Health-Care Stocks: A Dose of Reality from J&J

Profits were higher than Wall Street anticipated, but investors want to see signs that sales are improving

By David Bogoslaw

It's likely to be some time before health-care companies begin to enjoy the fruits of any economic recovery, judging by Johnson & Johnson's (JNJ) slight third-quarter revenue miss on Oct. 13. To be fair, the profits the company reported were higher than anticipated. But that stemmed mostly from cost-cutting and an unexpectedly low tax rate, while analysts and investors want to see signs that sales are improving.

The New Brunswick (N.J,) company earned $1.20 a share in the third quarter, beating analysts' $1.13 consensus estimate and the year-ago results of $1.17 a share. Revenue fell 5.3% from last year to $15.1 billion, with nearly half the decline coming from an adverse foreign currency impact. Analysts were looking for $15.22 billion in sales in the latest quarter. "Companies are not going to be given credit for financial management. They're going to be given credit for sales [growth]," says Jan David Wald, an analyst atNoble Financial Group in Boston. "Health-care companies can drop more [money] to their bottom line. That's not evidence of strength anymore."

Johnson & Johnson shares were down as much as 3% during trading on Oct, 13 before closing 2.4% lower at $61.01.

Medical Device Tax

The selling probably came in response to the disappointing sales numbers, but market sentiment wasn't helped by a 14-9 vote by the Senate Finance Committee — just hours after the company's earnings conference call — approving a $829 billion overhaul of the U.S. health-care system. Health-care reform is widely expected to put additional pressure on health-care companies' earnings.

The Senate health-care bill includes a provision to impose a $40 billion tax on the medical device industry over a 10-year period, That would amount to $4 billion a year, which is said to be apportioned among companies according to their market share. Johnson & Johnson is reportedly trying to get the medical device tax reduced by half or more.

If the tax ends up being only 1% of sales, "companies can find some other cost cuts and maybe do some other restructuring if they have to in order to offset it," says Jeff Jonas, an analyst at Gabelli (GBL). "But if it's 3% to 4% of sales, that's too big. That's going to really eat into their profits." Gabelli owns shares of Johnson & Johnson.

Baby-Care Weakness

Johnson & Johnson's global pharmaceuticals sales fell 14.1% to $5.3 billion, with 2.2% of the decline caused by negative currency translation effects. In the U.S., increased competition from generic products was especially damaging for sales of Johnson's anti-psychotic drug Risperdal, and Topamax, a drug for treating epilepsy and migraines.

Consumer sales worldwide dropped by 2.7%, to $4.0 billion, from the third quarter of 2008. Weakness in the baby-care products line does not bode well for other health-care companies directly connected to consumers, as opposed to hospitals and other commercial customers, says Wald at Noble. Baby-care products are one category he says he thought would have been somewhat immune to the weak economy.

A decline in sales of up to 20% for elective procedures such as breast implants and wrinkle removal is further "evidence that the closer you get to touching the consumer, the more likely you were to run into problems," he adds.

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