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Analyst Actions: Product Recall Hits Mead; A Speedy Response From FDA Is Needed, Says Credit Suisse

Product Recall Hits Mead; A Speedy Response From FDA Is Needed.

The Associated Press published an article today indicating that Wal-Mart has pulled a batch of 12.5 ounce cans of Enfamil off of its shelves "out of an abundance of caution" after a newborn in Missouri tragically died of a bacterial infection called Cronobacter. The FDA is now testing samples of the product that the child consumed. Mead says that they test for Cronobacter regularly and that this batch tested negative twice.

We are waiting to hear from management to find out how long they expect the FDA tests to take. Our sense is that the FDA will respond within a week given the severity of the situation and the fact that Mead was able to test its batch almost immediately upon hearing the bad news. Wal-Mart accounts for 12% of Mead's total sales and we estimate that this 12.5 ounce product alone accounts for 30-40% of Mead's $1.0 billion U.S. business.

This is a shoot-first, ask questions later moment for the stock. While the 8% hit intra-day feels like an over-reaction, we are recommending a fair amount of caution until more details emerge. The headline is scary enough to cause consumers to change their purchase patterns in the near-term, and no one knows how long that will last even if it is unjustified. The company's high P/E valuation makes it rather vulnerable as well.

Here are three scenarios:

Best case: No impact to sales. The FDA comes to a quick conclusion that the batch was clean. Consumers who can't find Enfamil on the Wal-Mart shelves go to other grocers to satisfy their demand. Zero hit to the stock.

Not-so-good case. Modest impact to sales. The FDA concludes that the batch was clean, but grocers follow Wal-Mart's lead by pulling the product off their shelves and consumers (especially new mothers) switch to Similac or other brands. Using Similac's 2010 product recall for context, we estimate Enfamil would lose 200 bps of market share in the U.S. over the course of a year.

1.5% temporary hit to Mead's total sales ($50 million) and EPS.

P/E multiple loses one turn, causing another 4% hit to the stock.

Total stock impact of 6%.

Really bad case. Bigger impact to sales. The FDA finds traces of the bacteria in the batch (and who knows how it got there). The issue drags on causing further public relations issues. In this case, we assume a 600 bps hit to market share ($150 million) or 4% to Mead's total sales and EPS. The P/E multiple contracts by three turns - a 12% hit to the stock - because the issue drags on. The total impact would be 16%.

4.0% hit to Mead's total sales ($150 million) and EPS.

P/E multiple loses three turns due to the fact that the issue drags on, causing another 12% hit to the stock

Total stock impact of 16%.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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