3 Things You Won't Learn by Focusing on Johnson & Johnson's Headline Figures in Its Q3 Report

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Johnson & Johnson (NYSE: JNJ) often kicks things off for the healthcare sector with the release of its quarterly earnings, and once again, the largest healthcare company by market cap surpassed Wall Street's loftiest expectations.

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Johnson & Johnson's Q3, by the numbers

For the quarter, J&J, as it's more commonly known, generated $19.65 billion in sales, a 10.3% increase from the prior-year period.  J&J was obviously aided by its acquisition of Actelion, whose specialty lung disease drugs tacked on approximately $670 million in sales during the third quarter. Overall, pharmaceutical growth, sans currency fluctuations, came in at 14.6% during the third quarter, with operating growth of 1.6% for consumer health products and 6.6% for medical devices. It should be noted that the acquisition of Abbott Medical Optics accounted for 5.2% of the 6.6% increase in medical devices, meaning organic growth was a bit tamer. Nonetheless, J&J topped Wall Street's sales expectations by more than $300 million.

Seemingly as always, Johnson & Johnson also handily surpassed profit projections from Wall Street. After accounting for acquisition-related expenses, the company earned $1.90 per share, which was a clean $0.10 ahead of expectations.

Management also wound up increasing the company's full-year earnings and sales outlook for the third time this year. The new guidance calls for $76.1 billion to $76.5 billion in sales and adjusted full-year EPS of $7.25 to $7.30. That's up from its second-quarter guidance calling for $75.8 billion to $76.1 billion in sales and $7.12 to $7.22 in adjusted full-year EPS. 

Three things we just learned about Johnson & Johnson and the drug industry

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By the headline figures, it was another great quarter for J&J and its shareholders. But focusing on the headline figures alone will leave you missing some key pieces of the puzzle. Here are three important things we learned about J&J and the drug industry from its Q3 report.

1. Biosimilars are going to change the game

Despite growing pharmaceutical sales, J&J's highest-margin operating segment, by 14.6% on a constant currency basis, worldwide sales grew by only 6.7% without the aid of acquisitions. What becomes even more apparent if acquisitions and divestments are excluded is that J&J's mature drug portfolio is beginning to stagnate. Why, you ask? While patent expirations are a threat to all brand-name drug developers, J&J has found itself with a bull's-eye on its back by biosimilar drugmakers.

Biosimilar drugs are nothing more than biologic copycats of brand-name drugs. Drugmakers focusing on biosimilars are angling to bring these therapies to market at a double-digit percentage discount to the list prices of brand-name drugs, potentially stealing significant market share in the process. No one was exactly sure how successful biosimilars would be given the legalese surrounding patent protections, but a sales decline in J&J's blockbuster anti-inflammatory Remicade is showing that biosimilars should be able to carve out a healthy niche in the prescription drug industry.

As reported, Remicade's worldwide sales fell by 8.2% on a constant-currency basis to $1.65 billion during the third quarter, which included a 1.3% decline in U.S. sales, a 10.2% decline in international sales, and a 38.8% tumble in U.S. exports. J&J and its management can no longer mask the fact that biosimilars are a force to be reckoned with.

2. Invokana's troubles are for real

Secondly, we learned that the recent struggles of Johnson & Johnson's blockbuster type 2 diabetes drug Invokana are for real. Sales of J&J's top-selling diabetes drug have tumbled by 18.3% on an operating basis year to date, and they plunged by 19.3% during the third quarter. While international sales grew by nearly 32%, sales in the U.S. tumbled by just over 25%.

What's going on with Invokana? Part of the blame could be an increase in competition in the SGLT-2 inhibitor space. Invokana is a drug that works by blocking glucose absorption in the kidneys and allowing the patient to excrete excess glucose through their urine. The SGLT-2 class of drugs also offers the welcome side effects of lowered systolic blood pressure and weight loss in patients. While Invokana was the first SGLT-2 inhibitor to make it to market in the U.S., which came with obvious advantages, there are now about a half-dozen SGLT-2 inhibitors on pharmacy shelves.

Perhaps the bigger issue is the mixed long-term study results for Invokana released this year. On one hand, while the Canvas studies matched Eli Lilly's (NYSE: LLY) and Boehringer Ingelheim's Jardiance in terms of successfully lowering the composite measure of cardiovascular risk, two separate studies run by J&J also showed a higher risk of foot and leg amputations for Invokana users relative to a placebo. Mind you, the risk was still quite low for Invokana users, but it's a warning that's clearly resonating with physicians and consumers based on its recent sales swoon. J&J thankfully has a large drug portfolio to fall back on, but Invokana's run may be officially done. This might be Jardiance's market share to lose moving forward given that it doesn't have the same safety concerns as Invokana.

3. Even Johnson & Johnson is fallible

Last, but not least, we learned that just because Johnson & Johnson is a healthcare giant, it doesn't mean the company isn't capable of disappointing investors.

In May of this year, the company outlined a plan to file new drug applications for at least 11 blockbuster drugs by 2021. A blockbuster drug is defined as one that has $1 billion or more in annual sales. Between 2009 and mid-2014, half of J&J's 14 novel medicines that were brought to market reached blockbuster status. This is a big reason why the company's pharmaceutical sales have soared in recent years, and why pharmaceuticals have been accounting for an increasingly larger percentage of total sales.

However, two of the developing drugs that were part of this earlier announcement – sirukumab for rheumatoid arthritis, and talacotuzumab for acute myeloid leukemia -- have now been shelved, according to Johnson & Johnson. 

Sirukumab's fate was sealed when the Food and Drug Administration (FDA) declined to approve the drug in September. The FDA cited the an imbalance in the number of deaths in patients taking sirukumab relative to the placebo for its rejection, and required J&J to run additional clinical safety studies before it'd consider approving the drug. J&J found it easier to shelve sirukumab given that rheumatoid arthritis is already a crowded indication. 

J&J gave no reason for the discontinuation of talacotuzumab, which had moved into the phase 3 portion of its phase 2/3 trial earlier this year. 

Steady as she goes

Despite some relative weakness hidden beneath juicy headline figures, there's nothing to suggest that J&J's growth strategy has been derailed. Losing two of its 11 expected blockbuster drugs may encourage the company to be more active on the collaboration or acquisition front, but this isn't really anything new that we haven't seen from J&J in recent years. Margins remain high, its portfolio is well-diversified, and the company's dividend is truly a marvel after increasing for 55 consecutive years. If you're a long-term shareholder, you're still in great shape.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson. The Motley Fool has a disclosure policy.