Johnson & Johnson (NYSE:JNJ) faces an issue many might have never imagined for the company until recently—a compromised reputation. The New Brunswick, New Jersey-based healthcare giant potentially faces billions in fines from legal settlements regarding its products, and it’s going to put a real smudge on JNJ stock.
More importantly, it could lose many of the reputational benefits built over decades. Given the uncertainty this perceived loss of character has caused, investors likely face more risk than potential reward by buying at current levels.
A Diminished Reputation and JNJ Stock
For generations, Johnson and Johnson has remained the venerable maker of household first aid products. It had also built its good name among more conservative investors for consistent stock price growth and the 56 straight years of dividend increases.
However, in recent months, the reputation of J&J has taken a beating. One, a lawsuit linked one of its better-known products, talcum powder, to possible ovarian cancer risks. Secondly, and more important, Johnson and Johnson faces a $572 million verdict in Oklahoma over deceptive marketing practices to push the sale of opioids.
Admittedly, this does not take JNJ to the level of other opioid makers. Teva Pharmaceuticals (NYSE:TEVA), which has fallen almost 70% from its 52-week high. I also do not see the company facing bankruptcy like Purdue Pharma.
Still, Johnson and Johnson faces challenges most investors could not have imagined until recently. As of now, no other companies besides J&J and Microsoft (NASDAQ:MSFT) hold the vaunted AAA credit rating. However, following the verdict, Moody’s adjusted its outlook on this rating from stable to negative as the cost of settlements starts to weigh on the company. This endangers the credit rating that has long boosted the company’s reputation.
Do Not Buy JNJ Stock Now
This situation will tempt many into buying JNJ stock. After all, it trades at a forward price-to-earnings (PE) ratio of 14.3. Moreover, the company will likely settle these disputes and move forward.
While it will hurt the company to a degree, it should not hurt the long-term prospects for Johnson and Johnson. Still, I caution against buying now. I say this mainly because the constant drip of negative results has only begun.
Yes, the $572 million opioid settlement came in lower than many anticipated. However, the company also faces more than 2,000 lawsuits that have consolidated in a federal court in Ohio. Moreover, an actual downgrade in the credit rating would probably take JNJ stock further down. With such a rating almost never rewarded, getting the AAA rating back could become almost impossible.
Watch Earnings and Dividends
Investors need to also watch forecasted earnings. Few analysts have revised earnings and profit growth projections to reflect the cost of these suits. For now, Wall Street forecasts earnings for this fiscal year of $8.60 per share. However, analysts made that same prediction 90 days ago.
Also, analysts forecast a 5.1% profit increase this year and 6% rise in fiscal 2020. These growth rates tend to mostly attract conservative investors focused on dividends. However, one has to wonder how many of them will still want to own Johnson and Johnson amid this scandal. I think this also calls into question whether its long streak of payout hikes can continue.
Our own Larry Ramer, who advocated shorting JNJ stock, has gone so far as to claim the lawsuits could force a dividend cut. Although I have not arrived at that conclusion, I cannot discount the possibility. Such a move would bring years of harm to Johnson and Johnson. While I still think that JNJ will eventually come back with or without a reduced payout, a dividend cut would probably delay that recovery.
Final Thoughts on Johnson and Johnson
Although the lawsuits should eventually make J&J a buy, investors should first wait for the full extent of the bad news. Yes, JNJ faces potentially billions in fines from the talcum powder and opioid lawsuits. Even Moody’s has indicated the AAA credit status that has long bolstered JNJ may not survive.
Also, analyst estimates for the company remain largely unchanged. Moreover, the company still faces thousands of pending lawsuits that could drain the cash, profits, and possibly even the dividend in Johnson and Johnson stock. Both of these situations indicate that more bad news will likely come.
However, JNJ stock has yet to reflect the level of pain these court cases will probably bring to the company. Moreover, even if it avoids those fates, J&J has long benefitted from a reputation of integrity and reliability. Seeing its character suffer to this degree will likely turn some consumers away from its products. If the lawsuits do not harm its profit growth, its compromised integrity might.
Eventually, Johnson and Johnson will settle the lawsuits. I also think it will ultimately restore most of its reputation and return to steady growth. However, until investors can realize the full impact of the lawsuits, they should not buy JNJ stock.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.