Johnson & Johnson (J&J) managed to beat analyst earnings estimates due to unexpectedly strong first-quarter results in its consumer health and pharmaceutical businesses. But while those saw revenues climb in the double digits, its medical devices business declined by almost 5% due to deferred procedures. Wall Street rewarded the New Brunswick, N.J.-based company by driving its shares (NYSE:JNJ) up more than 5%. That’s even though the company also lowered its 2020 guidance.

The health care conglomerate had seen its valuation shed roughly $60 billion, or about 18%, during the worst of the COVID-19 market downturn. But it since has recovered to reach a market cap of almost $390 billion, a bit higher than where it started this year, in part on the strength of optimism for its development efforts around a COVID-19 vaccine that were detailed March 30.

Pandemic impact

“In medical devices, we are experiencing a near-term negative impact and expect this to continue, while elective procedures are deferred and hospital resources are redeployed to address patients impacted by this pandemic,” said Alex Gorsky, J&J's chairman and CEO, during the earnings call. “That said, medical devices has historically been a strong market, and we believe the underlying fundamentals of the market remain intact.”

Medical device sales for the company were $5.9 billion, down by 4.8%, after excluding the net impact of acquisitions and divestitures, such as the sale of ASP business in specialty surgery. J&J attributed roughly half of the net impact of COVID-19, which it estimated at about 750 to 800 basis points, as a result of deferred procedures in the Asia-Pacific region.

The remaining impact of postponed activity due to the pandemic was apportioned about 30% to the U.S., with the remaining roughly 20% primarily in Europe. Only about one-third of the company’s medical devices business is based on procedures that cannot be deferred. The second quarter is expected to be the bottom for the medical devices, with 65% to 85% deferral of procedures. By the third quarter, that decline is expected to be 20% to 60% vs. prior expectations.

Surgical vision, ear, nose and throat, aesthetics, orthopedics, spine and electrophysiology procedures are expected to see the worst declines, with activity almost ceasing entirely during the worst of the pandemic in the hard-hit areas. By contrast, trauma and stroke procedures are relatively inflexible and likely to proceed largely apace.

By contrast, consumer health was up 11% to $3.6 billion in sales during the first quarter due to robust, COVID-19-driven demand related to purchases of over-the-counter analgesics and allergy medications, as well as personal care products. Pharmaceutical sales also grew 10.2% to $11.1 billion, due primarily to newer autoimmune and cancer drugs.

Outlook prediction

J&J expects the impact of COVID-19 to peak in mid-April in the U.S., with a European peak in mid-to-late April, based on data from the Institute of Health Metrics and Evaluation. The company is assuming a recovery for procedures related to its medical devices business to start in the third quarter and continue into the fourth. It presumes that testing and therapeutic options will be further along by then, helping to enable a return to some normalcy. It’s even more optimistic for the longer term.

“We hope 2021 looks a lot like we thought it was going to look like maybe three months ago. We really have to let that play out. We did see and put into our modeling anywhere from normal level of procedures in the fourth quarter to a recoupment, if you will, of plus 15%,” said Joe Wolk, J&J's executive vice president and CFO. “But it's really going to depend on the pandemic itself: What are the health priorities, how are patients and consumers feeling about going to the hospital for these procedures?

“What we've heard from hospital CEOs is that they would like to get back in the business of elective surgeries,” he continued. “Mayo Clinic, most recently, announced only 25% utilization in their elective suites. That is putting financial strain on major hospital systems, and we want to make sure that when we return to normal, that there's good quality health care still in place. I think it would be a little bit irresponsible for me at this point in time to comment on 2021. The hope and the optimism is [that] for whenever the pandemic abates, we'll be at or above expectations that we all once had.”

Despite the incredibly difficult task of trying to predict business conditions in the current environment, Wall Street seemed approved of J&J’s long-term outlook. “Based on our own analysis, surveys and physician calls, we believe [J&J's] outlook for recovery is reasonable and should bode well for the industry to return to more normalized growth exiting 2020,” said Wells Fargo analyst Larry Biegelsen.

Between them, China, Japan and South Korea represent roughly 20% of the company’s medical devices revenue, while the U.S., U.K., Italy, France, Germany, Spain and Russia account for about another 60%. These are the top 10 markets by country for J&J in medical devices. The remaining roughly 20% of revenue comes from other countries around the world.

All told, J&J expects the negative operational sales impact of the pandemic to be about $4 billion to $7 billion below its prior guidance in medical devices.

J&J reduced its 2020 adjusted operational EPS guidance to a range of $7.65 to $8.05, down from $9 to $9.15. Its operational sales 2020 guidance slipped to $79.2 billion to $82.2 billion, down from $85.4 billion to $86.2 billion. That puts the change in adjusted operational sales at -3% to 0.5% for the year, down from the prior guidance of 5% to 6%.

Wall Street remains upbeat on longer term prospects in the J&J medical devices business. “We expect device sales to decline faster in the second quarter followed by a rebound in growth in early 2021,” summed up Morningstar analyst Damien Conover in a note. “However, we expect the strong switching costs inherent in the products will allow the firm to maintain market share and support its moat.”

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