Upgrading to Outperform: STELARA's Worst Quarter Is in the Books, IM Grows Through the Trough, MedTech Accelerates Across All Subsegments, and the DePuy Synthes Spin Structurally Re-Rates the Remaining Franchise

Rating Action: Upgrading to Outperform

This is our second publication on Johnson & Johnson, and it follows our initiation report from July. We are upgrading our rating to Outperform from Hold (constructive bias).

Arc walk

• Q2 2025 (Initiating at Hold, constructive bias) — We initiated coverage at Hold on July 17, 2025 on a clean Q2 beat-and-raise that lifted FY operational sales by ~$900M and adjusted EPS by $0.25 to $10.85. The Hold rather than Outperform was a price-and-setup judgment, anchored on five specific reservations: (i) the STELARA biosimilar curve was still steepening into 2H toward a Year-2 HUMIRA-like trajectory, (ii) the talc Daubert hearing this fall was a binary regulatory event the equity was not pricing, (iii) MedTech segment margin had compressed ~350bps (25.7% → 22.2%), (iv) the post-print breakout above $167 had removed the cheap-setup cushion, and (v) the 2H pipeline catalysts (TAR-200, CAPLYTA-MDD, subcu RYBREVANT, icotrokinra) were real but earnings-unvalidated. Innovative Medicine had crossed $15B for the first time and MedTech had reaccelerated to +6.1%.
• Q3 2025 (Today — Upgrading to Outperform) — The five Hold reservations have each materially de-risked. STELARA Q3 erosion of -42% is in line with rather than steepening past management's modeled trajectory, and the ex-STELARA IM portfolio grew ~16%. The Daubert ruling timing is now confirmed for 2026 with management stating explicit confidence. MedTech segment margin compressed further (24.1% → 21.0%) but management announced the planned spin-off of DePuy Synthes (Orthopaedics), structurally adding +75-100bps to both top-line growth and operating margin of the remaining business. Pipeline catalysts that were prospective in July are now substantially earnings-validated: INLEXO is FDA-approved and launching with peak-sales potential reaffirmed at $5B; CAPLYTA-MDD is approval-pending; subcu RYBREVANT is approval-pending; icotrokinra has been filed with the FDA; CARVYKTI is at 8,500+ patients with growth re-accelerating. Management telegraphed 2026 revenue above current Street consensus of 4.6% (their internal expectation: >5%) and adjusted EPS approximately $0.05 above the $11.39 consensus — an unusual pre-flag from a CFO that does not pre-flag lightly. The setup, the operational acceleration, and the structural strategic action together argue for a more constructive rating.

The franchise quality view we held at initiation has not changed; what has changed is our confidence that the through-cycle execution narrative is now substantially proven, the binary tail risks have moved closer to resolution windows that are within investment horizon, and a deliberate strategic action (the DePuy Synthes spin) re-rates the remaining MedTech franchise's quality profile. We move to Outperform.

Results vs. Consensus

The print is a clean two-line beat. The revenue beat (~+1.1% above Street) is composed of an operational beat plus a 140bps FX tailwind from the weaker dollar. The EPS beat (~$0.03 / ~+1%) is operational quality even after absorbing the 31.2% effective tax rate in the quarter (vs. 19.3% prior year), which itself reflects a one-time $1.0B remeasurement of deferred tax balances tied to the One Big Beautiful Bill Act. Adjusted operational EPS growth of +15.7% is the cleanest read on underlying earnings power and is the strongest YoY EPS print since at least the Kenvue separation.

Segment Performance

Innovative Medicine: $15.6B, +5.3% operational (-1,070bps STELARA drag)

The reading we have anchored on for two consecutive quarters is the ex-STELARA growth rate of the rest of the IM portfolio — the test of whether the post-Kenvue franchise is structurally capable of growing through the largest LOE in JNJ's history. In Q3, that ex-STELARA portfolio grew approximately +16% (management's disclosure: the pharmaceutical business in Q3 grew ~16% excluding STELARA). The first time IM crossed $15B was Q2 2025; it has now done so twice in succession, and grown 5.3% operationally while doing it.

