The S&P 500 may be on its longest losing streak in a month with four straight down sessions, but you'd hardly be able to tell by looking at The Motley Fool CAPS database, where 50% of the stocks are currently trading within 10% or less of a new 52-week high. 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. Tech giant Apple (NASDAQ:AAPL), for instance, has quietly wiggled its way back to a fresh 52-week high after investors readjusted their unrealistic growth expectations for the company and came to terms with it simply being a dominant force in tech that can grow its top line at 4% to 7% annually. It's certainly not as if Apple is hurting, having sold 33.8 million iPhones and 14.1 million iPads during the fourth quarter and generating $9.9 billion in free cash flow. With activist investor Carl Icahn now on board looking for ways to improve shareholder perks like dividends and share repurchases, I feel there are few reasons for shareholders to worry.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
I'll be the first to admit that I'm not a huge fan of solar power, but over the past year I've been blatantly wrong as most solar companies have found a floor (and profitability) in the process. Solar demand is improving as prices have dropped to attractive enough levels for governments and enterprise customers to make the switch. One company that's been able to take advantage of this resurgence is semiconductor and solar technology solutions provider SunEdison (NASDAQOTH:SUNEQ).
I will certainly give SunEdison credit for exciting shareholders with the prospect of a spinoff of its semiconductor business in 2014 so it can focus solely on its rapidly growing solar business, which also represents about two-thirds of its total revenue. Spinoffs have a way of unlocking shareholder value by making particular business components more transparent. It'll also help remove the cyclicality and drag of the semiconductor business from SunEdison's solar growth projects.
However, my big concern is SunEdison's huge net debt position of approximately $2.5 billion, which has been built up over the past half-decade since the company hasn't generated positive cash flow on an annual basis since 2008. The spinoff should help create more financial flexibility for SunEdison, but I'm worried that another protracted downturn in the solar industry could wreak havoc on this company much more so than its peers.
With the company only delivering breakeven profits on an adjusted basis in its most recent quarter, it also turned to a 30 million share dilutive offering in September to boost its cash position. This offering boosted its outstanding share count by more than 10%, which should have had the effect of reducing SunEdison's share price. With the company valued at more than 50 times next year's earnings, it's going to be a while before it'll have a chance to deal with its enormous debt load, leaving me more than enough recourse to suggest sticking to the sidelines.
Reality sets sail
You might be under the impression that the oil shipping business should be booming with oil prices hovering around $100 per barrel for much of the year, but that simply hasn't been the case. Since the recession, the Baltic Dry Index, which determines daily charter rates, has been crushed as demand for commodities has struggled to get back to pre-recessionary levels and oil tanker operators like Frontline (NYSE:FRO) have been punished for their rapid expansion in the mid-2000s as oversupply weighed down market rates.
In recent weeks, Frontline has been on fire following a better-than-expected third-quarter earnings report, where it reported a 12% increase in operating revenue and a slightly narrower-than-anticipated loss due to heavy cost-cutting. Frontline has worked diligently to retire older ships in its fleet, which require more maintenance costs in an effort to push its costs lower over the long run. For this, I won't fault the company one bit.
However, the reality is that many of its peers aren't having the same success of retiring older tankers, nor are they in the financial position to continue ordering new ships with debt levels in the sector dangerously high. That compounds the problems for Frontline, which is working with more than $1.3 billion in net debt and a negative book equity. Not to mention that at its current charter rates, it could be years before Frontline is profitable. In other words, I'm genuinely concerned that Frontline doesn't have enough financial flexibility to pull through this weakness. I could absolutely be wrong, but I'd much rather sell into this rally than chance Frontline running into major debt troubles.
Potentially unrealistic expectations
The biopharmaceutical sector is a make-or-break experience like no other. With the SPDR Biotech Index soaring roughly 50% this year, biotech companies have been rushing to go public en masse in order take advantage of a very generous IPO market and raise much-needed cash for clinical research.
One of the more recently debuted on this list is Relypsa (NASDAQ:RLYP), which has jumped more than 50% since going public. The lead drug behind Relypsa's pipeline is patiromer, a treatment for hyperalkemia (excess potassium buildup in the blood) for patients with chronic kidney disease. According to Relypsa, the only current modes of treatment are dietary potassium restriction or Kayexalate, which isn't well-tolerated by patients. Therefore, Relypsa anticipates, given its successful phase 2b trial, that patiromer will be the lead hyperalkemia treatment for CKD patients.
I'm certainly not going to argue that Relypsa's initial data on patiromer has been encouraging, but the fact of the matter remains that if patiromer isn't successful in its phase 3 study or the drug fails to live up to expectations, then Relypsa will be in a world of hurt since it only has one other researched compound that is currently in preclinical trials. Until we have this concrete phase 3 data shareholders are playing with fire and Relypsa could easily get clobbered if patiromer isn't "all that and a bag of chips."
My suggestion would be to take your early gains and hit the sidelines until we're able to make a more educated guess on how the Food and Drug Administration may rule on patiromer's fate once that critical phase 3 data is in.
This week's theme is really about proving whether these three companies can hold their recent rallies given some serious long-term questions. For SunEdison and Frontline, debt is the big concern. The cyclicality and price weakness of the solar and shipping industry make both very risky plays in my opinion. For Relypsa, it's a matter of putting all your eggs in one basket before we have all the cards out on the table. To me, it's a risky bet I wouldn't suggest taking.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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