Johnson & Johnson (JNJ, Outperform Rating, $148 TP) “Pharma Growth Drivers Poised to Deliver Further Upside” Reinstating Coverage of JNJ with an Outperform Rating and $148 Target Price: We reinstate July 20, 2017 coverage of JNJ after the close of the Actelion acquisition. The stock has appreciated ~20% since the deal was announced on Jan 26 (vs. the S&P 500 +7.5%) but we see room for further upside, driven by RESEARCH ANALYSTS key pharma growth drivers. Based on channel checks and detailed modeling we have done across various therapeutic areas, we see opportunities for significant upside from assets such as Xarelto, Vamil Divan, MD (212) 538-5394 Darzalex and Imbruvica. [email protected] Full COMPASS data next main pharma catalyst. JNJ (and partner Bayer) will release full results of Michael V. Morabito, Ph.D. the Xarelto COMPASS trial on Aug 27. We already know COMPASS was successful in reducing major (212) 325-7298 adverse cardiac events. Based on the details in the data, our analysis suggests an additional 4MM [email protected] patients (or more) could become candidates for Xarelto. Beyond Xarelto, we are also optimistic on Barbara Kotei Imbruvica and Darzalex as both products have had strong uptake to date and are moving into earlier lines (212) 538-8119 of therapy and additional cancer indications that can drive further growth. In immunology we expect [email protected] additional Remicade biosimilars to take a greater toll on JNJ in 2018, but strong growth from Stelara as Duaa Mohamed well as initial uptake of Tremfya and sirukumab should offset this expected decline. (212)538-8127 Actelion acquisition adds another area of focus, but at a steep price. We believe the ~$29.1Bn [email protected] that JNJ paid for Actelion is slightly above what the company was worth, although it does bring JNJ another area of growth and possible future upside through the equity stake in R&D spin-out Idorsia. Catalysts: (1) COMPASS data for Xarelto at ESC on Aug 27; (2) sirukumab PDUFA in mod-severe RA HOLT CONTACT on Sept 22; (3) potential entry of additional Remicade biosimilars in the US in 2H 2017. Conchita Gonzalez de Castejon Risks: Disappointing clinical data, challenging commercial launches, increased concerns around drug (212) 325 2547 pricing and integration risk represent the primary downside risks to our call. conchita.gonzalezdecastejon@credit- suisse.com Valuation: Our $148 target price is based on a 75%/25% blend of DCF ($149) and relative ($144) valuation and suggests ~10% upside from the latest closing price. We use a 7.0% WACC along with a 1.5% perpetuity growth forecast for our DCF valuation and apply 18.5 times our new 2018 EPS estimate of $7.79 for our relative valuation. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Table of Contents Financial Executive Statements Summary Company Product Background Story Valuation Financial Outlook Investment Business Risks Development Catalysts The authors of this report wish to acknowledge the contribution made by Selvakumar Nallasamy and Brajesh Nirala, employees of CRISIL Global Research and Analytics, a business division of CRISIL Limited. CRISIL Limited is a third-party provider of offshore research services to Credit Suisse. Key Charts Key Charts for JNJ Pharma Key Growth Driver Through 2021 CS Total Pharma Sales Estimates Vs. Consensus Through 2021 (Total Company Sales in $ Billion) (Pharma Sales in $ Billion) $100 CAGR $50 $90 $44.5 3.1% $45 $43.3 $80 $41.3 $41.7 $39.4 $40.0 $70 $40 $38.1 $38.2 $60 3.7% $35.3 $35.5 $50 $35 $40 $30 $30 5.8% $20 $25 $10 $0 $20 2016 2017E 2018E 2019E 2020E 2021E 2017E 2018E 2019E 2020E 2021E Pharma Medical Devices Consumer CS Estimates FOA Consensus CS Total Sales Estimates Vs. Consensus Through 2021 CS Estimates an Expanding Operating Margin (Total Company Sales in $ Billion) (Operating Margin in %) $95 38% $88.6 $90 $86.8 36% $85.4 $84.4 $85 $82.3 $82.8 34% $79.5 $79.9 $80 32% $75.4 $75.8 $75 30% $70 28% $65 26% $60 24% $55 22% $50 20% 2017E 2018E 2019E 2020E 2021E 2016A 2017E 2018E 2019E 2020E 2021E CS Estimates Consensus JNJ - CS Estimates JNJ - Consensus Source: Company data, Credit Suisse estimates, Thomson Eikon, First Order Analytics 3 Table of Contents Financial Executive Statements Summary Company Product Background Story Valuation Financial Outlook Investment Business Risks Development Catalysts Executive Summary Executive Summary Reinstating Coverage of JNJ with an Outperform Rating and $148 Target Price: JNJ’s stock has appreciated ~20% since the Actelion deal was