Can UnitedHealth Group and Johnson & Johnson Continue Their Winning Ways?

UnitedHealth Group (UNH 2.96%) and Johnson & Johnson (JNJ 0.67%) are two of the stock market's biggest companies, and last quarter each delivered better financial results than industry watchers were expecting. In this episode of The Motley Fool's Industry Focus: Healthcare, host Shannon Jones and Motley Fool contributor Todd Campbell dig into the details to explain what was behind their better-than-expected results and what investors ought to be watching from here. In the show, they discuss:

• What caused J&J's consumer goods business to grow
• Why oncology is so important to J&J's future
• The multibillion-dollar drug that could dent J&J's sales in 2019
• How Medicare and Medicaid are boosting UnitedHealth's sales
• The tailwinds supporting UnitedHealth's insurance and analytics business

Additionally, Jones and Campbell explain how Genfit, a small French biotech company, hopes to outmaneuver large competitors like Gilead Sciences (GILD -1.15%) in nonalcoholic steatohepatitis, a potential $35 billion market.

A full transcript follows the video.

This video was recorded on Oct. 17, 2018.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today is Wednesday, October the 17th, and we're talking Healthcare. I'm your host, Shannon Jones, and I am joined by healthcare specialist, expert, and all-around good guy Todd Campbell. Todd, how are you?

Todd Campbell: I'm great! I'm sad that I'm not in Alexandria at HQ to film with you in person live like last week. That was so much fun!

Jones: It was perfect! I loved having all of you guys here. For our listeners, if you did not have a chance to check out that show, we did a marijuana roundtable last week. I got all the guys here in the studio. We talked about -- which is prime for today. Today is Green Day in Canada! Marijuana is now legal from an adult-use recreational perspective. We were able to talk about that, the implications of that, what to look for. 

Two, if you want to keep track -- I'm going to put a quick plug in here, Todd -- of all of the news, all of the industry insights, we've actually put together a page specifically for you, if you just go to www.fool.com/marijuana-stocks. Be sure to check it out. We will keep you up to date on all the latest.

Turning our attention to some other good news in the sector this week on the healthcare front, we're talking earnings. And, you got the special opportunity to interview management behind one of probably the most-followed companies in the NASH market, Genfit. We'll get into all of that.

Let's actually start with the big behemoth in the room. Johnson & Johnson just reported earnings here on Tuesday. This is the dividend aristocrat, the steady-eddy, all-around good company to buy and hold for the long term. That's ticker symbol JNJ. The stock was up about 2% off of earnings yesterday, Todd. What can you tell us about what they reported on?

Campbell: It was again a little bit today when I looked earlier on, Shannon. This is a giant among Goliaths. It's just crazy how big this company is, every quarter when I track it. So many of our listeners own it somewhere. Even if you don't think you own it, you probably do, because it's going to be in ETFs and mutual funds.

Revenue in the quarter clocked in at $20.3 billion. Yes, that's with a B, billion -- $20.3 billion. That was up 3.6% year over year. For people who are newer to the story, they operate their business in three different segments. They've got a consumer goods segment, they've got a pharmaceutical segment, and they've got a medical devices segment. But by far, Shannon, it's the pharmaceuticals business that drives the car that is J&J.

Jones: Before we get to the pharmaceutical segment, it's interesting, for those that have been following Johnson & Johnson, everybody's probably familiar on the consumer business side. You're thinking about Band-Aids, thinking about Tylenol. Also, their really iconic baby care line has really gotten back into the spotlight as of recent. If you look at, over the past few years, their consumer business segment has actually been declining in sales. A little bit earlier this year, it may have been this quarter, the company decided to relaunch their baby care line. It was really targeting those millennial parents -- getting rid of dyes and sulfates and ingredients that many millennial parents don't want to see. They also did some repackaging. It was really interesting, of the three segments, you actually started to see them turn a corner. 

Todd, you mentioned the three segments. Pharmaceuticals really is the revenue driver for them. But, you actually saw on the consumer side, sales of $3.4 billion, which were up about 1.8% year over year.

Campbell: Right. And like you said, people aren't going to get overly excited about 2% growth. But compared to what we've seen in the past, this has been a business that basically just cranks out cash flow every quarter and hasn't been overly exciting when it comes to growth rates. 

