Johnson and Johnson Remains Favorable Despite Liability

Erick is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Johnson & Johnson (NYSE: JNJ) has been reeling recently from the scandal associated with its ASR XL hip cup system, which may bring 10,000 more lawsuits and $1 billion in potential liability. A British study of the hip socket system for hip replacements estimated more than a third of the implants failing in less than 5 years, and that figure could be as high as 50% at 6 years.

That is a huge percentage and simply unacceptable for a company of the caliber of J&J.  It represents a failure in the core mission of the company, a company that wrote the book on how to handle such public relations situations, as it did previously with the Tylenol cyanide tainting scare.

As a shareholder of J&J and as a surgeon I really expect a lot better and hope to see the management of this company step up to the plate and clean up this mess. Lawyers have smelled blood in the water and they are currently in a feeding frenzy due to this implant disaster.

J&J is of course a highly diversified healthcare conglomerate with products ranging from consumer products such as Tylenol and Band Aids to medical devices such as knee and hip replacements in its DePuy division and trauma products in its newly acquired Synthes division. J&J in the past has been an exemplary corporate citizen, and remains a solid company in terms of its core mission to patients and shareholders, but as of late it has faltered by letting an implant system such as the ASR system get through what was supposed to be a rigorous control process.

As a medical device company and healthcare giant, J&J has no real peers. There are other pure plays in the sector, such as Stryker (NYSE: SYK) which has its own problems with implant recalls. In Stryker's case they are recalling a pair of hip stem systems that may show early failure from something called "fretting corrosion," a problem which can affect modular hip systems, but this recall is not in the same league as the one from J&J. It cost Stryker $133 million in this last quarter in terms of earnings, but the company has recently hit a 52 week high and the market has figured out that the potential liability is much more limited in the case of this recall.

Pfizer (NYSE: PFE) comes close to being a peer, with a market cap of $200 billion that is even with J&J and a formidable pharmaceutical business. Stryker, on the other hand, weighs in at a paltry $23 billion in market cap. Pfizer doesn't have a competing medical devices business, and it has divested a lot of its consumer products division.

In terms of the future, J&J needs to clean up its corporate act and behave responsibly. As a company it remains a good value play in this market with regular dividend increases, and a dividend yield of 3.3% which is nothing to sneeze at these days (although not quite as nice as the 3.6% Pfizer is paying out). Its revenue growth remains in the mid single digits, with only the consumer division showing declines in revenues. Once it cleans its liability issues the demographics of the baby boomer generation should favor J&J. Synthes, its newest division, is a leader in trauma products and should complement well its DePuy joint replacement business.

xerohype owns shares of JNJ and PFE. He owns no shares of SYK. As a surgeon he has used JNJ, SYK and PFE products in the past, but he does not take any direct or indirect payments from any of the companies mentioned in this article except for quarterly dividends on the stocks he owns. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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