Johnson & Johnson (NYSE:JNJ) announced third-quarter earnings Oct. 18 that were a mixed bag. Sales grew 6.8%, to $16 billion, while earnings per share declined 6.5%, to $1.15 a share. On an adjusted basis, they were essentially flat. They weren�t horrible but they weren�t anything to write home about either. Investors can do better elsewhere. My advice is to sell J&J and replace it with GlaxoSmithKline (NYSE:GSK). Here�s why.
Third-Quarter Earnings
Johnson & Johnson and GSK announced Q3 earnings within eight days of each other. Let�s have a closer look to see how they compare. Including the currency exchange, J&J�s revenues grew 2.6% year-over-year compared to 3% for GSK.
However, GSK faced some difficult year-over-year comparisons. In Q3 2010, it got a boost from one-time, pandemic-related revenue. In Q3 2011, its diabetes drug Avandia saw a sharp decline in sales due to potential heart risks associated with its use, and Valtrex, its drug to treat herpes, came off patent cover. Excluding those items, GSK�s revenues increased 6%, with all three segments (pharmaceuticals, vaccines and consumer health care) producing positive gains.
On the earnings front, J&J delivered $3.4 billion in net income, which is a net margin of 21.5%, 130 basis points lower than in the third quarter last year. GSK had net earnings of $1.5 billion for a net margin of 21.1%, 140 basis points higher than the third quarter last year. Head-to-head, GSK�s third quarter was marginally better.
Rest of the World
Both companies have mature businesses in North America and Europe, so let�s start our examination with their performance in the rest of the world. J&J�s revenues in the rest of the world grew 18.7% in the third quarter and represent 31.3% of its overall sales. GSK�s grew 17% in the quarter, while its rest-of-the-world revenue accounts for 38% of sales. While J&J�s revenues grew slightly faster, GSK has a more balanced geographic mix, so I�ll call it a draw.
Comparing profits for the rest of the world is a lot more difficult because Johnson & Johnson�s press release doesn�t break down geographic operating profit, only revenues. However, GSK�s information gives a few hints. Its operating profit for the rest of the world in the third quarter for its pharmaceuticals and vaccines segment was $1.04 billion on revenue of $2.47 billion, for an operating margin of 42.1%. The consumer health-care segment�s revenue in the rest of the world was $780.46 million.
The operating margin for the entire world, including the U.S. and Europe, was 24.7%, so even though the margin�s likely higher in the rest of the world, I�ll use the same number, which comes to $192.77 million. Overall, its rest-of-the-world operating profit totals $1.23 billion on revenue of $3.25 billion, for a margin of 37.8%.
JNJ�s rest-of-the-world revenue in the third quarter was $5.01 billion. It didn�t provide operating profits by segment in the Q3 release, so I�ll use the second-quarter margins, plus a couple of percentage points for good grace. We�ll have a better idea when it releases its 10-Q in a couple of weeks.
Its overall operating profit based on its three segments� operating margins (consumer, pharmaceuticals and medical devices) was $4.1 billion, which is very close to the actual results with an operating margin of 25.6%. That�s 510 basis points lower than GSK.
If you apply the same discount to its rest-of-the-world operating margin (37.8% less 5.1%), Johnson & Johnson�s operating profit in the quarter was $1.64 billion, leaving $2.46 billion for the U.S. and Europe on $11.0 billion in revenue. GSK is clearly outperforming J&J on a margin basis, so why the lower valuation?
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