We also saw some strength in the consumer business out of the beauty care products, which I think grew something like 4% year over year. Medical devices, also not a huge growth driver for the company. As a matter of fact, their sales in the quarter year over year were relatively flat. That was because of them getting out of some diabetes businesses last year. Those sales clocked in about $6.6 billion. You've got medical devices giving you $6.6 billion, you've got consumer giving you $3.4 billion. That leaves you about $10 billion more, which of course comes from the pharmaceuticals side of the business. 

Jones: Yeah. Really, the focus here is on the pharmaceuticals side, also known as Janssen. Now, pharmaceuticals are about 50% of revenue for the company. What's so interesting -- and I know we'll get into this a little bit more -- is one of the bigger concerns has been with J&J's drug Remicade. You started to see some big numbers happen with the biosimilar Inflectra that was released earlier. Now you're starting to see the impact of that. But, on the flip side of that, they actually had some good, positive news in their oncology portfolio.

Campbell: Right. Remicade is the big question mark for investors currently. Pfizer launched out their biosimilar back in 2017. Of course, Johnson & Johnson, in a bid to keep their market share, has cut their prices on Remicade. I want to say that during the conference call, J&J's management said that those price cuts have allowed it to maintain about 93% market share when it comes to volume. So, yes, they're providing a lot more in terms of volume that you might expect vs. having this new biosimilar on the market, but it did take a toll on sales. Sales fell 16% year over year. Still clocking in, though, around $1.4 billion. I think that the strategy here has been to mitigate or slow the rate of decline for Remicade by doing these things to hold onto market share. So far, it seems to be working, because, as we already talked about, they were able to deliver top-line growth year over year in the quarter, despite that Remicade headwind.

Jones: For our listeners that are not familiar, biosimilars are what you would consider the generic equivalents of some of these brand-name pharmaceuticals. Not a true identical comparison, but very close. Oftentimes, there's the interchangeability factor that you want to look at with biosimilars. 

Shifting gears, you've got the oncology portfolio. As we talk about big pharma and even big biotech, oncology is still one of the hottest areas in the market to invest in. Saw some really impressive numbers, particularly with their blockbuster Darzalex, and also Imbruvica. I was actually quite impressed with their double-digit growth this past quarter.

Campbell: Something that investors have to pay attention to with J&J is the oncology franchise. Yes, they're involved. They've got some great drugs that treat central nervous system disorders. Stelara has been growing its sales by double digits following a label expansion to include its use in Crohn's disease patients. But really, it's been oncology that's allowed them to offset some of the loss of exclusivity that's associated with patent expiration. 

If you look at the oncology sales last quarter, they grew 36% year over year to $2.6 billion. A lot of that growth was because of Darzalex, their multiple myeloma drug. That drug has been winning increased use as trials have allowed it to expand its label into earlier lines of therapy. Obviously, the earlier that it gets used in therapy, the larger addressable patient population, and the greater potential to turn that increasing use into revenue growth. I think they did $498 million. That gives it almost a $2 billion run rate last quarter, and that was up 57% year over year. 

You mentioned Imbruvica and I think you may have also mention Zytiga. Those are the other two that you really have to watch here in cancer. Imbruvica is a blood cancer drug. Sales there grew 38% to about $700 million, $2.8 billion run rate. Zytiga, which is their top-selling prostate cancer drug -- we should talk about Zytiga later on when we talk about patent risks -- Zytiga sales grew 43% year over year to almost $1 billion, $958 million in the quarter. You're talking about almost a $4 billion drug there.

Jones: Absolutely fascinating. Really impressive growth all across the board for the pharmaceutical segment. Looking ahead, though, there are a few key areas that I think investors do need to be mindful of when it comes to J&J. Great quarter, love to see the growth that's happening. But there are actually some key decisions coming up, one being a potentially new product for depression. Todd, what can you tell us about that? 

Campbell: It's a nasal spray, Esketamine. They did five Phase 3 trials. Three were good, two really weren't great on the primary end point. But I think that it has a good shot of getting approved, and that could be a nine-figure drug for the company, hundreds of millions of dollars of potential sales revenue there. They also have an FDA decision for Erdafitinib, which is a locally advanced or metastatic urothelial cancer drug. If that gets approved, that would also help their oncology franchise. 

It's very important, Shannon, for J&J to win new FDA approvals and continue to grow sales. One of the things I mentioned just a second ago was, Zytiga is a concern. You've got Remicade. They're executing a good strategy to protect the Remicade sales. Zytiga, however, had a patent thrown out early in 2018. As a result, there is the chance that you could get Zytiga generics on the marketplace in 2019. J&J isn't issuing guidance yet. They're going to do that later on this year, probably after the fourth quarter wraps up, maybe at an industry conference in January. But that is a concern, especially since you're talking about $4 billion in sales.

