causing asbestos present alongside talc in their baby powder. Facing approximately 100,000 claims, J&J offered a $8.9b settlement but also tried absorbing the claims through a Chapter 11 bankruptcy of an affiliate, LTL Management LLC, strictly formed to absorb the talc claims.
However, a US Bankruptcy judge rejected a second attempt to resolve the situation, claiming that the company wasn't in immediate financial distress to qualify for Chapter 11.
The “divisive merger,“ first allowed in Texas in 2006, has been used by companies like 3M and Georgia-Pacific in an effort to stop further litigation, capping its costs. However, the trend is clearly against such practices.
According to Reuters, J&J allegedly knew about these risks for decades, with the earliest mentions of tainted talc going as far as 1957.
With the pushback against solving the litigation through an affiliate company, it is likely that the settlement and litigation cost might need to come from JNJ’s pocket, meaning we could see a one off $8.9bn expense take a chunk out of their cash balance. With the latest news, I view the probability of this occurring as likely/unlikely.
Dividend History and Price Stability
With interest rates at multi-decade highs, yield-oriented stocks are not in the spotlight as they used to be. However, interest rates seldom stay high for too long, and investors eventually seek quality dividends again.
With a 62-year-long history of dividend increases, JNJ stock is an attractive dividend-paying prospect. Particularly given its forward yield of 2.82%, which is well above the industry average of 1.6%. Yet, a high payout ratio of 92% is worth noting, meaning that possibly too much earnings get paid out as dividends.
Finally, a low monthly beta (0.5) is another plus for investors seeking stability, which means the stock is far less volatile than the average market.
Kenvue Spinoff
JNJ completed a Kenvue spin-off earlier this year as a standalone successor to JNJ's consumer health division. Currently, JNJ owns a majority stake in the business, although it incentivized its shareholders to swap some of shares at a 7% premium ($100 in JNJ shares to receive $107 in KVUE).
Kenvue owns popular brands such as Band-Aid, Listerine, and Tylenol. The company is well-capitalized, with a strong cash flow and an attractive dividend yield. As a smaller, more nimble business, Kenvue can pursue higher growth and deliver stronger returns in the long run. And, as a majority shareholder in the business, JNJ will benefit from this growth.
Assumptions
Growing Revenues and Stability
Outside of FDA drug test approvals for minor companies, Healthcare and Pharmaceutical sectors are unexciting but steady performers. Thus, low Beta stocks like JNJ attract particular interest because they lower the volatility of investors' portfolios.
Given the healthcare industry, is expected to grow at 10.4% over the next 5 years,I believe JNJ revenues will continue growing, with a minor slowdown in 2025 due to expiring patents, but averaging 3% per year over the next 5 years.
New Products will Successfully Replace Lost Revenues
The company can rebalance its product portfolio to compensate for the sales lost due to available biosimilars. So far, Darzalex sales show potential , growing to $2.43b in Q2 2023, +22.4% Y/Y, while Tremfya grew to $706m in the same quarter, or 18.3% Y/Y. JNJ expects Darzalex to exceed $10b in sales for 2023.
Carvykti has a strong potential to revitalize revenues, as its sales grew over 60% Q/Q to $117M. I expect sales to break $750M by 2024 if the company receives additional approvals.
Finally, the FDA just approved the oral anti-cancer agent Akeega as a combination therapy for certain adults with metastatic castration-resistant prostate cancer. As a statistically significant combination therapy with prostate cancer drug Zytiga, this approval should boost Zytiga's sales which declined 23% in 2022 but still generated $1.8b. Prostate cancer has a market size of $12b, and it is growing by 8.7% per year.
Talc Litigation will Resolve at a Higher Cost
I expect the talc litigation to resolve in the near future. So far, the litigation expense sits at $8.9bn – which is considerable even for a company of this size. While U.S Bankruptcy Judge Michael Kaplan halted the second bankruptcy attempt by the LTL Management LLC subsidiary, he rejected a 6-month ban on future bankruptcy filings. I believe this scenario will pressure both parties to find common ground, resulting in a slightly higher settlement offer.
I believe one case that went to a trial is the sole example due to an extremely rare disease which is different from almost all other pending cases.
Risks
In my current narrative, I don’t believe JNJ’s growth prospects justify the current price. However, there are a few “risks” to my narrative that could help the company perform better than I anticipate.
New Drugs Performing Better Than Expected
FDA just approved Akeega and Talvey for prostate cancer and multiple myeloma treatment, which was a success for JNJ since these are large and growing markets.
However, executive VP Jennifer Taubert stated they base their optimistic growth projections based on multiple novel medicines in the pipeline. Less known drugs like IL-23 inhibitor Tremfya (for psoriasis and psoriatic arthritis) could find new applications in Chron's disease and ulcerative colitis. Chron's disease treatment market alone is around $11.7b in 2023.
If JNJ wins more FDA approvals for its novel combo treatments, it could grow faster than anticipated.
Accelerating Industry Growth
Healthcare and pharmaceutical industries are generally regarded as “stable” and “reliable”. They're typically outside of the spotlight (besides drug trials and the occasional scandal).
Still, despite stable growth, there is a possibility these industries accelerate growth at a much higher pace than I anticipate.
With higher life expectancy and a declining birth rate, the number of the population over the age of 65 is drastically increasing in the U.S. Between 2010 and 2020; the 65+ population increased by 15.5 million, and as of 2021, there were 55.8 million people aged 65 and over in the US. This accounts for 15.6% of the population, and that’s expected to grow to 22%.
Since the healthcare industry disproportionately serves this population segment, its growth could benefit firms like JNJ more than I anticipate.
How well do narratives help inform your perspective?