J&J's strong quarter was amplified by new details around its big Kenvue consumer unit stake

Published Thu, Jul 20 20232:11 PM EDT

Johnson & Johnson (JNJ) reported strong second - quarter profit and revenue before the opening bell Thursday, with better-than-expected results both domestically and internationally, as well as across all major operating segments. J & J's second-quarter reported sales rose 6.3% year-over-year to $25.53 billion, exceeding the Refinitv consensus estimate of $24.63 billion. (On an adjusted operational basis, which excludes the impact of acquisitions and divestitures as well as currency fluctuations, sales rose 6.2% annually.) Adjusted diluted earnings came in at $2.80 per share, a solid beat versus the $2.59 per-share estimate and just over 8% higher than a year ago. (On an operational basis, earnings per share (EPS) increased 9.7% year over year.) JNJ YTD mountain Johnson & Johnson (JNJ) YTD performance Wall Street on Thursday was rewarding the Club name and Dow component handsomely even as uncertainty remains around how the company can resolve the tens of thousands of talc lawsuits filed against it. Those talc litigation worries have weighed on the stock this year, with shares down more than 4.5% year to date compared to the S & P 500 's nearly 18.8% advance over the same stretch. Bottom line While talc remains an overhang, there was a lot to like in this report. All three segments performed better than expected. We saw strength across the globe. Though not earnings related, we also got a welcome update on management's plans for the remainder of the company's stake in Kenvue (KVUE), J & J's consumer health split-off that became a publicly traded stock back in May. As a result of the strong performance, management raised their sales and earnings outlook for the remainder of the year and reiterated their ambitious 2025 Pharmaceutical sales target. Additionally, management called out an annual improvement in the company's income before tax profit margin, which expanded to 34.6%, a 60 basis point expansion versus the year-ago period as improvements in the Pharmaceutical and MedTech divisions were only partially offset by a contraction in Consumer margins. While remaining conscious of talc litigation concerns, we're reiterating our 1 rating and $195 price target due to the strong operating results and management's update on the Kenvue separation. Given what we saw in Thursday's release, we continue to believe that a resolution on the talc front — even if J & J has to put up a bit more than the $8.9 billion it has already committed to — would result in significant upside as it would remove the biggest thing holding the stock back years. Guidance Compounding the strong quarterly results, management increased their full-year guidance for both adjusted operational sales excluding Covd vaccine-related revenue and adjusted operational EPS. Full-year 2023 adjusted operational sales (excluding the impact of acquisitions and divestitures, currency fluctuations, and Covid vaccine sales) are now expected to increase 6% to 7%, up from the previously forecasted range of 4.5% to 5.5%. Operational sales (excluding currency fluctuations and Covid vaccine sales) are now expected to come in the range of $99.3 billion to $100.3 billion (an increase of 7% to 8%), up from the previously forecasted range of $97.9 billion to $98.9 billion (or annual growth of 5.5% to 6.5%) Reported sales (excluding Covid vaccine sales) are now expected to be between $98.8 billion and $99.8 billion (an increase of 6.5% to 7.5%), up from the previously forecasted range of $97.9 billion to $98.9 billion (or annual growth of 5.5% to 6.5%). This compares to expectations of $98.8 billion coming into the print, so a beat at the midpoint. Adjusted operational EPS (excludes the impact of currency translations) are now expected to be between $10.60 and $10.70 (a 4.5% to 5.5% annual increase), up from the prior range of $10.50 to $10.60 (or a 3.5% to 4.5% annual increase). This guide matches expectations coming into the print, at the midpoint. Adjusted EPS are now expected to be in the range of $10.70 to $10.80 (growth of 5.5% to 6.5% versus the prior year), up from the prior forecast of $10.60 to $10.70 (or growth of 4.5% to 5.5% versus the prior year). Kenvue plans Management updated their thoughts on how to handle J & J's 89.6% interest in Kenvue. Along with the release of quarterly financial results, the company announced it "intends to 'split off' Kenvue shares through an exchange offer as the form of its next step in the separation, subject to market conditions." On the call, management added that a tender offer could launch as early as "the coming days." What this means, is that rather than selling shares into the open market, like we saw with the Kenvue IPO in what is referred to as a "carve out," J & J will offer existing shareholders the choice to exchange all, some, or none of their shares of Johnson & Johnson common stock for shares of Kenvue common stock. This differs from a "spin-off" because investors must give up their J & J shares —whereas a spinoff would simply have the Kenvue position given to them, almost