There's a court decision coming up, and you're going to want to pay attention to see how that court decision goes. Then, you're going to want to watch and see what the guidance is for 2019. You'll also want to keep an eye on what happens with Xarelto. Xarelto is an interesting drug. It's a blood thinner, it's very heavily used, but the sales have flattened out. Last quarter, they were $612 million, down about 4%. There's a lot of competition that's emerged in this area. They just got a new approval, however. You're going to want to see whether or not that kick-starts sales, gets it back to growth in 2019. 

Then, as far as guidance is concerned, I think they're looking now for $81 billion. [laughs] Just mind-boggling. $81 billion in full-year sales this year, and full-year earnings per share of about $8.13 to $8.18.

Jones: So many good things to watch. Also, this is much further down the line, but also, J&J announced the licensing deal with Arrowhead for gene silencing in hepatitis B. Again, that'll be further down the road, but will be worth watching. That was a deal potentially worth up to $3.7 billion. Hep B, hep C -- huge market, competitive market. It'll be really interesting to watch what happens there.

Let's turn our attention to another behemoth, another healthcare giant, and that's UnitedHealth Group, ticker UNH. Todd, this is the largest health insurer overall. They reported earnings on Tuesday, hitting near record highs, above $272 a share. This stock has been on an absolute tear this year and over the past few years. This quarter was another quarter to again be impressed.

Campbell: If you thought J&J was big, wait until you hear these numbers. Right, Shannon?

Jones: [laughs] Yes!

Campbell: Last quarter, UnitedHealthcare, as you mentioned, biggest insurer. $56.56 billion in revenue last quarter. Well over a $200 billion annualized run rate. That was up 12.4% year over year. Most people think of UnitedHealth, they think of the health insurance business. Certainly, that gives them most of their sales. They also operate a data analytics business and a pharmacy benefit management business. That's under their Optum brand. When we're looking at sales and considering investment in UnitedHealthcare, you want to not only consider the health insurance market, but you want to consider how people are going to be using data in designing treatment programs, how intervention by health insurance may help people stick to their courses of therapy and stay on their medication, avoid hospitalizations, all that kind of stuff. 

Jones: I think it's the data and the analytics side with that Optum brand that really has me intrigued, as someone who's in the healthcare space. When you can leverage artificial intelligence, machine learning, now into these insights that physicians and patients can use to really tailor and personalize care, you're really talking about a whole new revolutionary way to tackle many of healthcare's biggest problems. I love their Optum brand. That will be a key area to watch. 

For UnitedHealth, it really comes down, their biggest revenue drivers, you've got the Optum brand, but you've also got the employer-sponsored plans and also Medicare Advantage, as well. This quarter showed some really impressive growth in those areas on a numbers basis. They served 2.8 million more consumers in the third quarter. That's pretty impressive. 

Campbell: Yeah, and a lot of that is obviously Medicare and Medicaid, which I think are probably the two most important pieces of the health insurance business to track at UnitedHealthcare going forward. One of the things that, when you're looking at insurance, you always want to keep an eye on the medical cost ratio, which is the MCR.

Sometimes different insurers will call it something slightly different, but it's essentially how much of the premiums that they're collecting are spent back out on patient care. You hear those huge revenue numbers, that's the gross premiums that they're collecting plus, in the case of UnitedHealthcare, Optum. Then, of course, you've got to consider that they're putting out a lot of that money in premiums back into patient care. Last quarter, that improved to 81%. It was down 40 basis points year over year. That makes the company more profitable. They reported $3.41 in earnings per share. That was $0.12 better than the Street was looking for. That was up 28% year over year, which was more than twice the rate of growth of its sales. Again, a big reason for that is the success that they're having in Medicare and Medicaid. Medicare sales were up 15.2% to $18.8 billion. That was because they added 525,000 new Medicare Advantage members. The Medicaid business grew about 18% to $11.1 billion, because they added about 255,000 people to their roles over the past year. 

