Despite the threat of budget cuts expected to take effect tomorrow and uncertainty surrounding the Italian elections, the markets can't be stopped. For skeptics like me, that's an opportunity to see whether companies have earned their current valuations.
Keep in mind that some companies deserve their current valuations. Refiner Tesoro (NYSE: TSO ) , for instance, reported record fourth-quarter results three weeks ago as crack spreads improved $5 per barrel over the year-ago period, allowing it to boost its dividend by 33% and repurchase $140 million in shares since it authorized a buyback program. At less than 10 times forward earnings, Tesoro still looks like a great value.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Grounded for the interim
Up until now I've generally avoided taking a negative stance on companies that rely on defense spending to drive some, or all, of their growth. However, with regard to Boeing (NYSE: BA ) , there are enough additional factors on top of the potential sequestration fears that make me feel it should be grounded in the interim.
Obviously, the fear that the government is going to remove $85 billion from its budget should have negative implications for Boeing, whose military aircraft revenue accounted for 20% of total sales last year. With fewer dollars to go around without some sort of spending-cut delay, Boeing's revenue may fall short of its own optimistic estimates.
Also, the 787 Dreamliner battery issue is much more than just simply a temporary blip. Although solutions are being worked on to resolve the issue -- if even just temporarily -- the PR nightmare the issue has caused, and the possible financial ramifications that Japan Airlines or other customers may seek, can't be quantified as easily.
Finally, there's always the looming threat of a labor strike. Boeing met, just yesterday, with the Society of Professional Engineering Employees to discuss a new collective bargaining agreement. With the expectation of higher wages and sufficient health care coverage, Boeing is going to have a difficult time meeting employees' demands in a slow-growth and weaker defense-spending environment.
Don't spam your portfolio
Hormel Foods (NYSE: HRL ) , the maker of Spam, is currently sitting at a new 52-week high after boosting its full-year forecast last week by $0.03 on the heels of stronger-than-expected grocery segment sales. However, what should worry investors is the company's valuation following its run higher and the rising costs of supplying its various meats.
Hormel has made some smart moves in recent months, including purchasing Unilever's Skippy peanut butter brand last month. Peanut butter is a strong-selling product in tough economic times, so it appears to be another prudent purchase. However, turkey operating margins slumped badly, down 550 basis points over the previous year, and refrigerated product sales -- which represent half of total revenue -- fell 2% as pork processing costs rose. Furthermore, commodity costs associated with livestock feed remain high, giving Hormel the choice of either raising prices to keep margins consistent and scaring consumers to a competitor, or eating the difference.
Another concern would simply be Hormel's valuation here in relation to its growth potential. Based on Wall Street's estimates and the midpoint of Hormel's guidance, investors are paying a fairly lofty 19 times this year's earnings for revenue growth of just 7%. Keep in mind that its sales growth is including its acquisition of the Skippy brand, which is expected to add $370 million in annual sales. This means investors are piling into a stock with a projected organic growth rate of just 2% this year. That's not impressive enough to me to merit such a frothy valuation, and I'd suggest throwing this spam out of your portfolio.
Don't chase performance
Sometimes you have to take a step back from a top-performing stock, note that it's completely outpaced its peers, but also realize that the trend of outperformance is likely to wane in the future. That's precisely the case for why it looks like a good time for investors to head for the exits at asset management provider Virtus Investment Partners (NASDAQ: VRTS ) .
Virtus' results have been nothing short of phenomenal for an asset management company. Total sales increased 46% in the fourth quarter and operating income soared 80% on the heels of strong net flows from mutual funds and double-digit organic growth. However, the potential to keep this up seems limited with the threat of sequestration, potential financial turmoil in Europe caused by Italy, and the payroll tax casting doubts in investors' minds. Consumer confidence figures roared higher in January, but I feel that, deep down, investors are worried.
Virtus is now valued at 18 times forward earnings and would need assets under management to grow by perhaps 25% per year just to meet these estimates -- no easy feat for a company so intricately tied to a global recovery.
This week's theme is all about continuation. Neither Boeing, Hormel, or Virtus appears to have the underlying factors in their business sectors working in their favor, which makes continued outperformance of their peers seem unlikely.
I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question is: Would you do the same?
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