announced on January 26 (vs. the S&P 500 +7%) but we see room for further upside, driven by key pharma growth drivers such as Xarelto, Darzalex and Imbruvica. Full COMPASS Data Next Main Pharma Catalyst: JNJ (and partner Bayer) will release full results of the Xarelto COMPASS trial on August 27th. We already know COMPASS was successful in reducing major adverse cardiac events. Based on the details in the data, our analysis suggests an additional 4MM patients (or more) could become candidates for Xarelto. Beyond Xarelto, we are also optimistic on Imbruvica and Darzalex as both products have had strong uptake to date and are moving into earlier lines of therapy and additional cancer indications that can drive further growth. In immunology we expect additional Remicade biosimilars to take a greater toll on JNJ in 2018, but strong growth from Stelara as well as initial uptake of Tremfya and sirukumab should offset this expected decline. Sentiment on Macro Factors Likely an Important JNJ Driver in Coming Months: We expect investor focus in Pharma (and Health Care in general) in the coming months to remain on the news out of Washington, D.C. Expectations around drug pricing and tax reform are both headed in the direction that would be of benefit to JNJ (and its larger pharma peers) as significant reforms to how drugs are priced in the US is more and more unlikely in 2017 while corporate tax reform occurring in 2018 remains a real possibility. Actelion Acquisition Adds Another Area of Focus, But at a Steep Price: We believe the ~$29.1Bn that JNJ paid for Actelion is above the ~$23Bn that we think the company was worth. However, the revenue synergies could be significant given JNJ’s commercial infrastructure, and the structure of the deal does provide JNJ with another avenue for future upside through its equity stake in the R&D spin-out Idorsia. Additional business development and M&A remain possible (especially if tax reform does occur) despite the price paid for Actelion. Blended Valuation Suggests Room For ~10% Further Upside: Our DCF (based on forecasts through 2026, a 1.5% perpetuity growth rate beyond that, and a 7% WACC) suggests that JNJ is worth $149/share. On a relative basis, using an 18.5x P/E multiple off of our 2018 EPS estimate of $7.79 suggests that JNJ is worth $144/share. Our blended target price, based on 75% DCF and 25% relative, is $148, or about 10% above the latest closing price. Source: Company data, BLOOMBERG PROFESSIONALTM, Credit Suisse estimates 5 Financial Summary JNJ Financial Summary Page Johnson & Johnson (JNJ.N) Price (18-Jul-17,US$) 134.5 Market Cap (US$mn) 362212.8 Previous Value Current value Rating NEUTRAL OUTPERFORM Target Price (US$) 122.00 148.00 Year 12/16A 12/17E 12/18E 12/19E EPS (CS Adj.) (US$) 6.73 7.19 7.79 8.27 EPS Prev (US$) 6.71 7.23 7.47 7.86 EPS (Qtr 1) (US$) 1.73 1.83 EPS (Qtr 2) (US$) 1.74 1.83 EPS (Qtr 3) (US$) 1.68 1.83 EPS (Qtr 4) (US$) 1.58 1.70 Source: Credit Suisse Estimates, IBES Income Statement 2016FYA 2017FYE 2018FYE 2019FYE Per Share 2016FYA 2017FYE 2018FYE 2019FYE Sales revenue 71,890 75,802 80,133 83,066 Equiv. FPO (period Avg.) (mn) 2,789 2,743 2,743 2,744 EBITDA 24,919 26,304 29,549 31,515 EPS (CS Adj.) (US$) 6.7 7.2 7.8 8.3 Depr. & amort. -3,754 -4,276 -4,550 -4,725 Prev. EPS (US$) 6.7 7.2 7.5 7.9 EBIT (US$) 22,436 23,633 26,498 28,291 DPS (US$) 3.2 3.4 3.6 3.8 Net interest exp -358 -625 -818 -776 Dividend yield (%) 2.3 2.5 2.6 2.8 Other adj. 681 1,632 700 500 Dividend Payout (%) 46.8 46.7 45.6 45.3 PBT (US$) 22,759 24,641 26,380 28,015 Earnings 2016FYA 2017FYE 2018FYE 2019FYE Income taxes -3,263 -4,277 -4,727 -5,038 Sales growth (%) 2.6 5.4 5.7 3.7 Profit after tax 19,496 20,364 21,653 22,977 EBIT growth (%) 13.0 5.3 12.1 6.8 Associates & other -732 -636 -285 -285 Net income growth (%) 7.6 5.1 8.3 6.2 Net profit (US$) 18,764 19,728 21,368 22,692 EPS growth (%) 8.5 6.9 8.3 6.2 Other NPAT adjustments -2,224 -3,225 -1,215 -1,215 EBITDA margin (%) 34.7 34.7 36.9 37.9 Reported net income 16,540 16,503 20,153 21,477 EBIT margin (%) 31.2 31.2 33.1 34.1 Cash Flow 2016FYA 2017FYE 2018FYE 2019FYE Pretax profit margin (%) 31.7 32.5 32.9 33.7 EBIT 22,436 23,633 26,498 28,291 Net income margin (%) 26.1 26.0 26.7 27.3 Net interest -358 -625 -818 -776 Valuation 2016FYA 2017FYE 2018FYE 2019FYE Change in working capital -2,405 90 -1,230 -632 EV/Sales (x) 4.8 5.0 4.6 4.3 Other cash & non-cash items -1,784 -2,229 -977 -1,313 EV/EBITDA (x) 13.9 14.3 12.4 11.4 Cash flow from operations 17,889 20,870 23,473 25,569 EV/EBIT