Jones: On the Optum side of the table, you had revenue of $25.4 billion. That was up 11%. Also, just thinking about outside of the company, there's some really strong growth drivers, especially on the Medicare side. No. 1, you've got an aging baby boomer population that will continue to drive people to many of those Medicaid and Medicare plans. Also, on the employer-sponsored side, you've got really low unemployment. I think we're right at about 3.9% unemployment. That will continue to be a strong driver for the company and the health insurance industry in general, as well.

Where is the company looking, in terms of full-year guidance right now?

Campbell: They've been very actively buying back shares. That helps the bottom line results. You're going to want to see if they're going to be able to continue that pace. I think they will. They generate tons of free cash flow. They bought back $15.7 million shares this year alone, spent about $3.6 billion on that. Now, they're looking for EPS of $12.80 this year. That's up from $12.50 to $12.75 previously. Again, this is a very profitable company. They have very small margins because, again, they plow a lot of those premiums back into patient health, yet they benefit from scale. They do so much business that they're still able to generate so much money for the bottom line. They actually increased their dividend by about 20% this year because they're generating so much cash flow. 

Jones: That dividend hike certainly does not hurt. You've got two really strong healthcare behemoths reporting strong earnings. Hopefully this is a great prelude to a good earnings season across the entire segment. 

Todd, you recently had the unique opportunity to interview a member of the executive team of a smaller biotech that over the past few years has caught a tremendous amount of attention from biotech investors. That company is Genfit, ticker GNFT. Genfit best known for its late-stage Phase 3 candidate Elafibranor, which is being studied in a disease called NASH. Todd, NASH is quickly becoming the target that many biotechs are striving to hit.

Campbell: Right. Gilead Sciences' success in hepatitis C, raking in about $20 billion analyzed at one point after they came up with their new hepatitis C drugs earlier -- I think it was 2014 when they launched the first one -- really got the attention of researchers. They looked at it and said, "Jeez, what else can we tackle it in liver disease?" NASH is now fast becoming, instead of hepatitis C, the major cause of liver transplants. When you have liver disease, there's also the risk of liver cancer. So, a lot of people are looking at NASH and saying, "If we can find a way to tackle this disease, then maybe we can find the next mega blockbuster indication."

Like you said, I had the privilege of being able to go down to the Cambridge offices of Genfit. They are an European company. They're primary exchange is in Paris. They're a French company. But, they do have ADRs that trade here in the U.S. They're a little illiquid, though, so investors should know that. It's a relatively small company. I think their market cap's around $800 million. They're far from the only competitors who are angling to try and come up with a win in NASH, but they are one of the few that has an ongoing Phase 3 trial under way that's expected to read out data in 2019. If the data is good, then they could file this drug for FDA approval. There are no drugs right now that are approved specifically for NASH, so estimates right now are that you'll see up to -- I mean, I'm using the pie in the sky estimates -- up to a $35 billion market once these drugs get out there. Of course, they're going to have to prove their worth in the trials first. 

Jones: Exactly. What's interesting about Genfit is, they've actually got multiple shots on goal here. You mentioned Gilead. They've got a few drugs in the pipeline also going after this indication. But Genfit is actually a little bit different. They obviously have a therapeutic component, Elafibranor. But, what's really interesting is, they also have a diagnostic tool that, regardless of which treatment a patient may go with, being able to diagnose these patients earlier, sooner, I think, is a key area to win. Todd, tell us a little more about their strategy here. How are they expecting to upend this huge unmet need market?

Campbell: I was fascinated by this, the potential for the diagnostic. I hadn't been thinking that way. Like a lot of people, I've been looking at and saying, NASH typically occurs in people who are living sedentary lifestyles. As Western diets have become more prevalent globally, you see more and more people getting diagnosed with fatty liver disease and, unfortunately, NASH. You start spending most of your time thinking not about how you diagnose those patients, but instead of thinking about how you're going to treat those patients. I think that this gives Genfit a competitive advantage over some of these other companies like Gilead and everything that are focusing on the drugs but haven't spent as much time trying to figure out the diagnostic side of it. 

The reason I say that is that NASH is a silent disease. It's often not diagnosed until people really have advanced liver disease. The gold standard for diagnosis is a liver biopsy. Liver biopsies are expensive, they're invasive, and they're usually done by specialists. This is not a test you're just getting done by your primary care physician. 

