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Johnson & Johnson: The Next Eli Lilly?


By the Sick Economist


This wasn’t supposed to happen. It really shouldn’t be. Yet, somehow, it is. Eli Lilly, a formerly lumbering drug giant, founded in 1876 and still based in very uncool Indianapolis, Indiana, has skyrocketed in value as if it were some sexy Silicon Valley tech stock. In the last five years, the stock has catapulted from $110 per share to a lofty $837 per share. The shares are valued at a P/E ratio of 127, which is simply unheard of in the world of Big Pharma. As exciting as this development is, in reality, most investors have already missed this boat. If you weren’t smart enough, or lucky enough, to buy a few years ago, the company looks awfully expensive today. But you may get another chance. Johnson and Johnson, a company almost as stodgy and ancient (founded, 1887) displays many of the same ingredients that caused Lilly to explode in value. 

Could humble J&J be the next Eli Lilly? 


To find the next Eli Lilly, first we must understand the factors that transformed this staid, stale household name into the stock market beast of the 2020’s. It may feel like magic, but it isn’t. There are a few obvious factors to the company’s meteoric rise. 

The first factor that made Lilly’s run possible was it’s modest valuation before the surge of the last few years. Lilly performed just like most other Big Pharma companies, which is to say, well, but not sensational. In the year 2000, the shares were priced at $62.75, and in the year 2020, the shares had climbed to $110.89. If we included the dividends, investors received a total return of 208% over twenty years, turning a $10,000 investment into $35,000. Certainly nothing to sniff at, but quite modest compared to legends like Apple, which enjoyed a mind numbing 11,000% return over those same years, turning a $10,000 investment into $110,000. It seemed like the “slow but steady” world of Big Pharma simply couldn’t compete with names like Apple, Google and Nvidia, which enjoyed “life in the fast lane.” 

But that modest valuation made a big difference when Lilly started to roll out the hits. It means that the valuation had room to run. If you unleash a drug, or drugs, that are smash hits, it’s easier for a company to jump from a valuation of 20 times earnings to 90 times earnings, than it is for an already richly valued company to jump from 90 times earnings to 180 times earnings. If you were to buy into Lilly at today’s stratospheric P/E of 127, you would basically be hoping that the company can keep pumping out the same level of growth when your grandchildren reach retirement age. It’s a lot easier to reap gains when the company starts off lower. 

Secondly, Lilly brought to market at least two mega blockbusters with a very broad TAM, or “Total Addressable Market.”  Despite the many well documented shortcomings of the American Healthcare System, our biotechnology sector is thriving. American society has pumped out more treatments and cures in the last ten years than in the previous millennium combined. No one wants to be sick, but if you had to be sick, now would be the best time in human history to battle a disease. 

While this armada of new drugs is great for patients, it makes the pharmaceutical business an extra tough racket. If you were diagnosed with cancer, it’s likely that you would be offered multiple different treatment modalities. Faced with an acute healthcare crisis, not only did the biotech world craft one Covid vaccine on short notice, but several different options. This means that, for many disease states, the competition is fierce. 

Lilly captured the imagination of the investment community by pioneering not one, but TWO different drugs that have massive TAMS and few competitors. The first disease state is diabetes and obesity. For decades prior to the launch of Mounjaro, barely anything worked. Treatment regimens for diabetes were bad, and for obesity, much worse. Mounjaro (branded as Zepbound for obesity) works shockingly well. This is one of those few drugs that comes around once in a generation that will visually, obviously change America. 

Currently, Mounjaro’s only real competition is Wegovy by Novo Nordisk. There are other competitors rushing to push competing drugs onto the market, but these would-be contenders are years away from commercializing their offerings. Additionally, both Eli Lilly and Novo have a fusillade of “next generation” weight loss products ready to build on their current success. Lilly and Novo have effectively created a duopoly around diabetes and weight management, splitting countless millions of patients amongst just two companies. 

But Lilly didn’t stop there. The company is also weeks away from approval for yet another novel medication aimed at a massive patient population with few options. Much like obesity, millions and millions of Americans have suffered from Alzheimer’s Disease with few treatment options. This may all change in the next few weeks with the approval of Donanembub. This would be the second drug approved to treat Alzheimer’s disease. Much like the situation with obesity, Lilly would be establishing a duopoly in soft competition with Biogen. The two would be offering similar drugs to a desperate patient population with few options. Both companies have improvements and “2.0” formulations in the works, and competitors are years behind. With 10,000 Baby Boomers per day getting Medicare cards, Donanembub could be just as big as Mounjaro. And that is how you transform a once forgotten pharmaceutical concern into a raging Wall Street monster with the same characteristics as the titans of Silicon Valley. 


