Johnson & Johnson Bankruptcy Setback Has No Impact on Dividend Profile

On Monday, the U.S. appeals court rejected Johnson & Johnson's attempt to offload the more than 40,000 talc product lawsuits levied against the firm.

The healthcare giant tried to cap its exposure to this risk in 2021 by moving its talc liabilities to a newly created subsidiary, which promptly declared bankruptcy.

Talc is a mineral previously used in the company's ubiquitous baby powder that contained traces of asbestos and has alleged links to multiple cancers.

After Johnson & Johnson's subsidiary declared bankruptcy, all talc-related litigation against the firm was temporarily frozen until this week's court decision. Now, these lawsuits are permitted to proceed.

Had this bankruptcy attempt been successful, Johnson & Johnson would have been relieved from what could be an enormous liability burden if history is any indication. 

For example, in 2018 a talc-based lawsuit resulted in the company being ordered by a Missouri court to pay $2 billion to just 22 individual plaintiffs.

While that was an extreme case, the company has had a mixed record of talc-related lawsuits overall. 

In contrast to the noted $2 billion judgment against the firm, over 1,500 lawsuits have been dismissed by judges, and the majority of cases reaching trial resulted in favorable verdicts for the company.

This wide range of outcomes makes estimating J&J's potential financial obligation difficult. 

However, if we liberally assume all 40,000 plaintiffs get awarded a $300,000 settlement ($280,000 per claimant is the largest settlement the firm has ever encountered, per Wells Fargo), the company would be on the hook for around $12 billion.

While that is a massive settlement, the firm generated $5 billion in free cash flow last year after paying $12 billion in dividends. And J&J has a strong balance sheet with approximately $24 billion in cash reserves compared to $28 billion of long-term debt.

In fact, Johnson & Johnson is just one of two companies that boast a AAA credit rating from S&P, the other being Microsoft. This stellar rating can provide relatively affordable and easy-to-access financing if needed.

Simply put, the healthcare giant's substantial cash flow generation and flexible balance sheet position the firm to meet high litigation costs if needed. Especially considering claims will likely be paid out over a series of years and not in one lump sum.

We estimate that even if J&J were to finance this hypothetical $12 billion settlement by issuing debt and taking on the interest costs that come with it, the firm's payout ratio would remain at a healthy level near 45%.

As such, we are reaffirming Johnson & Johnson's Very Safe Dividend Safety Score and expect the firm to increase the payout modestly in April – extending an impressive 60-year dividend growth streak.

That said, we recognize there are still many moving pieces in the talc litigation story that could change expected outcomes. If the situation becomes much worse than our $12 billion liability estimate, we may consider downgrading Johnson & Johnson.

For now, we consider Johnson & Johnson a decent option for conservative investors looking for a stable income source at a reasonable valuation. 

Overall, Johnson & Johnson's scale, product breadth, recession-resistant cash flow, pristine AAA credit rating, track record of innovation, and geographic diversification seem likely to keep the firm relevant for decades to come – despite litigation challenges.

We will continue monitoring Johnson & Johnson's legal developments and provide updates as needed.