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It could be lights out for Lumber Liquidators, whose stock was floored by allegations of improper labeling by Chinese suppliers. Photo: Wikimedia Commons.

After 11 long days throughout which the stock of Lumber Liquidators (NYSE:LL) was mercilessly hammered, the flooring company finally responded last week to the ruinous 60 Minutes report alleging that Chinese-sourced flooring contained dangerous and illegally high levels of formaldehyde.

The response, while a forceful rebuttal to the damaging claims against it, may be a case of too little, too late. Lumber Liquidators may have let the story fester for too long before answering, and its reputation may be far too impaired to recover. Its stock, which had been trading near $70 a share before the damning report broke, has plunged below $30.

Bearing false witness
The 60 Minutes story alleges that Lumber Liquidators' Chinese suppliers knowingly and illegally mislabel flooring shipped to the company as being compliant with California standards (and recently federal regulations as well) known as CARB2 that limits exposure to formaldehyde emissions in laminate flooring.

According to the story, 60 Minutes also independently verified that the flooring contained formaldehyde many times above levels considered safe, calling into question Lumber Liquidators' oversight of its suppliers.

It took a week and a half, but the flooring specialist finally responded. A 60-minute conference call and 50-page rebuttal later, Lumber Liquidators refuted the charges against it and said it stood by the safety of its products and that they're compliant, but for anyone still concerned, they will provide an in-home test and free remediation if there proves to be dangerous levels.

Companies that often take such bold stances defending their products (so long as their defense is true) often have a good chance of recovering consumer goodwill.

He who hesitates is lost
Unfortunately, Lumber Liquidators may have let the narrative get away from it. Forever to be known as the company that sells dangerous flooring, regardless of the claim's veracity.

Certainly Lumber Liquidators had to research the issue, but it knew the story was coming -- it warned about it in its February earnings conference call -- and should have had its defense ready to go immediately afterwards.

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Lumber Liquidators sales growth and profit expansion are in jeopardy as it fights back against the allegations against it. Image: Lumber Liquidators investor presentation, March 12, 2015.

Instead, Lumber Liquidators' reputation could be tainted, just like these examples of negative, but not completely true, stories that received high media exposure:

  • Toyota Motor (NYSE:TM) is synonymous with so-called "sudden acceleration," even though the Department of Transportation ultimately concluded that most cases were caused by drivers stepping on the gas instead of the brake. 
  • Lean finely textured beef producer AFA Foods, maker of lean finely textured beef, or LTFB, was driven to bankruptcy after ABC News pounded so-called "pink slime," despite its being "nutritionally equivalent to 95% lean beef," according to the USDA; allows for fewer cows to be slaughtered each year; and lowers the costs of beef products.
  • The apple industry suffered hundreds of millions of dollars in damage and numerous apple growers went bankrupt after 60 Minutes reported on the growth-regulating chemical Alar. Even though it was quite safe, it was alleged to have a high risk of causing cancer in children.

An ax to grind
Like the Lumber Liquidators story today, someone with an agenda brought the Alar scare to the CBS News program's attention. In the case of the apple pesticide, it was the National Resource Defense Council that shopped the story to 60 Minutes; with Lumber Liquidators, it was noted short-seller Whitney Tilson.

But just because there is an ulterior motive doesn't mean a story isn't true. Short-sellers like Tilson get a bad rap because they're betting against a stock, but they also tend to be the only ones willing to dig past the cheerleading pronouncements of management to uncover the real story. They're really providing a useful service to the market.

So the claims from Tilson and 60 Minutes shouldn't be rejected out of hand, but the question for Lumber Liquidators is whether it can regain control of the narrative and prove its case.

Time heals all wounds?
Yet there's still hope. Toyota, after all, reported its fourth straight month of record new-vehicle sales in February and last year sold 2.37 million vehicles, a 6.2% increase over 2013 and its best sales record in seven years. Also, one of the biggest producers of LFTB, Beef Products, announced last year that it will start making pink slime again, as demand soared in the face of rising beef prices.

But that means the flooring specialist could be in for an extended period of depressed valuations before it truly recovers.

Although its stock initially surged 15% after it made its defense, the shares have since resumed their decline. That means Lumber Liquidators hasn't nailed down the story, and its reputation -- and its investors -- could pay the price, no matter if it's telling the truth or not.

 

Follow Rich Duprey's coverage of all the most important news and developments in the leading brand name products you use. He has no position in any stocks mentioned. The Motley Fool recommends Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. 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.