Mead Johnson Clear, But Damage Is Done

01/04/2012 2:50 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The Centers for Disease Control and the Food and Drug Administration have concluded that there is no evidence of Cronobacter contamination during the manufacture or shipping of Mead Johnson Nutrition’s (MJN) Enfamil baby formula.

Shortly before Christmas, a baby in Missouri who had consumed the formula died from the bacteria. The two agencies also concluded that the formula involved in the illness of another baby in Illinois was from a different batch than in Missouri.

“Based on the test results to date, there is no need for a recall of the infant formula,” the agencies said in the joint statement. Walmart (WMT), Supervalu (SVU) and other retailers had pulled the product from their shelves on December 22 after reports of the infant’s death.

 The tests by the Centers for Disease Control and the Food and Drug Administration found traces of the bacteria in the bottled water used to prepare the formula and in an opened container of the Enfamil product, but not in the sealed containers from the factory.

This is about as good an outcome as possible for Mead Johnson Nutrition. The stock fell 14.6% on the news of the infant’s death, and on reports that Walmart and other retailers had pulled the product. Shares have since recovered, but they’re still down 6.4% from the closing price on December 21, before the news.

The question for investors now is, what happens to the shares? (Mead Johnson Nutrition is a member of my Jubak’s Picks portfolio.)

Mead Johnson has rightly decided to launch a marketing campaign to restore consumer confidence in the brand. That’s a necessity, given the understandable tendency by parents to play safe and switch brands even if the government has decided that the formula is safe. Marketing campaigns cost money, however, and that will put a small dent in earnings over the next few quarters.

The company is still likely to see sales drop, however. Credit Suisse estimates that sales will fall by 1.1% in 2012 and that earnings per share will decline by the same amount. That amounts, Credit Suisse calculates, to about 3 cents a share off the top of its forecast of $3.21 a share in earnings for 2012.

Three cents doesn’t seem like much, but this is a forecast based on comparison with market share and sales losses in similar incidents and with the recall last year of Abbott Laboratories' (ABT) Similac formula. In other words, it's a good projection, but it is by no means guaranteed.

And the increase in expenses for additional marketing comes at a critical time, since one of the arguments for owning Mead Johnson Nutrition now was projections that showed the company raising margins in 2012. That's less likely if the company has to pay for increased marketing.

I don’t think you need to rush out and sell these shares—they should continue to recover some of the ground lost after December 22 over the next week or so. But the stock isn’t priced for much error—the consensus Wall Street estimate calls for $3.20 a share in 2012, and not the $3.18 projected by Credit Suisse—and the shares trade at better than 25 times trailing 12-month earnings.

And that makes me worried about the company’s next earnings report on January 26—not so much for what the company might say about the fourth quarter of 2011, but about what it might forecast for the next quarter or two in 2012. Guidance might disappoint quite a few investors in the short term.

As of January 4, I’m cutting my target price to $74 a share, from the prior $79, and I’d be looking for an exit if the stock recovers the majority of the ground between that target price and the $70.61 price as of 1:30 p.m. New York time today.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares in Mead Johnson Nutrition as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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