STELARA itself declined 42% in Q3, in line with management's modeled biosimilar erosion plus Part D redesign trajectory. This is the operationally important read for the upgrade: in Q2 we flagged that "the STELARA biosimilar curve is still steepening into 2H." In Q3 the curve is in line with the management framing rather than running ahead of it. The decline rate compares Q3 (-42%) to Q2 (-43%), and the headwind to total IM growth narrowed from 1,170bps in Q2 to 1,070bps in Q3 — the first quarterly narrowing in the cycle.

Eleven brands grew double-digits in IM, the breadth that we identified at initiation as load-bearing for the through-cycle thesis:

The depth here is the analytical point. No single asset's ramp is the franchise's whole story; the portfolio's breadth is doing exactly what management promised it would do at the 2023 enterprise business review. Of these, we view TREMFYA (now growing 40% on IBD uptake with subc induction approved) and CARVYKTI (running at $524M / +81% / +18.5% sequential) as the two most-leveraged contributors to the back-half-of-decade thesis, with INLEXO — just FDA-approved — as the highest-leverage 2026 launch.

MedTech: $8.43B, +5.6% operational (US +6.6%, OUS +4.5%)

This is the segment that has been the swing factor on the rating decision in both quarters. In Q2 we noted MedTech reaccelerated to +6.1% operational and that segment margin had compressed materially (25.7% → 22.2%) on macro cost-of-products-sold pressure. In Q3, the headline is +5.6% operational growth (slight deceleration from Q2 on the +6.1% headline, but with US growth accelerating to +6.6% and broad-based subsegment improvement) and segment margin compressed further to 21.0% (from 24.1% prior-year Q3). The compression line is the line we said we would watch.

Three reasons we read the compression as the cyclical trough rather than a structural shift, and as a buying-rather-than-selling signal:

1. Mix is improving and lapping unfavorable comps. Cost of products sold pressures called out by management (macroeconomic / tariff / product-mix) are largely transitory and offset by the lapping of the prior-year Shockwave fair-value inventory step-up. The underlying segment growth profile is shifting toward higher-margin Cardiovascular and Surgical Vision.
2. Cardiovascular is the fastest-growing category and the highest-margin growth vector. Cardiovascular grew approximately +12% in Q3, with electrophysiology +9.7%, Abiomed +15.6%, and Shockwave +20.9% — double-digit globally in both coronary and peripheral. Shockwave is on track to become JNJ MedTech's thirteenth $1B+ platform by year-end. Variable-pulse ablation (Varipulse) achieved 99.7% acute effectiveness in real-world evidence with no incidence of stroke. Abiomed posted long-term DANGER-SHOCK NEJM data showing a 16.3% mortality reduction over ten years — clinical-evidence-tier validation that meaningfully strengthens reimbursement defensibility. None of this looks like a structurally lower-quality business than the one we initiated on.
3. Orthopaedics is being spun. The largest single drag on MedTech's segment margin and the lowest-growth subsegment within MedTech is being structurally separated. This addresses the segment-margin question directly — not by improving Orthopaedics, but by removing it. Management's quantification: at-least +75bps to both top-line growth and operating margin on normalized 2025 results, with the CFO acknowledging that on a 2025 stand-alone view the impact is closer to 100bps each.

The most structurally interesting item beneath the headline: Orthopaedics returned to growth at +2.4% in Q3 (vs. -1.6% in Q2). Hips +5.1%, knees +5.6%, with spine returning to growth and trauma improving. This matters because the better Orthopaedics performs going into the spin-off, the better the term value of the separation transaction is to JNJ shareholders — and because the inflection itself signals that the operational improvement program in Orthopaedics is working before the separation is even structured.

Surgery grew +3.3% (50bps divestiture drag and competitive pressure in Energy plus China VBP remain the headwinds). Surgical Vision grew +13.8% on TECNIS PureC, ODYSSEY and iHance launches. Contact-lens grew +3.5%. Vision overall +6.1% growth.