like a dividend. KVUE ALL mountain Kenvue performance since May IPO We like the decision to go the route of a split-off versus the other two options because, as management noted, it offers the company the ability to divest its Kenvue stake while potentially — depending on how many investors choose to accept the offer — while acquiring "a large number of outstanding shares of Johnson & Johnson common stock at one time in a tax-free manner for U.S. federal income tax purposes." Think of this as a kind of buyback that uses no cash and does not reduce the company's future financial flexibility. Given Kenvue's market cap of roughly $48 billion, and J & J's 89.6% stake, we could be looking at a potential buyback in the area of $40 billion. Once we have a better understanding of the terms of the offer, we will provide our own thoughts and an update on our intentions. For now, our initial thought is to stick with our Johnson & Johnson shares as we prefer the Pharmaceutical and MedTech divisions, which will make up the new J & J and trade under the existing JNJ ticker symbol, to the Consumer segment, which will go with Kevnue whose ticker symbol is KVUE. This decision to go the split-off route may well be contributing to the more than 6% increase in JNJ on Thursday and the roughly 3% selloff in KVUE. The thinking behind these moves is to entice investors to take the deal. It's possible that J & J management will offer up Kenvue shares at a discount to market value. If that's what investors are indeed thinking then what we're seeing could be an arbitrage play, with investors buying shares of JNJ with the mind that they can flip them later for discounted KVUE shares. Regardless, arbitrage isn't our game and we want to be invested in J & J for the long term. We believe the new company consisting only of the Pharmaceutical and MedTech-oriented businesses has a large runway for growth ahead of it, after the separation is complete. Companywide Q2 Results from the Consumer unit, represented by Kevnue, will for the time being continue to be reported as part of Johnson & Johnson's quarterly numbers. The only change — since J & J owns 89.6% of Kenvue — is that 10.4% of earnings generated since Kevnue went public in early May to the end of the quarter are no longer attributed to J & J. (Remember, that 10.4% is the part of the Kevnue Consumer business is does not own.) Consumer Second-quarter Consumer sales rose 5.4% year-over-year on a reported basis (as reflected in the earnings table above) to just over $4 billion, exceeding estimates. (On an adjusted operational basis, sales rose 7.7%). As we can see, the outperformance here can largely be attributed to the over-the-counter revenue. On the call, management called out "strategic price increases and growth in OTC globally due to strong pain performance and cold, cough and flu season." Consumer pretax profit margin contracted from "25.9% to 23.5% due to incremental costs to support the standalone Consumer Health business, foreign-exchange impacts and commodity inflation, partially offset by supply chain efficiencies," the team added. Pharmaceutical Pharmaceutical sales were up 3.1% on a reported basis in the second quarter, coming in at $13.73 billion, exceeding estimates. (Sales on an adjusted operational basis rose 3.9%). On the call, management noted that when excluding the impact of lower Covid vaccine results, sales were up 6.2% on an operational basis (which excludes the impact of translational currency). Though small, we want to highlight better-than-expected results and superb annual growth seen in Spravato and Carvykti, the latter of which contributed to over 30% annual growth in J & J's multiple myeloma portfolio. These drugs are "expected to be important contributors to achieving [J & J's] 2025 [Pharmaceutical] sales target" of $57 billion, the team said. The strong growth here is encouraging because the Street remains skeptical of the achievability of this target, currently modeling out just under $55 billion in Pharmaceutical sales for 2025. Management also said Pharmaceutical pretax margin expanded from 42% to 42.7%, "primarily driven by favorable patient mix, sales marketing, and administrative expense leverage." They added research and development (R & D) portfolio prioritization was "partially offset by higher milestone payments." MedTech MedTech sales in Q2 soared nearly 13% on a reported basis to a better-than-expected $7.79 billion. (Sales rose 9.9% on an adjusted operational basis). Driving the results were "electrophysiology products in Interventional Solutions, trauma in Orthopedics, wound closure products in General Surgery, biosurgery in Advanced Surgery, and contact lenses in Vision," the company said. MedTech pretax margin expanded from 26.5% to 28.6%, "driven by favorable intellectual property-related litigation settlements and cost management initiatives partially offset by commodity inflation," the team added. (Jim Cramer's Charitable Trust is long JNJ. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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A Johnson & Johnson building is shown in Irvine, California.

Mike Blake | Reuters