Emerging Markets Earnings Roundup: Johnson & Johnson, Abbott (Part 1)

Emerging markets received a lot of attention during the fourth quarter earnings calls of both Abbott Laboratories and J&J. CEOs at both companies proved upbeat on the year ahead and talked about momentum across product lines from medical devices to pharmaceuticals.

Emerging markets provided a boost to Johnson & Johnson during the fourth quarter with Brazil, India, Russia and China, (the so-called BRICs) up 12% year-on-year. CEO Alex Gorsky also stressed that medical devices in emerging markets have been a leading growth driver for the company followed by consumer health, with the company’s rich portfolio of brand name products also providing an opportunity. Southeast Asia was also a focus.

Although J&J spoke about China broadly, the company did not mention the industry-wide compliance push by Chinese authorities over sales and marketing practices.

For Abbott Laboratories Inc., cash from abroad will come home in 2014 – $2 billion of it. Meanwhile, CEO Miles White updated investors on the company’s troubled infant nutritional business in China, which was impacted by a recall from New Zealand supplier Fonterra Co-operative Group Ltd. (Also see "China’s New Regs For Infant Formula Makers Look To Raise Quality Of Local Industry, Level Playing Field" - Scrip, 22 Jan, 2014.).

In a recurring feature, PharmAsia News combs through quarterly earnings reports to bring you highlights on emerging markets.

J&J's fourth-quarter net income jumped 37% to $3.52 billion, and excluding one-time items, beat analyst estimates. Fourth-quarter revenue rose 4.5% to $18.4 billion (Also see "J&J’s Consumer Woes Finally Subside As Pharma Continues Strong" - Pink Sheet, 21 Jan, 2014.).

As he has before, CEO Alex Gorsky highlighted opportunities in the BRIC nations, but added a bit of color and detail during the company’s Jan. 22 quarterly call, which put more focus on emerging markets and the role of medical devices in the company’s outlook (Also see "Emerging Markets Earnings Roundup: Roche, Johnson & Johnson, Abbott (Part 1)" - Scrip, 30 Oct, 2012.).

“As you know, Johnson & Johnson is the leading company in this segment [medical devices], with 85% of our key platforms, the number one or number two positions in the market. Integrating Synthes Inc. has been our number one priority and we've made good progress on that,” Gorsky told analysts.

“Emerging markets in this segment are also a really important driver of growth and we've been successful in developing, making products specifically for these markets that are driving growth within our medical devices and diagnostics segment,” Gorsky said.

“We're also increasing our competitiveness in this dynamic global market in order to better position our business for future growth by investing in innovations that will help us increase our leadership positions, by optimizing our portfolio to ensure we're focusing in areas where we feel we can really have the greatest impact.”

Overall, 22% of J&J’s $71.3 billion in global sales in 2013 came from emerging markets, the company reported.

Remicade Under Threat

Gorsky and Louise Mehrotra, VP of Investor Relations, also took time to emphasize the broad swathe of products the company sells in emerging markets, including J&J’s top-selling drug, tumor necrosis factor inhibitor Remicade (infliximab), with global sales of $6.7 billion in 2013, which is seeing new threats from biosimilars (Also see "As They Look To The U.S., Celltrion And Hospira Win Approval For Remicade Biosimilars In Canada" - Scrip, 20 Jan, 2014.).

“Earlier this year, the company made certain supply chain changes for Remicade, resulting in sales to distributors, previously recorded as U.S. export sales, now being recorded as international sales,” Mehrotra said. “Adjusting the base to reflect this impact, the fourth-quarter 2013 U.S. immunology growth was approximately 26%, and operational growth outside the U.S. was approximately 14%.

“Remicade outside the U.S., adjusted for the supply chain change just mentioned, was up approximately 2% operationally, with strong growth in Canada partially offset by the lower sales in Latin America due to pricing pressure and timing of shipments.”

“The opportunity in health care is immense with an overall spend of about $8.4 trillion and the demand for health care products worldwide and services, it continues to grow” – J&J CEO Alex Gorsky

“We also had some tender business on Remicade. So it's in the emerging markets, you have a lot more of tender business and it can cause some fluctuations,” Mehrotra said.