Key Topics & Management Quotes

The DePuy Synthes (Orthopaedics) spin announcement

The most consequential strategic action since the Kenvue separation. Management framed the rationale as a focus action, not a financial-engineering action: positioning the remaining MedTech business on Cardiovascular, Surgery, and Vision (the three categories where JNJ has the strongest competitive position and the highest unit growth) and creating a standalone champion for the orthopaedics market.

"This decision further sharpens our focus as a healthcare innovation leader and accelerates the shift of our MedTech portfolio to areas of greatest unmet need and higher growth, which includes cardiovascular and robotic surgery." — Joaquin Duato, Chairman & CEO

Mechanics:

• Targeted completion within 18-24 months
• Initially structured as a tax-free spin-off; other avenues considered
• To be named DePuy Synthes, led by Namal Nawana (industry veteran)
• Largest orthopaedics company in the world; ~$50B addressable market
• JNJ dividend not impacted; mindful of stranded-cost typical patterns

Quantification of the impact on the remaining JNJ MedTech business:

"If we just look at normalized year-to-date 2025 results, MedTech's top-line revenue growth and operating margin would both improve by at least 75 basis points." — Joe Wolk, CFO

Under questioning as to whether 75bps was conservative given the higher-margin profile of Cardiovascular and Surgical Vision, Wolk acknowledged that on a 2025 stand-alone basis the impact would be "probably closer to 100bps both on top and bottom" but moderated by margin-improvement initiatives already underway in the higher-growth subsegments. We read 100bps as the right read for the FY26 modeling and 75bps as the right read for the post-stranded-cost run-rate.

Assessment: This is a structural change to the franchise that warrants a structural change to the rating. The remaining MedTech business will be growing structurally faster, structurally higher-margin, and structurally more competitive. Combined with what is now demonstrated (in Q3) as IM's ability to grow through the STELARA cliff, the post-spin JNJ is a higher-quality compounder than the pre-spin company we initiated on.

Talc Daubert update

Joe Wolk addressed the Daubert motions directly in his prepared remarks — which itself is a tell about confidence:

"We look forward to and expect to secure favorable rulings on the Daubert motions, which should be rendered by 2026." — Joe Wolk, CFO

The structurally important phrase is "by 2026" — the timing now sits within investment horizon. At Q2 we flagged this as a binary regulatory event the equity was not pricing. At Q3, the timing is bounded, the company's confidence is on the record, and the legal framing (re-examination of plaintiff-side scientific basis through the Daubert process) gives the company a pathway to materially de-risk the litigation overhang. We are not assuming a specific outcome; we are noting that the time-to-resolution has shrunk.

2026 above-consensus pre-flag

The most unusual single management statement on the call was Wolk's explicit pre-flag that current Street consensus understates 2026:

"Based on my last look at your 2026 models, it appears current revenue consensus of 4.6% growth in your models for 2026 is lower than we project, which we believe in total will exceed 5%. Similarly, with the expectation that adjusted earnings per share is commensurate with sales growth, there appears to be some upside to the current adjusted earnings per share consensus of $11.39, perhaps as much as $0.05." — Joe Wolk, CFO

Assessment: Pre-guides of this specificity are rare from JNJ's investor relations posture. The CFO is not someone who flags consensus mismatches casually. The signal is consistent with management's stated view that JNJ is in "a new era of accelerated growth" expected to last "the balance of the decade," and is consistent with both the IM ex-STELARA growth profile (~16%) and the post-spin MedTech growth profile (5.6% + ~75-100bps). We expect the formal January 2026 guide to be in the +5%-to-+5.5% revenue range with adjusted EPS at or modestly above $11.44.

