The biggest risk facing Johnson & Johnson (JNJ 1.49%) today is its exposure to talc-related lawsuits. The company has already spent billions on payouts and legal costs to address lawsuits from people who allege they developed cancer from the use of its baby powder products contaminated with asbestos. With 60,000 claimants still out there, this presents a huge cloud over the business.
The company developed a plan to address the issue and limit its liability by creating a subsidiary that would then file for bankruptcy protection. But the courts pushed back on that strategy, and that could pose a big problem for Johnson & Johnson.
A second judge rejects the bankruptcy strategy
In 2021, Johnson & Johnson created a subsidiary, LTL Management. The plan was to have the company assume control of the talc operations, including the parent company's talc liabilities. Then the business would file for bankruptcy protection. By doing so, Johnson & Johnson could significantly limit its exposure to talc lawsuits.
LTL Management recently offered plaintiffs an $8.9 billion settlement to address the claims, which it says had strong support from the plaintiffs' lawyers. But in July, a federal judge dismissed plans to bankrupt the business on the grounds that LTL Management was not in financial distress. It's the same reason that a judge gave earlier when dismissing Johnson & Johnson's first attempt at the strategy.
Initially, Johnson & Johnson set aside $2 billion to address the claims, but in its most recent offer, it increased that to $8.9 billion. The problem is that simply adding more to the offer may not be enough to settle the claims; judges are opposed to the fundamental approach of bankrupting the subsidiary business. Johnson & Johnson generated just under $18 billion in profits last year and would be in an excellent position to help a struggling subsidiary out.
Johnson & Johnson does plan to appeal the judge's decision, however. The company's vice president of litigation, Erik Haas, states that "the bankruptcy code does not require a business to be engulfed in 'flames' to seek a reorganization supported by the vast majority of claimants."
The risk of not reaching a settlement could be extremely costly
With tens of thousands of plaintiffs and those numbers potentially rising in the future, there's ample incentive for Johnson & Johnson to find a way to limit its liability. In 2020, a Missouri court ordered the company to pay $2.1 billion to 22 women who said they developed ovarian cancer due to the company's products. And that's after the penalty was reduced from almost $5 billion.
While not all payouts will be that significant, it's an example of how Johnson & Johnson's costs could quickly spiral out of control if it were to go through all of the claims it is facing. It recently spun off its consumer healthcare products business into Kenvue (KVUE -0.45%), but Johnson & Johnson will still retain talc-related liabilities that arise in the United States and Canada, and promises to indemnify the newly formed company for any related costs. Kenvue is still on the hook for any talc-related lawsuits that might arise outside of North America.
For investors, it's next to impossible to determine how much of a liability these talc lawsuits may end up costing Johnson & Johnson, but it's hard to understate them. They have the potential to significantly weigh down the company's financials and jeopardize its dividend. In the worst-case scenario, they could put the entire business' future at risk.
Is Johnson & Johnson too risky of a stock to buy?
The big appeal of Johnson & Johnson over the years has been that it's a relatively safe stock to own, and it also offers an attractive dividend yield of 2.8% -- the S&P 500 average is just over 1.5%. Johnson & Johnson has also been increasing its dividend annually for more than 60 consecutive years and is a Dividend King.
But the past doesn't predict the future, and as long as this legal uncertainty is weighing on the company, investors may be better off avoiding the healthcare stock. Not only are there higher-yielding dividend stocks out there, but there are also better growth stocks than Johnson & Johnson to invest in. There simply isn't a compelling reason to buy the stock given the significant risks it's facing right now.