Mix Of Products

The mix of pharmaceuticals, over-the-counter products and medical devices, Gorsky said, made the company well placed to benefit from an expected explosion in global demand.

“The opportunity in health care is immense with an overall spend of about $8.4 trillion and the demand for health care products worldwide and services, it continues to grow and it's being driven by an aging population and an increasing middle class,” Gorsky said before adding a caveat that may be a reference to China.

“Despite going through radical changes as health care ministers and governments across the globe press for greater transparency around costs and quality … these influencers certainly present challenges, but they're also creating significant opportunities for Johnson & Johnson.”

Enterprise-wide Models In China, SE Asia

“Johnson & Johnson has been operating in China for over 28 years, and while many of our competitors are currently expanding in the region, our strong heritage and business foundation provides a unique viewpoint for us to look at growth,” Gorsky said. But the CEO made no mention of the industry-wide compliance crackdown in China, instead focusing on key personnel and reporting structure changes for the company (Also see "Emerging Views On Emerging Markets: J.P. Morgan Healthcare Conference" - Scrip, 21 Jan, 2014.).

“Last fall, we appointed Jesse Wu to the role of chairman, Johnson & Johnson China, a new enterprise-wide leadership position,” Gorsky said (Also see "Asia On The Move: J&J Appoints Janssen UK Head To Oversee Building Of Largest Pharma Plant In China" - HBW Insight, 3 Dec, 2013.).

“Jesse comes from the region, and he's been a leader within our great company for more than 25 years and he's got a strong track record of success. But he's working now to optimize our capabilities and really to drive growth in China by enhancing our ability to meet the country's unmet health care needs.”

In addition, Gorsky highlighted a similar “enterprise-wide” commercial model that the company is adopting for Southeast Asia, called One Johnson & Johnson. Under the model, J&J will align operations and management from nine countries, including Indonesia, Singapore and Vietnam, to form a single $1.4 billion business.

"We think we're going to be more efficient, while also increasing our ability to compete in these [small or] mid-sized markets with more streamlined approaches, led by one managing director," Gorsky said.

New J&J Southeast Asia Structure

Source: J&J Q4 slides

Emerging Sales, Currencies

In its reporting, J&J breaks out the Asia-Pacific, Africa region, which grew 7% operationally (constant currency) in the fourth quarter over the prior year, driven by the success of major therapeutic areas such as immunology products, which grew 31.9% outside the U.S. For the full year, J&J reported 8.6% operational growth in Asia-Pacific, Africa, with sales of $13.38 billion, or 18.7% of global sales.

However, J&J CFO Dominic Caruso said currency fluctuations continue to have an impact (Also see "PharmAsia News Favorite Stories From 2013" - Scrip, 8 Jan, 2014.).

“As we discussed on our third quarter call, the Japanese yen devalued by approximately 25% versus the U.S. dollar and the euro in 2013. [But the] impact of the yen devaluation on 2013 results was not significant because of our policy of hedging foreign currency transactions 12 to 18 months in advance.”

“However, the impact of the devaluation of the yen will be a significant headwind in 2014, and our 2014 guidance reflects a negative impact to gross margin in 2014 of approximately 60 basis points or an equivalent net impact to EPS of approximately 11 cents.”

“Likewise, in the event of a significant devaluation of any other major currency, such as the Venezuelan bolivar, we will look to mitigate that impact, again depending on the magnitude of the impact. Such a potential devaluation of the bolivar or any other currency is not reflected in our guidance.”

“We see that these markets will likely continue to grow at about three to four times the growth rates that we're seeing in developed markets over the next several years” – J&J CEO Alex Gorsky

During the Q&A session, Citigroup analyst Matt Dodds asked Gorsky to drill down on emerging markets, which he did at length.

“Overall the headline that I'd encourage you to think about is we think that there's a big growth opportunity in emerging markets,” said Gorsky.

"In spite of some quarterly ups and downs, in spite of a few shifts here and there in specific segment or product performance, we see that these markets will likely continue to grow at about three to four times the growth rates that we're seeing in developed markets over the next several years,” Gorsky explained.