What Genfit has gone out and done is, it's been able to identify some biomarkers that show up in the blood of NASH patients. The idea here is to be able to create a low-cost, easy to take blood test that would show you whether or not you're likely to have NASH, and if you are, theoretically, you move on to a biopsy or something else. Next year, they're going to roll this diagnostic test out into different research facilities. In theory, this is a drug-agnostic approach diagnostic. It's not going to be used with Genfit's drug that's in Phase 3 trials. It could be used with Gilead's drug, it could be used with Intercept's drug, it could be used with Madrigral's drug, it could be used with Viking's drug. All these companies that are racing toward the finish line in NASH could theoretically drive demand for diagnostics beyond that specialty office market. 

Jones: Looking ahead, I think it's really interesting. Phase 2 for Genfit's drug, Elafibranor, actually didn't meet its primary end point. There's some nuance there. I think this is an important point, especially for biotech investors. The company did a post hoc analysis. We've talked a little bit about the problems with that. There was some nuance here because it really came down to study design. It sounds like, for this Phase 3 trial that they're currently running, they've designed it with that in mind. 

Tell me, looking forward, what are some of the key things that you'll be looking at with this Phase 3 trial with that in mind? 

Campbell: Yeah, I think that we always have to be very cautious when it comes to post hoc analysis. But we also should remember that this is an indication that there are no approved treatments specifically for. Phase 1 and Phase 2 truly are much more exploratory than maybe it would be in other, more proven-out indications. And, each one of these companies is targeting a slightly different mechanism of action. For example, Genfit's targeting a dual agonist of the PPAR, which is a pathway that helps regulate things like metabolism and lower the amount of fat that's in the bloodstream. Their drug is a dual PPAR. But you also have Intercept, that has an Fxr agonist, which works slightly differently. You have Gilead's Selonsertib, that's different drug, works a little bit differently, as well. All these companies have these different drugs that are going through trials, and they're using these Phase 2 trials to try and figure out the best way to get the drug across the finish line in Phase 3. It truly is exploratory.

In that regard, maybe I'm willing to give a little bit of a benefit of the doubt to post hoc analysis. In speaking with management, it does sound like they have a really good grasp of the type of patients that are most likely to respond well to this drug. We'll have to wait and see. The interim data that could back an FDA approval, that's not expected until the end of 2019. But, that's about a year away. You're not waiting too long to find out whether or not they're onto something.

Intercept and Gilead, interestingly, their data is going to come out first. They'll have data in the first half of 2019. But Gilead is actually not even looking at NASH resolution as the primary endpoint in their Phase III study. They're actually looking at improvement in resolution of fibrosis. It really may come down to, which ones do you use in different levels of treatment, or do you use these because they all have mechanisms of action that are slightly different? Do you use them as combination therapies? How that's all going to shake out, I don't know.

So, yeah, take it with a little bit of a grain of salt, because Phase 3 is based on post hoc analysis, Phase 2 maybe isn't that indicative overall of what's going to happen in Phase 3.

Jones: It'll be important to also watch a Phase 2 study in another chronic liver disease indication, PBC, which is marked by progressive destruction of bile ducts within the liver. The read-through from that Phase 2 study will obviously have implications from an investor perspective on what that means for their drug. Then, you've got to be mindful of cash burn, as well, because the company may need to do a capital raise pretty soon.

Campbell: I think so. The PBC data is expected later on this year. Intercept already has their drug that they're studying in NASH, approved in PBC. That's generating out about $43 million a quarter for Intercept. You're talking about a nine-figure opportunity. They will need to conduct a Phase 3 study, but if the Phase 2 data is good in PBC for Genfit, then maybe that helps validate the mechanism of action a little bit more, maybe that causes share prices to rally a little bit. If so, I wouldn't be too shocked if they went out and did a capital raise, issued some shares, to try and bolster up the balance sheet. This is certainly not desperate times. They've got $275 million using current exchange rates, euros to dollars, right now on the books. But they are going to have to increase their spending unless they do a licensing deal or something. They're going to have to bolster their cash through some other way if they're going to launch this on their own.

Jones: Such an interesting space, so much to watch here in this particular company with Genfit. It's really companies like these that keep me so intrigued in the biopharma market. We should come back and do a NASH show. There's so much more we can dig into about the race to approval and how they differ and how they're similar. We'll have to put that on the calendar, Todd! [laughs] 

Campbell: Absolutely! We could absolutely do a 20- to 30-minute show on that alone.

Jones: On that alone, that's for sure. Well, thanks so much for tuning in this week! That's it for this week's Industry Focus. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Heather Horton. For Todd Campbell, I'm Shannon Jones. Thanks for listening and Fool on!