With the S&P 500 and Dow Jones Industrial Average making new records on a nearly weekly basis, it should come as no surprise that new 52-week highs outnumber new lows by a lot. 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 Applied Materials (NASDAQ:AMAT), which has delivered an impressive run for existing shareholders over the past year. I would suggest that the need for semiconductor equipment to handle a surge in demand for mobile devices and networking hardware, as well as Applied Materials' size (which gives the company unprecedented pricing power), should more than accommodate additional upside in its share price. With $650 million in net cash and a nearly 2% yield there's little reason for Applied Materials' shareholders to lose sleep at night.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
You can't squeeze blood from a turnip
Investors occasionally need a reminder that some companies can't go up forever, and that's my intention this week with this first selection: Alexion Pharmaceuticals (NASDAQ:ALXN).
On the surface Alexion is doing fantastic. Only one of the company's drugs, Soliris, has been approved by the Food and Drug Administration -- but it's a doozy! Because Soliris is approved to treat a rare blood disorder known as paroxysmal nocturnal hemoglobinuria, as well as atypical hemolytic uremic syndrome, the company can charge a mammoth $400,000-plus per year for its rare disease drug. This, compounded by the drug's orphan status that gives the company an extensive period of product protection, allows Alexion a veritable monopoly when it comes to treating these orphan diseases.
In its most recent quarterly report, the company delivered 67% year-over-year revenue growth to $566.6 million and a 135% spike in adjusted earnings per share. With Soliris' price being what it is the company's gross margin of 94.2% is just insanely high.
My concern is that investors haven't left Alexion many routes to expand over the coming years. With its current $31 billion valuation it's been essentially priced out of buyout territory. Roche (NASDAQOTH:RHHBY) had been a rumored suitor in the past, but I just can't see a company with one of the most bountiful oncology pipelines in the business spending in excess of $30 billion to acquire a single drug.
Alexion is valued at close to eight times 2017's sales projections and about 19 times 2017's EPS projections. If we were talking about the current year that would be a bit lofty, but it's even more outrageous when we're talking about fiscal estimates three years from now -- and we're basing this lofty valuation solely on the prospects of a single drug! I just don't see how investors are going to squeeze anymore juice of out this turnip; Alexion shares seem pretty much at a peak here.
I "wood" not suggest it
The next stock up on my list recently beat short-sellers to a "pulp."
Mercer International (NASDAQ:MERC), a supplier of higher-end pulp known as Northern bleached softwood kraft, or NBSK, trounced Wall Street's first-quarter earnings estimates in May, and shares have been barking higher ever since.
For the quarter, Mercer reported 381.8 million air-dried metric tons of pulp production, a modest increase from the 361.2 ADMT it recorded in the year-ago period. But Mercer had a sizable jump in European NBSK pulp list pricing to thank for its $0.37 in adjusted EPS, which more than doubled the $0.17 that the Street had expected.
Still, here's my big concern: NBSK pricing per metric ton. A 30-year chart on monthly wood pulp prices shows only four previous instances in which prices have eclipsed $880 per metric ton. Rarely did prices last but a year above that mark before plummeting back to earth. With NBSK prices at roughly $920 per metric ton when Mercer reported its first-quarter results, it would potentially behoove investors to consider taking their profits off the table here based on a pretty glaring history of where demand dries up.
Another point is that even with improved operational efficiencies it's not as if Mercer's production is going to further expand much, if at all, unless it makes an acquisition. There's only so much demand for paper products that use this high grade of pulp; considering this, placing a forward P/E in excess of 20 on Mercer just doesn't seem prudent.
The wheels on the bus go round and round
As I've often stated before, not every company among this series represents an intriguing short-sale candidate so much as a company that may have reached its peak share price. That's the case with the high-yielding Student Transportation (NASDAQ:STB) which, as its name would imply, provides school bus transportation services and management services via a fleet of more than 11,000 vehicles.
On one hand, we're talking about a business that's on the border of being a basic necessity. Because Student Transportation negotiates contracts for its services it's able to defer revenue out if it hits a rough patch, such as the blustery winter weather that resulted in a number of school closures in January and February. This has a calming effect on investors and allows Student Transportation to pay a monstrous 7%-plus annual yield. And, might I add, it pays a stipend to shareholders once a month.
But a stock investment needs to be more than a dividend, and Student Transportation simply doesn't fit the bill.
Despite the company's ability to grow through acquisitions, its inability to generate strong enough cash flow has caused Student Transportation to turn to share offerings on a regular (and I mean regular!) basis. According to figures from Morningstar, Student Transportation's shares outstanding have ballooned from just 12 million in 2005 to roughly 98 million as of its most recent quarter. Student Transportation tries to make up for these offerings with its high dividend yield, but that is ultimately such a dilutive force that it's stymied any chance for the share price to head significantly higher. And, as icing on the cake, it has convertible bonds outstanding that can be turned into shares that would require the company to issue even more common stock.
The business itself isn't very intriguing, either, from an investors' fundamental viewpoint. Despite offering basic-needs allure, Student Transportation's costs have steadily risen while its gross margin has dipped annually since 2010. On the plus side, the company remains profitable, but only marginally at best with a triple-digit forward P/E forecast in 2015. Finally, book value has also steadily declined, which speaks to the idea that the current management team has lost its focus.
I would suggest not being lured in by this delectable dividend and letting this bus pass you by without hopping aboard.
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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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