Johnson & Johnson: The Sleeper Candidate? 

Thus, we can see that Lilly did not go supernova by accident. Although the company has achieved an unprecedented level of success, there was a very specific set of circumstances that allowed this to happen. They caught lightning in a bottle, which is difficult to copy. Difficult, but not impossible. 

Today, Johnson and Johnson displays many of the same characteristics that Lilly did five years ago. 

First, J&J sports a modest valuation of just 22 times earnings. While many would consider this to be richly valued, in today’s super pumped up stock market, J&J’s price tag is quite reasonable considering the firm has handed in 150 years of solid performance. Put another way, even if Johnson and Johnson were to double in price over the next few years, and arrive at a P/E of 40, that would still look modest next to Lilly’s extreme valuation. So, in a way, Lilly has cleared the way for other titans to rise, as well. 

Second, J&J is also working on novel treatments for patient groups with colossal TAMs. One of J&J’s most exciting new candidates is Posdenimab, which targets Alzheimer’s disease. The reason why this drug is extra exciting, despite pre-existing competition from Lilly and Biogen, is that it targets the disease from an all new angle. While Lilly and Biogen’s agents target Amyloid plaques, J&J is targeting TAU, another toxic brain protein closely associated with the devastating cognitive decline of Alzheimer’s. Although Lilly and Biogen have blazed a path by offering the first effective Alzheimer’s treatments, their overall results are still suboptimal, and leave much room for improvement. Posdenimab may just be that improvement. The drug is currently in phase II trials with data readout expected sometime over the next 12 months. Additionally, J&J has other, more experimental Alzheimer’s treatments in its pipeline. It’s worth noting that Lilly’s stock price started to take off just after the world started to learn about promising results in phase II trials. With some luck, J&J could be just the same. 

Much like Lilly, J&J is far from a one trick pony. Another realm of deeply unmet needs is MDD, or Major Depressive Disorder. Although there are already many medicines on the market, this disease remains notoriously difficult to treat. Many treatments fail to deliver relief for specific subsets of patients, and most “new” drug launches over the previous decades have just been small tweaks to existing science. J&J is bringing three different, novel agents to this market (Seltorexant, Aticaprant and the recently approved Spravato) the company could easily see Lilly-like revenue gains in the coming years. There are still millions of clinically depressed patients out there, and J&J is ready to offer much needed help. 


Downside Risk

Legendary investor Warren Buffet is famous for quipping, The first rule of an investment is: don’t lose money. And the second rule of an investment is: don’t forget the first rule. And that’s all the rules there are.”   So, we would be remiss if we didn’t consider the risks of an investment in Johnson&Johnson. 

Most of the medicines discussed in J&J’s pipeline are in stage II or stage III testing. This means that some, or all, of the medicines could still generate disappointing results. The further along in testing, the less risky an asset is considered. However, the jewel in the crown, Donanemub for Alzheimer’s, is still in phase II. Efficacy is not guaranteed, and many yet fail in the quest to treat this dread disease. 

That being said, J&J is substantially less risky than most high octane biotech stocks. Since 2014, the firm has grown operating income from $17 billion per year to $20 billion. During that same time, the company has grown it’s annual dividend from $1.99 to $4.75. Currently it sports $171 billion in assets versus just $100 billion in liabilities. This is not a fly-by-night, entrepreneurial venture that could disappear tomorrow. Given the company’s reasonable current P/E of 22, it would be hard for an investor to lose too much money on this bet. 

J&J has been the target of a host of lawsuits regarding it’s sale of talcum powder, a product that allegedly caused cancer. While this litigation created a cloud over the company for the years, the fireworks are now winding down. J&J has implemented several strategies to limit risk to the company while still meeting all of it’s legal obligations.  The market has had a long time to digest all of the news about these legal wranglings, so any litigation risk is likely baked into today’s J&J share price. 

Limited downside, while offering potentially unlimited upside potential. This is what the sophisticated investor calls an “asymmetric bet.”  In other words, the chances of reward are much greater than the risk of failure. For most people, this is probably a much safer investment than chasing Eli Lilly at today’s rich valuation. Everybody wishes they had a time machine, where they could go back to 2020 and buy today’s wonder biz. If you find a time machine somewhere, you know what to do. If not, you might just invest in J&J: it could be the next best thing. 

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