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

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Health-Care Uncertainty

Worldwide sales of $5.8 billion for the medical devices and diagnostics division were 2.3% higher than a year ago. The company's orthopedic joint reconstruction, spine, and sports medicine products and minimally invasive surgical products were big contributors to the growth in this business. On the conference call, the company said it had already repurchased shares worth $8.9 billion and will complete the buyback of the remaining $1.1 billion in shares at a slower pace than initially expected.

The company shared a fairly conservative view on the pricing of medical devices over the next few years, says Jonas at Gabelli. Much of the pressure on prices will be due to hospitals having to give back $155 billion over 10 years to the Medicaid program as part of the health-care reform, he says.

All the uncertainty around health-care reform has pushed stock valuations down across the health-care industry, arguably too far, according to Linda Bannister, an analyst who covers pharmaceutical companies for Edward D. Jones "Once we have some clarity, as long as it's not more of a burden on these companies than the current bill outlines, these stocks should have a relief rally," she says. It's hard to predict the timing of such a rally, however, she concedes.

"Buy" Rating on J&J

Attractive dividend yields are paying investors to ride out that uncertainty, she says. The yield on Johnson & Johnson's dividend is now 3.21%, and it's more than 5% for some of the pure-play pharmaceutical companies.

Bannister has maintained a "buy" rating on Johnson & Johnson because "we think their pharma pipeline will drive a resumption in revenue growth in 2010 and 2011, [which] bodes well for the shares."

During the third quarter, the U.S. Food & Drug Administration approved Stelara, a drug for plaque psoriasis, and Invega Sustenna, an extended release, injectable treatment for adult schizophrenia. On Oct. 6, the European Commission approved Simpon, an injectable treatment for rheumatoid arthritis and psoriatic arthritis.

Flat Sales for J&J

On Oct. 13, Standard & Poor's Equity Research reaffirmed its buy rating on the stock and its 12-month price target of $70, which equates to 14.3 times projected 2010 earnings of $4.90 a share. S&P said it believes Johnson & Johnson "is correctly addressing its challenging pharma business through recent acquisitions and alliances in vaccines, and new oncology and Alzheimers drugs."

Still, Wald at Noble says he expects to see flat sales for Johnson & Johnson and its peers until the economy has turned around and consumers feel more comfortable, He wouldn't be surprised to see up to a 6% decline in Johnson & Johnson's worldwide sales in the fourth quarter.

In spite of the challenges facing health-care companies, analyst Rick Wise at Leerink Swann & Co. says he sees sales stabilizing in dollar terms, but he too believes the recovery will be very gradual.

Watching Health-Care Giants

After Johnson & Johnson's report, Wall Street will be watching two other health-care giants this week for additional clues. Analysts expect Abbott Laboratories (ABT) to report earnings of 90¢ a share on Oct. 14, vs. 79¢ a year ago. Baxter International (BAX), reports on Oct. 15, with analysts expecting the firm to earn 97¢ a share, up from 88¢ in the third quarter of 2008.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

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