Remember our recent correction? It looks to be in the rearview mirror, with new highs outpacing new lows, once again, by more than 11-to-1. 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. Skyworks Solutions (SWKS 1.81%), a provider of power-amplifying modules in smartphones, is one such company. Skyworks has an edge over a number of its peers in PAMs and boasts a solid long-term relationship with Apple, which, last I checked, still had the top-selling mobile device in the U.S. With consistent growth in the high single-digits and low double-digits, a forward P/E of just 12, and nearly $649 million in cash with no debt, I believe Skyworks is a tech supplier you can trust.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Short-selling immunity?
It happened again! Another biopharmaceutical company came out of nowhere to deliver a jaw-dropping one-day gain earlier this week. This time, the culprit was the struggling InterMune (ITMN.DL).
On Tuesday, shares of InterMune gained 171% after the company released late-stage data from its ASCEND trial involving pirfenidone (also known as Esbriet) as a treatment for idiopathic pulmonary fibrosis, or IPF. The results showed that pirfenidone met its primary and secondary endpoints, reducing the occurrence of a 10% decline in IPF patients' forced vital capacity, or death, by 48% compared to the placebo, and also reducing the number of people who saw a decline in the six-minute-walking-distance test by 27.5%. The cumulative results led to a 43% reduced risk of death or disease progression for patients on pirfenidone.
On one hand, this data is great. I don't think the Food and Drug Administration could possibly ask for much more on this go-around -- Esbriet was rejected back in 2010 -- which should lead to an approval for this therapy by sometime in the second or third quarter of 2015.
That optimism aside, Esbriet is already approved in select EU countries, and despite the fact that there are few IPF treatments available, sales of the drug are only expected to total between $115 million and $135 million in fiscal 2014. Even with the addition of a U.S. approval, which is still no guarantee, RBC Capital analyst Michael Yee foresees peak sales between $300 million and $500 million. Given InterMune's valuation of roughly $3 billion, this represents a premium of nearly seven to 10 times peak sales, which seems a bit excessive.
What's more, InterMune might appear well-capitalized, with $337.2 million in cash as of last quarter, but investors should consider that it's burning through anywhere from $150 million to $200 million in cash annually. Making matters worse, InterMune also carries $263.6 million in debt, which could be difficult to pay off if Esbriet's U.S. launch isn't flawless.
There are simply too many risks and very little reward built into InterMune shares at this price. I'd suggest it's time to head for the exit.
Is the sun setting on this opportunity?
Sometimes you have to be willing to change your investing thesis on a company you like when the valuation no longer make sense. That would be the precise situation I'd say Elon Musk's other brainchild, SolarCity (SCTY.DL), is in.
I'm not a huge fan of solar power to be honest, but the idea on paper just makes a ton of sense. Instead of laying down the huge costs of purchasing solar panels or retrofitting them to a house or business, residents and businesses can instead rent these panels from SolarCity. This way, the consumer remains in control of their energy habits should they move; there's no fear of leaving their expensive panels behind, and they can also enjoy the lower energy costs associated with solar panels.
While the business model is intriguing, the valuation is currently far from it. SolarCity is nearing a $7 billion valuation -- a better-than-quadrupling in price from where it was a year ago, despite the fact that its losses aren't expected to shrink anytime soon.
Top-line growth for SolarCity remains strong, with sales growth of 61% expected in fiscal 2014. However, SolarCity also burned through more than $1 billion in free cash flow since fiscal 2009 and is projected to lose money until perhaps 2016 or 2017. I understand the company needs to make investments in its infrastructure to boost its ability to meet customer and enterprise needs, but at some point, it needs to also control its as-of-now exponential costs -- otherwise, it'll never turn a profit.
At 46 times current sales and 21 times book value, I'm declaring shenanigans on this valuation.
Fatally flawed
This month has been filled with some of the most head-scratching buyouts I've witnessed since before the recession. Perhaps none had me as surprised as the buyout announcement by Signet Jewelers (SIG 1.38%), the operator of Kay Jewelers, of Zale (NYSE: ZLC) for $690 million, or $21 per share.
Signet made the move for a number of reasons. First, Zale has a much stronger presence in the U.S., which will help the company reduce its reliance on overseas markets. Second, the combination of the two companies should result in up to $100 million in cost savings. Most importantly, though, it allows these two companies, which will control approximately 10% of the mid-tier jewelry market share, to leverage their size and market share to their advantage when buying diamonds. This could mean savings for the consumer down the road, but it'll almost certainly lead to beefier margins for Signet.
Having worked in the industry previously, however, I have a number of problems with this deal, and I don't think it'll run nearly as smooth as investors expect.
For one, Signet just agreed to pay a hefty premium for a company boasting an awful lot of debt. In fact, Zale needed to take a bridge loan in 2010 just to survive, and it still carries $495 million in net debt. Had Zale not been purchased, I believe it would have been extremely difficult for the company to emerge from under this debt pile.
Second, it's not as if Zale has demonstrated any earnings consistency since the recession. Yes, Zale is profitable now, which is a far cry from where it was in 2009, but it's still heavily reliant on the holiday season, whereas Signet is cranking out profits on a quarterly basis. Not to mention that Signet also runs a tighter ship when it comes to expenses and total margins.
Ultimately, I wouldn't be shocked if Zale wound up dragging down Signet over the coming years because of its debt and erratic growth patterns. I suspect we'll see quite a few store closures and many regrets from Signet over this huge premium paid to purchase Zale.
