With stocks reaching 52-week highs five times more frequently than lows, it appears that the two-day swoon of two weeks ago is only a distant memory. 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 valuations. Take oil and gas service contractor Halliburton (NYSE:HAL), which reported stellar earnings results earlier this week. For the first quarter, Halliburton saw revenue rise 5% and earnings per share jump to $0.73 from a loss of $0.02 in the year-ago period. Halliburton attributed its strong growth to Asia and the Middle East, where revenue and operating income both increased 13%, and the company even alluded to a possible second-half rebound in North American markets. The big news was the expectation that EPS should grow 25% in the second quarter, which was more than enough to send the stock to new highs. With that kind of momentum and expanding margins, I wouldn't dare stand in the way of Halliburton.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Pulling out the stuffing
Trust me: I'm not the kind of heartless guy who goes around wishing ill fortune on a company that makes stuffed bears for kids. But if you pulled all the fluff out of the recent rally in Build-A-Bear Workshop (NYSE:BBW), you'd have little substance remaining.
Let's start with the basics. Have things improved? Yes. Build-A-Bear reported net income of $5.4 million in the fourth quarter compared to a whopping year-ago quarterly loss of $36.5 million. The company has closed underperforming stores, put a tight lid on capital expenditures, and emphasized its brand value and operating efficiencies to drive growth. This was clearly evident in its gross margin, which expanded 250 basis points to 44.9% during the quarter.
But there are a number of other worrisome long-term factors at work here. There were 28 fewer stores in operation during the fourth quarter, and the company plans to close an additional 10 to 15 stores in 2014. Although its earnings commentary alluded to opening new stores on an "opportunistic basis," that's a fancy way of saying Build-A-Bear is still backed up against the wall and cutting costs to boost profit.
Another potentially scary sign is the company's holiday season same-store sales figures. You'd think with the company shutting down underperforming stores that it would have no trouble delivering improved results, but that wasn't even close to the case. Consolidated same-store sales fell 2.2% for the quarter, led by a 2.8% drop in North America, which points to a tough spending climate for its very niche market base. Worse yet, its e-commerce division saw comparable sales sink 4.8%. How on Earth a company manages to screw up Internet sales is beyond me, as convenience is among the most paramount of factors influencing purchase behavior these days.
While cost-cutting will likely sustain profitability for Build-A-Bear, it's not setting the company up for long-term success. Treading water doesn't make investors rich. If Build-A-Bear doesn't find a way to enhance its brand value and successfully open new stores in order to expand its top line, then it's probably not worth your money.
Buy this, not that
There are few sectors at the moment that look ripe for an ongoing rally more than fiber-optic component suppliers. Domestic telecom service providers are spending billions to upgrade their networks and infrastructure, which should translate into big wins for component suppliers. We've already seen strong earnings reports from the likes of Alliance Fiber Optic and Finisar, but that doesn't mean you can simply throw a dart and buy any stock in the sector. If there's one name I'd suggest you keep your distance from here, it's Oclaro (NASDAQ:OCLR).
Similar to Build-A-Bear, there were noticeable improvements in Oclaro's latest quarterly report. In its second-quarter report released in early February, Oclaro delivered 6.5% revenue growth to $102.9 million, a 4% improvement in adjusted gross margin to 17%, and a smaller adjusted operating loss of $16.8 million compared to the sequential first quarter.
Oclaro also got a boost from the $88.6 million sale last year of its amplifier and micro-optics business to II-VI. This big boost to its cash on hand helped light a fire under Oclaro's share price, shooting it from sub-$1 to greater than $3 per share now. But is this valuation justified?
Consider for a moment that over the past decade Oclaro has turned in only one full-year profit and has had a net cash outflow in every single year, with an average outflow of better than $40 million over the past six years. Based on its current cash balance and historical performance, that means roughly three years before it's out of cash again.
If you think shedding its amplifier and micro-optics business will allow the company to stay focused and grow its remaining optical subsystems, think again. Between 2007 and 2013 Oclaro nearly tripled its top line, but saw its losses balloon. By my estimate, Oclaro needs its gross margin between 25% and 30% if it hopes to be profitable, but its results and forecast call for non-generally accepted accounting principles margins of 13%-17%, meaning more losses on the horizon.
While you could throw a dart in this sector and potentially hit a winner, Oclaro is not a company that should be a remote consideration for even the most risk-taking of investors.
Big Lots, little hope
I have to admit that I was a supporter of Big Lots (NYSE:BIG) for a long time. I believed that after the recession, cost-conscious consumers would flock in droves to the company's stores in search of good deals. Unfortunately, I failed to follow the clues that Big Lots was yesterday's news and that consumers much prefer dollar stores or warehouses for their thrift-shopping needs. Needless to say, with Big Lots bumping its head up against a 52-week high, I believe it's time for shareholders to give up the dream.
Like the previous two stocks, news-driven events have been the primary catalyst for Big Lots. Primarily, the company's tail-between-its-legs exit from Canada, where it announced it would close its Liquidation World stores, is a case in point in which existing shareholders are thrilled. Although the business venture failed, it serves as a means for Big Lots to focus its efforts on U.S. markets and puts an end to its ongoing losses in Canada.
On one hand, Big Lots shareholders aren't worrying about the company's ability to stay profitable. If anything, it's been a paragon of consistency, with gross margins stuck in a 160-basis-point range (39% to 40.6%) over the past decade. My concern relates to its inability to grow its top line meaningfully and with any consistency.
In its fourth-quarter results, released last month, Big Lots met its previously guided EPS range but reported a whopping 7.3% decline in sales and a 3% dip in comparable-store sales for U.S. locations open at least 15 months. Big Lots' answer to weakness has always been to cut costs and repurchase shares rather than to focus on the customer and get the right products in its stores. In fact, it announced a $125 million share repurchase program just this past quarter.
Big Lots has since 2005 reduced the number of shares outstanding by nearly half, which has masked its lack of top and bottom-line growth well. In reality, though, this isn't a long-term solution, and shareholders should look for more from Big Lots than ongoing share repurchases and cost reductions. Big Lots isn't particularly expensive at just 14 times forward earnings, but with a growth rate of 1% or less, the stock is easily passable at these levels.
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Sean Williams manages a portfolio that owns shares of Alliance Fiber Optic, but has no material interest in any other 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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