”If we look at our current business, clearly MD&D [medical devices and diagnostics] is our leader in the BRIC markets and has done very well. What you see is high-teen growth, sometimes exceeding 20% based upon the investments that we've made in research and development, manufacturing, and commercial presence in those markets,” the CEO continued.

“Our consumer growth has also done well, and then impacted somewhat recently by some of the ingredient issues that we've faced.”

“Obviously, our pharmaceutical group is a little bit different, because we have been very open about our strategic intent not to participate in the generic segment, which has an impact there, but we still believe there's a lot of opportunity to address both unmet need, as well as the business opportunity with some of our higher technology products,” Gorsky said.

Cash Abroad

One area that also caught analyst attention was the company’s growing cash pile outside of the United States, with Mike Weinstein of J.P. Morgan, noting that “we've been talking for years about the cash that's trapped outside the U.S. It's significant; it's growing. All your cash flow is outside the U.S. after you pay your dividend. At what point do you change your thinking on this and actually start to repatriate?”

“But at some point … we would consider whether repatriating the cash would be a prudent thing to do” – J&J CFO Dominic Caruso

“Obviously, cash, we generate as you know, mostly outside the U.S., and it does grow, because of our healthy cash position,” Caruso said. “We obviously look to maintain the increase in our dividend, so we don't view that as a hindrance to doing that. We're still able to do that. We view that as a great opportunity to invest in the long-term growth of our business, as you saw with the Synthes transaction, where we were able to use cash outside the U.S. for a significant acquisition.”

“But at some point, and I'm not prepared to give you that point today, at some point, we would consider whether repatriating the cash would be a prudent thing to do. At the current U.S. tax rate and with the current penalty, quite frankly, on the repatriation, it appears to us that that's not a good way to utilize the cash, and it provides for a significant diminution in value to our shareholders by doing so.”

Abbott Laboratories To Repatriate $2 Billion In Cash To U.S.

Meanwhile, Abbott Chairman and CEO Miles White ran his senior executives through their paces in a fourth quarter earnings call Jan. 22, allowing them to show the depth and breadth of the company a year after it split off from its innovative arm, now called AbbVie Inc., which focuses on blockbuster Humira (adalimumab) and an R&D pipeline (Also see "Gilles Picard On Steering AbbVie Across Asia, the Middle East And Africa: An Interview With PharmAsia News (Part 2 of 2)" - Scrip, 20 Feb, 2013.).

By all accounts, the Abbott team had a lot to say on emerging markets. Abbott spent 2013 building up operations abroad, while also eyeing emerging markets as sources of financial leverage that can fund share buybacks, higher dividends and growth programs. The company plans on a one-time basis to repatriate $2 billion to the U.S. in 2014 (though not all cash is from emerging markets). Abbott said it would accelerate various long-term deferred tax assets to ensure taxes due in the U.S. on the repatriation are low.

Excluding one-time charges, Abbott’s adjusted fourth-quarter net income increased 20% to $918 million from the year-ago period. Sales hit $5.66 billion, up 0.4%. But Abbott’s full-year net earnings dropped 56.8% to $2.58 billion, which the company said was a result of restructuring post-AbbVie and a recall by Abbott’s New Zealand nutritional supplier Fonterra, which impacted infant formula sales in China in particular.

In the fourth quarter, overall emerging markets growth was 9% on an operational basis (constant currency), with sales of $2.3 billion. Full-year growth in emerging markets was 11%, driven by double-digit growth in the diagnostics, medical devices, and nutrition businesses, White said.

For the established pharmaceuticals business, Abbott reported that growth in its 14 key emerging markets was 6.3% for the full year and 10.1% for the fourth quarter over the prior year, led by “strong growth” in Brazil, Russia and China.

For established pharmaceuticals, Abbott will continue to focus on its 14 key emerging markets for 2014, which currently represent 50% of total sales.

Analysts seemed a bit skeptical about the numbers, but White and his team said they are missing a success story in emerging markets.