FY 2025 guidance raise

Management raised the operational sales midpoint by ~$300M to $93.2B (operational growth 4.8%-5.3%, midpoint 5.1%) and the reported sales midpoint to $93.7B (5.4%-5.9%, midpoint 5.7%) on a roughly flat euro spot rate. Adjusted EPS guidance was reaffirmed at $10.85 midpoint (range $10.80-$10.90), with the reaffirm absorbing both the higher full-year effective tax rate of 17.5%-18.0% (up from prior, on One Big Beautiful Bill remeasurement) and Q4 reinvestment intended to position for 2026 launch acceleration. Tariff guide was held; net interest expense guide improved to $0-$50M (from prior, on higher cash balances). Operating margin guide of +300bps for the full year was reaffirmed.

Inlexo (TAR-200): bladder cancer launch

The 2H 2025 catalyst we flagged in the Q2 recap as one of the highest-leverage operational unknowns is now an FDA-approved product in active launch mode. Initial indication: BCG-unresponsive high-risk non-muscle-invasive bladder cancer, with management citing the highest complete response rates without need for re-induction and over half of responders still cancer-free at one year. Management reaffirmed peak-sales potential of $5B+ and noted that the J-code for permanent reimbursement is anticipated in April 2026 — a typical buy-and-bill ramp pattern.

The development pipeline behind INLEXO is the more important strategic point: Phase 3 in BCG-experienced relapsed disease, head-to-head against BCG in frontline, and TAR-210 (next-generation device with erdafitinib targeting RTK-mutated bladder cancers, complete response rates >90%, three-month sustained release vs. INLEXO's three-week). Management's framing of the platform as another blockbuster with at least $5B in annual peak-year sales combined with TAR-210 in the pipeline suggests JNJ has constructed a multi-asset bladder-cancer franchise from a single early-stage acquisition (acquired for "a couple of hundred million dollars" in 2019).

Capital allocation discipline

Joe Wolk addressed the recurring question on M&A appetite directly:

"We rely on our thoughtful long-term approach to growing through any loss of exclusivity and won't carelessly deploy capital on speculative transactions out of desperation. Our current portfolio and pipeline have momentum, and with the STELARA loss of exclusivity increasingly in the rearview mirror, we do not need to rely on large transactions to drive our growth." — Joe Wolk, CFO

JNJ ended Q3 with approximately $19B in cash and marketable securities and $46B of debt, producing a net debt position of $27B (down from $32B in Q2). YTD free cash flow was $14B through nine months. The continued focus on smaller bolt-on transactions ("more than 60 deals in the last two years") is consistent with the long-running pattern that has produced INLEXO, RYBREVANT, and CAPLYTA at strong return-on-capital metrics. We do not expect a transformational acquisition; we do expect continued smaller-deal activity that compounds the existing pipeline depth.

Analyst Q&A: Highlights

The Q&A focused heavily on the orthopaedics spin and the 2026 setup. We summarize what we view as the analytically most useful exchanges; per house policy we do not quote analysts directly, but we attribute their lines of questioning to provide context.

On the spin-off margin math (Danielle Antalffy, UBS)

UBS pushed back on the +75bps margin uplift framing as conservative given the higher-margin profile of Cardiovascular and Surgical Vision in the residual MedTech mix. Wolk acknowledged that on a 2025 stand-alone basis the math is "closer to 100bps both on top and bottom" but framed the +75bps as the post-stranded-cost run-rate after several years. Tim Schmid (MedTech head) added that the spin is consistent with the "shrink to grow faster" portfolio philosophy. Our read: 100bps is the right number for FY26 modeling on the residual business; the +75bps is conservative for stranded-cost optics.

On 2026 growth acceleration vs. consensus (Larry Biegelsen, Wells Fargo; Asad Haider, Goldman Sachs)

Wells Fargo and Goldman both pressed on whether the 2026 acceleration commentary is on a reported or adjusted-operational basis. Wolk's response was that consensus is on a reported basis for both top-line and EPS, so the comparator he used is reported, with FX assumed approximately baked into Street's 4.6% top-line print. Goldman's follow-up on the disconnects yielded the most useful management exposition: TREMFYA, SPRAVATO, INLEXO and icotrokinra are the four products where management views consensus as most under-modeled; Innovative Medicine ex-STELARA grew 16% in Q3 and management views that as a sustainable rate as STELARA's headwind narrows.

