What's Happening? Mead Johnson Nutrition Co. (MJN), the market leader in baby formula, has hit a turbulent patch on the news that two babies had contracted the bacterial disease Cronobacter, including a newborn that died of the disease, with a "possible" link back to Enfamil (owned by MJN) formula. I say "possible" because MJN has tested the formula, and found no Cronobacter in the tests. Retailers have pulled batches of the formula from the shelves, in response, again, despite the tests from MJN that the formula is safe, and are waiting for the FDA to give the all clear. The stock has had considerable trouble since the news was announced on December 22, dropping 14.6% on very heavy volumes.
What Should the Conservative Investor Do Now? MJN is a generally expensive stock, even post the drop. Trading at 13.3x 2012 on an EV/EBITDA basis (and 20.4x on a P/E basis), the stock isn't showing much of a discount to reflect risk to the EBITDA and Earnings in the event that the company's test results are disputed by the FDA (and I, nor anyone else, has an edge on this one). Before the news hit, MJN had just hit the 52-week high (on December 21), and despite being expensive relative to peers (most trading under 10.0x forward), all technical indicators supported an uptrend. On the back of the news, MJN has broken (to the negative) the 200-day moving average (with conviction on volumes) and is still trading at a premium of four turns to peers like General Mills, Inc. (GIS) and to a lesser degree, Abbot Laboratories (ABT), which owns Similac formula, the principal product competitor to MJN. An expensive stock, now with a very negative overhang for a while, that has sold with super high volumes, is not a buy (I noticed an article on Seeking Alpha suggesting a buy of a 25% position, which doesn't make sense here, considering there is no need to establish a position). I would be a seller here if long, as cutting one's losses, as opposed to hoping for a positive outcome from the FDA, feels right to me. MJN has a great business, and will survive long-term, but holding or adding exposure outright here has more risk than reward, at least for the near-to-medium-term.
What Should You Do If You Want Some Risk? If you want something to do (not an idea I love, but for those who want to trade dislocated stocks on news, I want to give you something to think about), look at the bull put spread out in May. There is a reasonable probability there is some resolution to the Cronobacter issue by that point, and you can sell the $60 May 2012 Put and buy the $55 May 2012 put for a credit of $2.11 headed into the open on December 27. You have some mitigated risk thanks to the structure of the put spread, and if there is a positive outcome to the "news" and the overall market doesn't get wrecked (a risk you can mitigate, though), the put spread offers a reasonable up/down. Let me say again, I don't love taking risk here on MJN. The negative news won't take MJN out of business, and the velocity of shares that came out signaled that there were sellers waiting here looking for a reason to sell. But if you want a reasonable bet on recovery, with limited downside, there you go.