Understanding J&J's Risk From New FDA Label Warning For Invokana
Earlier this week, the FDA gave a jolt to Johnson & Johnson‘s diabetes business when it concluded that J&J must include a label warning that patients using its diabetes drug Invokana are at a higher risk of leg and foot amputation. Needless to say, this puts J&J in a difficult position as far as its diabetes franchise is concerned. A few years ago, Invokana was seen as a breakthrough for diabetes 2 treatment. But the situation appears to be grim now. Should this be a cause of concern for J&J’s investors? While we believe that the company may struggle to grow Invokana going forward, the valuation impact is likely to be minimal. Below we explain why.
Our price estimate of $119 for Johnson & Johnson is slightly below the market.
Why J&J Will Find It Hard To Grow Invokana
Invokana targets diabetes 2 patients, and was first in the latest class of diabetes drugs called SGLT2 inhibitors. We expect this class of medicines to face stronger competition going forward, and the slowdown in Invokana’s growth is already visible. While Invokana’s revenue jumped from $586 million in 2014 to $1.31 billion in 2015, the drug added only $100 million in incremental sales in 2016. In fact, the first quarter of 2017 saw more than a 10% decline in sales, which was primarily due to lower prices, which resulted from higher discounts for managed care contracting and more sales coming from the Medicaid channel, where pricing is lower.
The addition of the FDA’s boxed warning makes it fairly unlikely that Invokana’s sales will rebound significantly. The nature of the warning – risk of leg and foot amputation – also may alarm patients. It is likely to give J&J’s competitors ample ammunition to push their drugs in the market. We note that the warning is specifically for J&J, and not for the entire class of drugs. However, this may change going forward, as EMA has suggested that the warning about risk of lower limb amputation should be used for all SGLT2 inhibitors. Invokana earned more than 85% of its revenue from the U.S. in the first quarter of 2017, and therefore the EMA announcement is unlikely to level the ground against competition. Even if the FDA reaches the same conclusion, we believe that by that time it happens, Invokana would have lost significant ground against competition.
Why Valuation Risk Seems Minimal
While we believe that investors have reasons for concern regarding J&J’s diabetes franchise, we expect that the potential market impact is likely to be limited. Invokana accounted for just around 4% of J&J’s pharma revenue and a little under 2% of the company’s overall revenue in 2016. This suggests a limited contribution to J&J’s profits. Additionally, given the slowdown last year, competitive advancement and pricing pressure observed in Q1 2017, the market has likely already factored in the limited growth potential of Invokana. The inclusion of the FDA warning may reduce that potential further, but the incremental negative impact on valuation is likely to be minimal. Further, investors appear to be more concerned about J&J’s upcoming launches. The company expects to file nearly 10 drugs for FDA approval by 2021. Most of these drugs belong to the oncology, infectious diseases, neuroscience and immunology therapeutic classes. This diverse focus is likely enough to comfort investors.
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