Over the past decade, Johnson & Johnson (NYSE:JNJ) has had a quality control problem that has caused significant negativity in what used to be a brand that stood for quality and trust. I believe the company's planned acquisition of Synthes, a Swiss company with operations in the United States, is also questionable as the company has its own quality control problems. These events may be swaying to the positive side of the scale with the recently announced departure of Chief Executive Officer Bill Weldon. In this article, I will explore how quality control has been an issue for Johnson & Johnson, and whether or not now is the time to invest in its stock.
Under Bill Weldon's watch the company has suffered numerous negative events that have tainted Johnson & Johnson's reputation and affected the company's bottom line. There have been over 43 defective product recalls with numerous lawsuits involving death and injury related to these products since 2009. State government lawsuits and Congressional investigations have resulted from illegal marketing practices and stealth recalls of some of these products. This has resulted in strict federal regulation at several of the company's manufacturing facilities and the suspension of manufacturing at the McNeil Consumer Healthcare Fort Washington, Pa. facility.
For example, in 2010 the company had to recall over 43 products from its McNeil Consumer Healthcare division, which makes over-the-counter medicines, for problems ranging from musty odors that caused nausea to excessive concentrations of active ingredients. The products involved popular brand names such as Tylenol, Motrin and Benadryl to name a few. The departure of the chief executive officer is long overdue, in my opinion, and may pave the way for a top down structure change in the way the company handles quality control. In the process the company may regain some of the brand loyalty and reputation it has no doubt lost over the period.
In another disturbing event that is unfolding at this time, the company just set aside $3 billion for patients and lawyers in product liability lawsuits involving one of Johnson & Johnson subsidiaries DePuy Orthopedics. The money being set aside is for lawsuits that are being filed in connection with the DePuy ASR XL Acetabular System and the DePuy ASR Hip Resurfacing System. Metal debris from the implant led to the destruction of soft tissues neighboring the joint, leaving some patients with long-term disability. Ions of cobalt and chromium were also released into the blood and cerebral spinal fluid in some patients. These two products were recalled in 2010 as being potentially defective and represents another of Johnson & Johnson's issues with quality control. The $3 billion figure may or may not be enough to cover costs and damages but that is a subject for future debate. In my opinion, the monetary costs may be small in comparison to what the company takes in overall but the costs to brand name and reputation is a significant loss to the company as a whole.
Johnson & Johnson operates in three major divisions: consumer healthcare, medical devices and pharmaceuticals. These divisions are also very highly diversified with over 230 subsidiaries and geographically diversified with operations in over 57 countries along with products sold in over 175 countries. This diversification is what allows the company to withstand the 1500 or so law suits it has pending against it, and the substantial amount of recalls the company has absorbed in the past, in my opinion. Johnson & Johnson also holds around 54,000 patents for its various products around the globe. The company is what's more continually acquiring new companies in its efforts to expand this diversification. At this point in time, Johnson & Johnson is the second-largest manufacturer of healthcare products with over $62 billion in sales per year -- second only to its nearest competitor Pfizer (NYSE:PFE). I think this diversification is the only reason Johnson & Johnson hasn't suffered significant losses through litigation and recalls, and one can only speculate how well the company will do if it can get its quality back under control. This is the core issue that arises when companies expand to this degree, as policy implementation across all of its subsidiaries is just that much more difficult.
Looking forward, Johnson & Johnson does have a wide range of drugs in its pipeline that should be contributing to the company's bottom line in the near term. In particular, the company's prostate-cancer pill Zytiga has had just about the best recommendation a drug in its stage of development can acquire. The drug's effectiveness is currently under study by independent monitors who have publicly stated that Johnson & Johnson's Zytiga was so effective among test group patients that the study should end and Zytiga be administered to the placebo group as well. Zytiga was approved in April of 2011 for use in men with advanced prostate cancer who had already tried chemotherapy. The drug will be in direct competition, in my opinion, with Dendreon's (NASDAQ:DNDN) Provenge, although Dendreon officials say the drugs may be used together. Johnson & Johnson rose 1% on the news and Dendreon fell 7%, while Medivation (NASDAQ:MDVN), a biotechnology company developing a similar drug, rose 14%.
Despite the company's quality shortfalls and in light of the fact that Johnson & Johnson is taking appropriate steps to remedy the situation I would recommend a buy and hold strategy on the stock-- as it does have significant upside potential through its drug pipeline. I believe Johnson & Johnson is a relatively safe investment due to the company's diversified business model, and recommend buying shares today.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.