Steady Growth at J&J Reinforces Wide Moat, But Shares Overpriced

Buoyed by strong immunology and oncology sales,

As J&J ended the quarter with close to $17 billion in net cash, we expect it to make a large acquisition. With healthcare valuations down from their mid-2015 peak, we believe J&J is in a better position to create value through acquisitions. However, with several other large healthcare companies also looking to redeploy capital, we don't expect any good deals for J&J. The specialty pharmaceutical area looks most undervalued, but this is an area where J&J hasn't shown much interest recently. Therefore, we believe innovative biotechnology and medical device companies are the most likely targets.

J&J reiterated its commitment to increase operating margins by over 200 basis points, which looks achievable and is critical for the company to hit its 2016 outlook. We expect all expense lines to improve, although when generic competition intensifies in the drug group through 2018, margins are likely to reverse this trend as these older drugs carry hefty margins.

Lastly, recently launched cancer drug Darzalex is off to a strong start with sales likely approaching $100 million in the quarter, well above our expectations. Darzalex's early-stage data looks excellent in multiple myeloma and should easily top $1 billion in peak sales.

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