“Similar to other multinationals, we were impacted by a slowdown in several emerging economies as well as by foreign currency,” said Brian Yoor, VP of Investor Relations.

“However, in the first half of the year we will see some carryover effects from foreign exchange and the nutrition supplier recall, where we are making good progress to recover our share. The long-term fundamentals of our business are strong, and we remain committed to increasing returns to shareholders.”

First The Bad News, Then The Good News

Yoor focused on the elephant in the room – the nutrition business – where global sales increased 1% in the fourth quarter and were impacted, as expected, by the supplier recall.

“This sales disruption is estimated to have reduced global nutritional operational sales growth by approximately $90 million or somewhat more than 5% in the quarter,” Yoor said.

But Yoor took pains to show that spending plans in the segment support the company’s faith in emerging markets, and no analysts asked questions about the industry-wide compliance crackdown in China, nor did the company executives address the issue (Also see "Emerging Views On Emerging Markets: J.P. Morgan Healthcare Conference" - Scrip, 21 Jan, 2014.).

“Three new manufacturing facilities will come online this year, including plants in China and India,” Yoor said.

“In addition, we are investing in local R&D and recently opened a new R&D center in China and broke ground on a new pilot plant in Singapore. As a result of these efforts, we expect our R&D resources based in emerging markets to grow to more than 30% over the next few years.”

“For the full-year 2014, we are forecasting high single-digit sales growth on an operational basis for our global nutrition business. We are on track with our recovery efforts in the geographies affected by the supplier recall and forecast low double-digit operational sales growth in international nutrition,” Yoor said.

“There are three major geographies that we're paying a lot of attention to in the recovery of this recall that we experienced in nutrition. It is China, Vietnam, and Saudi Arabia” – Abbott CEO Miles White

For established pharmaceuticals, Abbott will continue to focus on its 14 key emerging markets for 2014, which currently represent 50% of total sales, with the ratio expected to rise to 60% over the next several years. "Key strategic priorities to accelerate growth in these markets include continuing to build locally relevant portfolios across key therapeutic areas and tailoring local commercial activities to each market," the company said.

During the call, CFO Tom Freyman provided more color on the established pharmaceuticals business noting: “Overall in the key emerging markets we are seeing basic market growth probably in that mid-single range, maybe even a little bit better in a country like Russia, for example. And I think most investors are familiar that Europe has been a pretty sluggish market overall from a volume perspective, and that has carried over into our business as well.”

Freyman also noted that India growth slowed in 2013 for Abbott’s pharma business, to the mid-single digit range, but expressed optimism that India would return to double-digit growth in 2014, citing data from IMS Health. India is a key market for Abbott’s established pharma business; the company is the top-selling pharma in the country.

Miles Takes The Floor On Emerging Markets

With the financials largely out of the way, White spent time on the quarterly call to detail his thinking on emerging markets.

“We put our focus on emerging markets that are sizable, where we've got critical mass, and are attractive. And our main focus there is two things: one, expanding the breadth of the therapeutic categories and the product lines that we are offering; and, frankly, improving our branding and consumer skills as an adjunct to that business. Because in any given country how we reach the consumer, whether through the physician, the hospital, or direct to the consumer and so forth, does make a difference,” White said.

Any analyst or investor skeptical about a rebound in emerging markets in the nutritional business should focus on three countries.

“There are three major geographies that we're paying a lot of attention to in the recovery of this recall that we experienced in nutrition. It is China, Vietnam, and Saudi Arabia, all of which are fairly important markets to us,” White said.

“We do get market share data. We get it from multiple sources in these countries. We get off-take data, meaning what leaves the shelf. We get a fair amount of actually measured data; we get it from multiple sources. And then we get a fair amount of anecdotal data as well. And we do track it. It is numerical. It is measurable,” he explained.

“We are ahead of our progress in China, or our model. We are ahead of our expectation. We are ahead of our expectation in Vietnam. And we are a little behind in Saudi Arabia. So we are able to measure that. We are able to see sequential evidence.”

“So I would say: yes, there is definite evidence, definite data, we definitely can see it, and I am pleased by what I see, frankly. I think our teams in those countries are doing an excellent job,” White said.