On underlying MedTech growth and reserve adjustment (Jayson Bedford, Raymond James)

Raymond James asked whether the +5.6% MedTech print was inflated by a Surgery reserve adjustment partially offset by Energy go-to-market changes. Wolk characterized the net impact as "moderate, certainly not material" — meaning the +5.6% is a clean-enough read for our purposes and the Q3 acceleration is not optical.

On icotrokinra positioning (David Risinger, Leerink)

Leerink asked about the strategic positioning of icotrokinra (oral peptide IL-23 receptor blocker, FDA-filed in July 2025) relative to TREMFYA. Jennifer Taubert (IM head) framed icotrokinra as occupying the "biologic-like efficacy with oral simplicity" positioning, with TREMFYA continuing to grow 40%+ in IBD; she noted the head-to-head psoriasis trial against the leading TYK2 inhibitor will publish in The Lancet, and that two NEJM papers on the placebo-controlled studies are in press. Our read: icotrokinra is being positioned as a multi-billion-dollar oral-immunology franchise alongside TREMFYA, not in competition with it — consistent with management's stated $5B+ peak-sales ambition.

On the pipeline anti-tau antibody (Terence Flynn, Morgan Stanley)

Morgan Stanley asked about the Phase 2 anti-tau antibody data expected by year-end, and whether the trial design supports an accelerated approval pathway. John Reed (IM R&D head) confirmed the data is expected in-house this year with a medical-congress presentation in 1H 2026, and that the trial includes both cognitive endpoints (traditional Alzheimer's regulatory measures) and tau-spread neuroimaging via PET. The accelerated-approval question was not answered directly — suggesting the company is not yet committing to a specific pathway. Our read: we treat this as optionality rather than near-term thesis, but it is a credible long-term lever given the differentiated tau epitope mechanism.

What They Are Not Saying

Three observations on what was deliberately or implicitly absent from the call.

1. Nothing on the talc litigation reserve. Management addressed Daubert timing and confidence, but provided no update on talc reserve levels or expected accounting impact under various ruling scenarios. This is consistent with a company that is confident enough in the Daubert outcome to not pre-position the balance sheet, but it leaves the residual reserve calibration as the line we still cannot triangulate.
2. Limited detail on stranded costs from the DePuy Synthes spin. Wolk noted being "mindful of any impact from stranded costs that are typically present in these types of transactions" but did not quantify them. The 100bps-vs-75bps margin commentary implicitly suggests stranded costs absorb roughly 25bps of margin uplift over time. We will sharpen this in the January 2026 guide.
3. No formal 2026 guide for STELARA. Management did not pre-flag the expected 2026 STELARA decline rate. Given Q3 is in line with Year-2 HUMIRA proxy, we model 2026 STELARA at -25% to -35% YoY. The IM ex-STELARA growth of ~16% provides ample cushion for any reasonable STELARA path.

Market Reaction

The print and the orthopaedics spin announcement were released pre-market. Initial market reaction was constructive but measured — the equity traded modestly higher into and through the call. The constructive read was the operational beat plus the strategic clarity of the spin announcement; the measured tone reflects (a) the EPS beat being modest in absolute terms (~$0.03), (b) the EPS guidance reaffirm rather than raise, and (c) the 18-24 month timeline on the spin meaning the structural re-rating is a multi-quarter unfold rather than a single-day event.

This is consistent with our preferred entry pattern: the structural improvement is real but the price action is not yet pricing it. The Q2 post-print breakout above $167 that compressed the cheap-setup cushion has not extended materially through Q3, leaving the equity in roughly the same place it was at our initiation, with materially better fundamentals. That is the textbook setup for an upgrade.

Street Perspective

The bull case being made by sell-side coverage post-print centers on three pillars: (1) the IM ex-STELARA growth rate has now demonstrated sustained mid-teens performance through the worst quarter of the cliff, (2) the orthopaedics spin is universally read as accretive to the remaining MedTech segment's growth and margin profile, and (3) the 2026 pre-flag from the CFO de-risks Street's 2026 model going into the January formal guide. The bear case argument that remains live is the talc Daubert binary risk and the secondary LOE wave (OPSUMIT 2026, IMBRUVICA 2027-28) that begins to take prominence in the back half of 2026.

