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Wall Street Huffs About J&J's Tylenol Recalls, but the Legal Bills Are the Big Issue

Wall Street has finally found some one-off charges it doesn't like: When Johnson & Johnson (JNJ) delivered its Q1 2011 earnings this morning, analysts were vocal about the ongoing cost of product recalls, mostly in its consumer drugs division which makes Tylenol and other household brands. They were quieter about J&J's legal expenses, which are large enough to negatively impact its bottom line.

Usually, when companies announce expenses for unusual events like recalls, Wall Street all but ignores the problem. Investors are interested in the future, and those expenses are in the past. Plus, because they are one-off charges, they don't reflect the underlying health of the business.

But J&J is in its second year of recall woes -- U.S. sales of J&J's consumer products were down 13.8 percent to $1.4 billion -- and analysts are finally getting sick of hearing about it. Bloomberg:

Investors, looking at the recalls, "are concerned about this damaging the reputation of J&J," Linda Bannister, an analyst at Edward Jones & Co. in St. Louis. "The company needs to make it right, to get these things fixed, to make sure there are no additional recalls and that these products get back on the market."
"I think we're seeing an inflection point in the consumer group," said Morningstar analyst Damien Conover. "You're beginning to get to where the company has had more time to fix some of the problems."
This is all very well, but J&J's legal problems will be more of a drag in the long-term than its recall woes. The recalls will eventually end; litigation will not. This quarter, J&J reported $271 in litigation costs, the equivalent of 8 percent of its net income. (J&J's net income was also down, but not as much as analysts thought it would be so the stock ticked up.) It also paid $70 million in a settlement of Foreign Corrupt Practices Act charges; and it lost a $482 million verdict in Texas over a patent on a stent held by its Cordis unit. J&J's annual report takes six and a half pages of single-spaced type to list all the lawsuits against it.

J&J is actually managing its costs quite well. Despite sinking Tylenol sales, its overall sales went up 3.5 percent to $16.2 billion. It continues to generate more dollars in revenue from every single dollar spent on sales, general and admin expenses:

Absent the recalls, those lines would be sloping even more steeply upward. While J&J deserves criticism for screwing up a stable of brands that were once beloved by consumers, it's actually well-placed to take advantage once the FDA gives the all-clear for those brands to come back online. At that point, the underlying problem with J&J's expenses are its lawyers, not its over-the-counter painkillers.


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