Ignore the Analysts: Johnson & Johnson Faces Serious Legal Liability

Analysts are seriously underestimating the risks from talc and opioid litigation

It’s been the best of times and the worst of times for Johnson & Johnson (NYSE:JNJ) stock. On the one hand, considering that much of its revenue comes from low-growth consumer staples or medical devices, the company’s revenue and profits are actually rising fairly rapidly. That’s partly because its pharma unit’s drugs are selling well. Further, the longer-term outlook for the pharma unit remains strong.

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But the owners of Johnson & Johnson stock can’t rest too easily. The company is facing huge legal liabilities that look poised to, at a minimum, force it to cut its dividend.

When Johnson & Jonson reports its fourth-quarter results on Jan. 22, the owners of JNJ stock should try to determine if the company’s operating business remains strong. However, they should also attempt to determine if the company’s legal troubles will weigh on the performance of the stock.

Relatively Strong Third-Quarter Results and Guidance

Earnings per share for the third quarter jumped 3.4% year-over-year. Excluding currency fluctuations, the company’s revenue (reported as operational growth) rose 3.2% year-over-year. Outside of the United States, that figure came in at an impressive 5.4%. That indicates that J&J is continuing to benefit from the growth of developing countries.

J&J’s worldwide consumer products revenue rose 3.3% year-over-year, while its pharma revenue surged 6.4%. Pharma sales in the U.S. soared more than 26%.

Among the standout performers in the pharma space were Stelara, an immunosuppressant used to treat Crohn’s disease and plaque psoriasis; Tremfya, a monoclonal antibody that combats inflammation and is used to treat plaque psoriasis; and Darzalex, a monoclonal antibody that stymies tumor growth.

Meanwhile, in recent months J&J has been racking up additional drug approvals. Those should boost its top and bottom lines going forward. For example, late last month, China approved Tremfya as a treatment for plaque psoriasis. The European Union also gave a nod to the company’s Spravato, a nasal spray used to combat treatment-resistant depression.

Legal Bills Still Look Huge

Johnson & Johnson is fighting a huge number of lawsuits that could ultimately force it to pay tens of billions of dollars. At the very least, the company will likely have to cut its dividend tremendously. In such a scenario, Johnson & Jonson stock, whose dividend has risen for 57 years in a row, would tumble.

JNJ stock has been resilient despite the company’s gargantuan legal issues. That’s partly because multiple analysts believe that the company can afford to settle all its lawsuits without breaking a sweat. For example, research firm Trefis estimated that all of the lawsuits combined could cost J&J over $6 billion. The firm thinks that just settling talc lawsuits could cost $4 billion.

And only last month, Morgan Stanley analyst David Lewis upgraded Johnson & Johnson stock to “overweight” from “equal weight.” He said that “the stock appears to be pricing in significantly more legal liability than our probability-weighted analysis suggests.”

Lewis probably thinks that JNJ stock is pricing in more legal liability than the company is likely to face because he’s using using similar numbers to Trefis.

These analysts aren’t legal experts. They think that Johnson & Johnson will be able to settle its talc cases for an average of a few hundred thousand dollars each.

But actual verdicts do not reflect this idea. Analysts’ views on this issue may be skewed by the fact that they usually cover litigation between companies that are eager to settle. People who believe their lives have been tragically shortened by J&J’s products may have much different views and motivations. As a result, they may be much less likely to settle than most corporate plaintiffs.

Current Cases

In May, one woman and her husband who sued J&J over the contamination of its talc won $25 million in compensatory damages. The company still faces additional punitive damages, which are likely to be much higher. In July 2018, J&J was ordered to pay $4.7 billion to 22 women. In November, a California woman with mesothelioma was awarded $40 million.

It’s true that Johnson & Johnson has won some cases lately. But according to FiercePharma, the company still faces almost 17,000 lawsuits over the talc issue.

If I (conservatively) estimate that the company will win two-thirds of those cases and have to pay an average of $40 million per case that it loses, that equates to an astounding $226 billion. Since the market capitalization of Johnson & Johnson stock is only $377 billion, JNJ stock would take a tremendous hit if it had to pay out that much money.

Nor are things going particularly well for Johnson & Johnson stock bulls on the opioid front. More than 500 cities and counties, some of which have large populations affected by opioids, decided not to become a part of the class-action lawsuit against several corporate defendants, including J&J. The governments who opted out of the class-action lawsuit are probably looking either to go to trial or get huge settlements, making J&J’s previous $4 billion settlement offer way too low.

The Bottom Line on Johnson & Johnson Stock

J&J’s businesses are doing pretty well, but the Street is vastly underestimating the company’s legal liabilities. As a result, I would recommend that investors who own J&J stock sell their shares. Patient investors should considering shorting JNJ stock.

As of this writing, Larry Ramer did not own of the aforementioned securities. 


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