J&J, Abbott beat expectations: a good sign for pharma results yet to come?

Two of the drug industry's bigger names -- Johnson & Johnson (JNJ) and Abbott Labs (ABT) -- managed to top Wall Street's profit expectations for third quarter earnings this week, revealing that diversification in product portfolios helped their bottom lines. But the better-than-expected results were met with opposite responses from investors, with J&J punished because its sales fell short of investors' hopes. Abbott shares, meanwhile, headed higher after reporting that third-quarter sales for its arthritis drug Humira, the drugmaker's biggest product, surged 24 percent to $1.49 billion, beating analyst estimates.

New Brunswick, N.J.-based J&J earned $3.35 billion, or $1.20 a share, compared with $3.31 billion, or $1.17, in the year-ago period. Analysts expected earnings of $1.13 a share. Despite the stronger showing, it seems investors' fears regarding generic competition materialized. Even though the Band-Aids maker managed to grow profit by 1.1 percent, it did so predominantly through cost cuts and lower taxes. More worrisome, sales declined 5.3 percent to $15.1 billion from $15.92 billion, missing the Street's revenue estimate of $15.19 billion.

Generic competition dented sales of several of J&J's top drugs and the recession hurt consumer product sales. Worldwide pharmaceutical sales tumbled 14.1 percent and consumer products 2.7 percent.

It's important to note that unfavorable currency exchange fluctuations negatively affected overall sales by 2.5 percentage points.

J&J boosted its outlook and now expects to earn between $4.54 and $4.59 a share, up from a prior forecast of $4.45 to $4.55 per share. But that didn't help offset the sales disappointment, nor did the medical device tax voted on in the U.S. Senate.

J&J's results weren't all that bad. They were helped by strength in products outside its pharmaceutical division. Those included its Aveeno skin care products, Splenda sweetener, Listerine mouthwash and the acquisition of Vania Expansion. Its biggest division, medical devices and diagnostics, also had a good showing.

The already diversified health care company is trying to expand even further, especially its pharmaceutical business unit, to counter drug-patent expirations. During the quarter, it completed the acquisition of an 18 percent stake in Elan (ELN) as well as its purchase of Elan's Alzheimer's Immunotherapy Program.

The fact that is not a pure pharma company and that it sells consumer products as well as medical devices have helped buffer J&J from some of the negative trends that have hurt its pure pharma competitors. It's perhaps because of that that its shares were beaten down as investors expected it to move past the cost cutting measures to create growth. In after-hours action on Wednesday, J&J shares were trading down 3 percent at $60.55 following its earnings announcements after the bell on Tuesday.

For Abbott, it was a different story, with its shares up more than 3 percent to $51.20 after hours on Wednesday. Being responsible for 19 percent of revenue, Humira's strong performance was enough to help the Abbott Park, Illinois-based company boost its quarterly sales by 3.5 percent (despite the large negative effect from unfavorable currency-exchange rates) to $7.76 billion. Its earnings grew by 36 percent to $1.48 billion, or 95 cents per share.

Excluding one-time items, Abbott earned 92 cents per share, topping forecasts by 2 cents. Sales were in line with expectations. Other than the jump in Humira demand, sales on nutritional products, including Similac baby formula and Ensure drinks, also grew during the quarter, as well as its vascular business sales.

Abbott also raised its 2009 profit expectations to a range of $3.70 to $3.72 per share, from a previous range of $3.65 to $3.70. Alleviating investors' concerns about its dependence on Humira, Abbott also boosted its full-year forecast for Humira, projecting revenue will increase 28 percent to 30 percent, excluding the effects of foreign currency exchange (or 18 to 20 percent reported sales growth, up from an earlier range of 15 to 20 percent).

Abbott CEO Miles White highlighted the company's four acquisitions during the quarter, bringing its 2009 total to six. The latest acquisition is an attempt to boost the company's international presence. Abbot announced plans to buy Solvay's pharmaceutical unit for $6.6 billion, in a deal that is expected to close in the first quarter of 2010. The deal will give Abbott full control of TriCor and TriLipix, cholesterol drugs it co-promoted with Solvay.

As a consequence, and very different from J&J's effect Tuesday, Abbott led pharmaceutical companies higher today as Pfizer (PFE) and GlaxoSmithKline (GSK), among others, followed suit. J&J shares was down again Wednesday.

Interestingly, however, even with Humira, it wasn't enough to stop the declines in the pharmaceutical division, where sales fell 1.6 percent to $4.06 billion, hurt by currency fluctuations and generic competition to the anti-seizure treatment Depakote. That drug's sales plunged 71 percent, highlighting the problems facing pharmas when drugs go off patent and a generic challenges them.

Comparing the two companies' results is interesting. Generally, most everyone agree that diversification was the key to both. While generics took a chunk out of revenue in both, J&J had its medical devices unit and products in its consumer unit that saw sales grow. Similarly for Abbott, which also felt the heat from generics, it wasn't all Humira, but vascular and nutritional products.

The question now is what will happen to pure pharmaceutical companies that don't have that diversification. While Pfizer and Merck (MRK) have been busy with mega acquistions of Wyeth (WYE) and of Schering Plough (SGP), respectively, they did it more to expand their pipeline than to achieve diversification. Similarly, smaller acquisitions have mostly served broaden existing pharma portfolios.

At some point, the patent expirations will catch up to Big Pharma and cost cutting measures will no longer be enough to achieve earnings growth. The question is whether we're going to start seeing it in this quarter after many generally beat expectations, even of the top line in the second quarter. Judging from the declines in pharmaceutical sales at Abbott and J&J, that could be a likely scenario, with the possible exception being vaccine makers as they may get a boost from H1N1 flu pandemic worries.

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