Johnson & Johnson: On the Same Road as Volkswagen?
Shares of healthcare conglomerate Johnson & Johnson (NYSE: JNJ) plunged 10% on December 14 in response to an investigative news story by Reuters that accused the company of covering up the use of asbestos in its popular baby powder product:
“From at least 1971 to the early 2000s, the company’s raw talc and finished powders sometimes tested positive for small amounts of asbestos, and that company executives, mine managers, scientists, doctors and lawyers fretted over the problem and how to address it while failing to disclose it to regulators or the public.”
The magnitude of the decline in JNJ, which lost $40 billion of market value in a single day, is somewhat surprising in that the company had previously settled lawsuits making similar allegations in the past, which are public information. Prior to that day, JNJ had been one of the few large-cap stocks to make headway during Q4 while the SPDR S&P 500 ETF (NYSE: SPY) lost more than 10% of its value.
The new wrinkle in the Reuter’s article, and what brought JNJ tumbling down, is the lengths to which JNJ executives purportedly went to hide information from the public regarding the use of asbestos in its products and their efforts to influence industry regulators to allow that practice to continue well after the company knew it might cause cancer in some of its users.
Smoke and Mirrors
If those allegations prove true, then JNJ may be on the hook for an MSA (master settlement agreement) similar to what the tobacco industry ultimately ratified twenty years ago. However, I don’t think that is likely to happen for several reasons:
- First, the effectiveness of huge government settlements in increasing deterrence has been called into question. Critics of the tobacco industry’s MSA claim that most of the money collected from cigarette manufacturers has not been spent on smoking cessation programs, but instead has been rerouted to unrelated activities.
- Second, this is not an industrywide event, but specific to one company. And that one company is strongly refuting the notion that it engaged in illegal behavior, and has documentation to prove that it had been communicating with regulators over many years over the use of asbestos in its baby powder products.
- Third, there is not yet sufficient scientific evidence to prove that the low levels of asbestos in those products is what caused cancer in some of its users. JNJ has millions of customers around the world, some of whom will be diagnosed with mesothelioma even if some other agent was at work.
That said, clearly JNJ has a huge reputational risk crisis to manage to win back the trust of its retailers and customers. To that end, the company intends to engage in a massive public relations campaign to explain its side of the story. How well that plan is executed will influence how JNJ stock trades throughout 2019 and beyond as the company deals with the inevitable onslaught of lawsuits and governmental investigations.
That effort is already underway. Three days after the Reuters story broke, JNJ replied in a full-page ad in several major newspapers with the headline “Science. Not sensationalism.” At the same, JNJ’s CEO, Alex Gorsky, appeared on CNBC to reiterate the company’s claims that its baby powder products are safe and have always been in compliance with industry regulations:
If JNJ is successful in avoiding a master settlement agreement with governments around the world then its recent share price decline may prove to be a rare buying opportunity. At a share price of $130, JNJ is valued at 15 times forward earnings while its dividend yield has ratcheted up to 2.7%.
To shore up its stock price until panic over this event begins to abate, JNJ announced that it has authorized an additional $5 billion to its share repurchase program for share repurchase to “be made at management’s discretion.” That amount represents less than 2% of JNJ’s reduced market capitalization of roughly $351 billion.
The company also reaffirmed its earnings guidance for 2018, although that is now immaterial in the minds of most investors. The far more important question is to what extent any financial liability from these allegations may impact future earnings, which at the moment is unknowable.
What is known is the way Volkswagen AF (OTC: VWAGY) has performed since it admitted to falsifying emissions data to conform to regulatory requirements in the United States three years ago. After nearly dropping in half, its share price recouped some of that loss but is still more than a third less than where it was trading before the scandal was revealed.
It was also three years ago that Lumber Liquidators (NYSE: LL) was accused by 60 Minutes of violating U.S. safety standards by allowing too much formaldehyde in some of its laminate flooring products. Four years ago, LL was trading above $100. Its stock has never recovered from that blow, and now trades at about one-tenth of that price (chart below).
Both of those examples illustrate why the stakes are so high for Johnson & Johnson. Yes, there are many important distinctions between this case and those two. But if it turns out its management team actively engaged in hiding information from government regulators that it knew to be in violation of the law then there may be a lot more pain in store for JNJ shareholders.