The Bad News Behind J&J's Good Q3 Earnings and Why Pfizer is Kicking Itself as a Result

(MoneyWatch)  Johnson & Johnson announced its third quarter earnings and reported good news: Sales were up year on year 6.4 percent to $15.9 billion. That topline number illustrates two things: how bad news can be concealed inside a diversified pharma play; and how dumb Pfizer was to sell J&J its consumer brands.

J&J's net income also increased, indicating that the company is managing the financial crisis like it ain't no thang. But the revenue number holds a little secret: "the positive impact of currency was 3.1%." That's a lot of money on $16 billion in sales. It suggests that J&J better pray that the U.S. economy doesn't recover too much, or that the Fed doesn't raise interest rates (and thus the value of the dollar).

More bad news: "Domestic sales were up .4%, while international sales increased 13.1%." J&J's sales are split almost evenly between U.S. and foreign territories, meaning that the American economic disaster is a significant drag on the company right now.

But check out CEO William Weldon's quote in the earnings release:

Of note was the strong sales performance of our Consumer segment and the solid sales results in our Medical Devices and Diagnostics segment.

Missing from that statement: Pharmaceuticals, which are sucking wind right now, staying flat at $6.1 billion.

The other thing that seems to be happening to J&J is an interesting cyclical pattern in the effectiveness of its marketing dollars. J&J generally gets around $3 in revenue per $1 of marketing money spent. But if you chart the growth in that ratio, you see that it cycles from quarter to quarter, growing one period and shrinking the next. Here's the percentage growth in the effectiveness of J&J's selling, general and admin dollars since the first quarter of 2007:

• Q2 2007: -4%
• Q3 2007: 2%
• Q4 2007: -9%
• Q1 2008: 13%
• Q2 2008: -6%
• Q3 2008: 3%

One period its growing, the next it's shrinking. That's great ... as long as you know that pattern will continue. But Motley Fool notes there's some significant negative pressures on J&J's pharma revenues in the near future:

Risperdal plunged after generic competition from Teva Pharmaceuticals arrived this quarter. Duragesic, another product that lost U.S. patent protection, saw sales fall 16%. Anemia treatment Procrit also kept dropping, but its less-than-4% decline compared to the previous quarter suggests that it may be reaching the bottom.

Migraine treatment Topamax also saw a nice 19% jump in sales, although it will lose marketing exclusivity in March 2009. In short, with so many drugs already off-patent or swiftly headed that way, don't expect a turnaround in pharmaceutical sales anytime soon.

So there's reason to wonder whether that golden $3-earned-per-$1-spent ratio will stay stable for long.

On the consumer side, J&J proved once again that Pfizer must have been crazy to sell its consumer brands. Check out these numbers:

Worldwide Consumer sales of $4.1 billion for the third quarter represented a 13.1% increase over the prior year with operational growth of 9.4% and a positive impact from currency of 3.7%. Domestic sales increased 11.2%, while international sales increased 14.7%; 8.1% from operations and 6.6% from currency.

As the Times noticed:

Among strong sellers for Johnson & Johnson during the quarter was Zyrtec, an over-the-counter allergy treatment that the company introduced this year. Zyrtec was part of the Pfizer consumer products acquisition."

What was Pfizer thinking? Facing a horrible post-Lipitor patent cliff it seems to have jettisoned the one division that had ongoing growth potential. J&J indicated in its call that it expects to break even on the buyout by 2009.