The market is far from perfect. It gets stocks wrong all the time, sometimes bidding them up beyond reason and other times selling them off due to unrealistic fears. That certainly seems to be the case with Exact Sciences (EXAS -4.83%), American Express (AXP 0.33%), and Cenovus Energy (CVE 6.98%), which we think the market has gotten completely wrong.
Valuing companies can sometimes be an in-Exact Science(s)
Sean Williams (Exact Sciences): Currently, Exact Sciences, the company behind the next-generation non-invasive colorectal cancer test known as Cologuard, has 12 analysts covering the company. Five rate it a "strong buy," three a "buy," and four a "hold." Not a single analyst believes the company is an "underperform" or "sell." However, this Fool does.
Before I tear down the bullish thesis, I want to give credit where credit is due. I happen to like Exact Sciences' diagnostic tool and believe it'll be around for years to come in helping to prevent what the company has described as the most preventable form of cancer. There's little denying that Cologuard offered significant improvement in detecting both colorectal cancer and advanced adenomas in clinical studies that led to its approval.
My valuation concerns with Exact Sciences are twofold.
First, the company is primarily targeting seniors with its diagnostic tool, since seniors are far more likely to develop colorectal cancer than younger adults. The good news for Exact Sciences is that Medicare has approved its diagnostic test for reimbursement. The bad news, which I believe Wall Street continues to overlook, is that Republicans control the legislative branch of the government. Republicans have previously tried, and may continue to try, to rein in federally funded healthcare expenditures. In other words, reimbursements for Cologuard have only one way they can head in my view: down. Exact Sciences will benefit if it can keep adding new patients each quarter, but its margin on those tests could very well shrink in the future.
Secondly, Exactly Sciences is still a long way from being profitable. Over the past three years, Exact Sciences has lost a combined $425 million, and burned through $394 million in cash. It did end 2016 with $311 million in cash, but with years of losses still expected, its cash balance would be expected to decline. It could be 2022 or 2023 before Exact Sciences' current valuation begins to make even the slightest shred of fundamental sense -- and that assumes it doesn't deal with a reimbursement cut from Medicare.
This is an instance where we have a really intriguing product, but the investing dynamics make absolutely no sense. I believe Wall Street has Exact Sciences all wrong.
A company that's living in the past
Jordan Wathen (American Express): American Express shares have exploded in value on the back of a surge in bank stocks, but I'm wary of its recent surge. It continues to carry an unjustifiable premium to other card companies, in my view.
Competition in the credit card industry is as strong as it has ever been. American Express is losing its position as the premier card for the most credit worthy borrowers. In travel cards, JPMorgan (JPM 1.11%) circled the high-end AmEx Platinum with the Chase Sapphire Reserve. In everyday cards, Chase Freedom variants offer more rewards than similar AmEx cards. Chase's Business Cards offer superior rewards at a lower annual fee than AmEx's Business Gold.
Not only are Chase's cards more rewarding, but they're also accepted in more places, as Chase cards carry a Visa (V 0.34%) label whereas AmEx cards are processed in its own closed-loop network. American Express also lacks the cross-selling opportunities of money center and consumer banks, which offer everything from mortgages to multi-million dollar commercial loans.
It's my view that American Express's brand is something of a wasting asset that is being slowly amortized as more people begin to question whether its cards' higher annual fees for cardholders and loftier fees for merchants are worth the pricetag.
But if all that isn't convincing, consider this: American Express talks about targeting 20% returns on equity in a world where most banks are ecstatic to eke out 12%. In a commodity business, it's rarely a winning model to be the high bid.
This was a great deal
Matt DiLallo (Cenovus Energy): Shares of Canadian oil and gas producer Cenovus Energy plunged after it announced a $13.3 billion deal to acquire several oil and gas assets from U.S. oil giant ConocoPhillips (COP 4.75%). Fueling its sell-off was the fact that Cenovus needs to take on a significant amount of debt to get the deal done, which increases its risk profile. Further, while the company acquired full control over its oil sands assets after buying out its joint venture partner, it also picked up several Canadian natural gas properties, which some analysts saw as unnecessary diversification.
However, I believe the market's negative reaction to the deal was the wrong one for several reasons. First, while Cenovus will borrow heavily to complete this deal, the company's leverage metrics will remain strong at 41% debt-to-book cap and 2.4 times debt-to-EBITDA, just above its long-term targets of 30%-40% and 1.0-2.0 times, respectively. Further, the company plans to sell off some non-core assets and reduce debt. In fact, it has already received strong interest from potential buyers in the assets it has on the market.
Not only will Cenovus retain its financial strength but this deal provides it with clearly visible growth. For starters, the deal doubles the company's production and reserves. Further, with full control over its oil sands assets, the company now has a clear line of sight on future expansions, estimating that it can grow production capacity from 356,000 barrels per day up to 500,000 barrels per day within five years. Meanwhile, it expects to increase gas output from the acquired properties 40% by 2019.
Finally, ConocoPhillips put its stamp of approval on Cenovus Energy by agreeing to receive $2.7 billion of shares in the deal, which enables it to participate in the upside created by the transaction. Add it up, and the market's decision to sell-off Cenovus' stock in wake of this deal appears to be the wrong move.