We agree with the bull pillars on substance and view the bear case as still real but materially compressed by the timing clarification on Daubert (rulings by 2026, with management on-record confident) and by the capacity of the IM ex-STELARA portfolio to absorb additional secondary LOE drag at its current growth rate. Our view differs from the consensus only in that we view the 2026 pre-flag as a minimum rather than a midpoint — we expect the formal January 2026 guide to be in the +5.0% to +5.5% revenue range with adjusted EPS at or modestly above $11.44 (vs. consensus $11.39 plus the management-flagged $0.05 of upside).

Model Implications

Updates we are making to the operating model on this print:

• FY 2025: Move operational revenue to $93.2B midpoint (from prior $92.9B); reported $93.7B; adjusted EPS held at $10.85. Effective tax rate to 17.75% (midpoint of 17.5%-18.0%).
• FY 2026 (preliminary): Revenue $98.0B-$98.6B (operational +5.2%-+5.8%, ahead of consensus 4.6%); adjusted EPS $11.45-$11.55 (vs. consensus $11.39 + management-flagged $0.05). MedTech segment margin recovers to ~22% as Orthopaedics drag stabilizes pre-spin and Cardiovascular mix continues to improve. IM segment margin ~44% as STELARA gross-profit erosion fully laps in Q1-Q2 2026.
• FY 2026 IM detail: STELARA -27% (Year-3 erosion proxy); ex-STELARA IM growth +13%-+15% (modest deceleration from Q3 rate as TREMFYA IBD launch laps and CARVYKTI growth normalizes off a higher base, partially offset by INLEXO ramp and CAPLYTA-MDD launch).
• FY 2026 MedTech detail: Total +5.5%-+6.5%; Cardiovascular +12%-+14% (electrophysiology, Abiomed, Shockwave all sustained); Surgery +3%-+4% (Ottava de novo submission a 2027 catalyst); Vision +6%-+7%; Orthopaedics +2%-+3% pre-separation.
• Post-spin pro-forma JNJ (FY27): Revenue ~$98B (assuming ~$10B Orthopaedics goes ex), top-line growth +6%-+7%, MedTech segment growth +7%-+8% (vs. blended 5.5%-6.5% pre-spin), MedTech margin ~23%. The structural quality improvement is the through-the-cycle story.

Thesis Scorecard

Overall: Six bull points are confirmed or in-progress, four bear points have de-risked materially, and two remain live (Daubert timing now clarified; secondary LOE not yet a current-period drag). The central tension at Q2 was that operational execution was strong but the equity had broken out and the binary tail risks were unresolved. At Q3, operational execution is stronger, the equity setup has reset, the largest binary tail risk has a bounded resolution timeline within investment horizon, and a structural strategic action (DePuy Synthes spin) re-rates the residual MedTech franchise. The price-and-setup judgment that gated the Outperform rating in Q2 has flipped.

Action: Upgrading to Outperform. Catalysts to monitor: (a) the formal FY26 guide in January — we expect +5.0%-+5.5% revenue growth and adjusted EPS at or modestly above $11.44; (b) Daubert ruling timing within calendar 2026 with our base case favorable; (c) INLEXO launch trajectory through Q4 with the J-code for reimbursement landing in April 2026; (d) CAPLYTA-MDD and subcu RYBREVANT FDA approvals; (e) the next two MedTech segment-margin reads as the cyclical trough resolves. Downgrade triggers: (a) STELARA Q4 erosion exceeds -45% (signaling cliff acceleration vs. plateau); (b) Daubert ruling adverse with material reserve implications; (c) MedTech segment margin compresses further in Q4 with no signs of stabilization; (d) electrophysiology growth deceleration suggesting Varipulse share losses; (e) DePuy Synthes spin terms diverge meaningfully from the +75-100bps framing.