Whether we like to admit it or not, the overwhelming majority of stock analysis slants toward the bulls. That's despite over a century of evidence that most of the stock market's gains are driven by relatively few companies, that many stocks fail to outperform the S&P 500, and that all stocks have potential pitfalls.
That simple reality means it's important for investors to be open-minded about the stocks in their portfolio and on their watch list. The mere presence of a red flag doesn't mean a stock should be avoided, but there are terrible investments lurking among us. I think Frontline (FRO -2.41%), Ferrellgas Partners LP (FGP), and Chemours Company (CC 0.76%) are three such examples. Here's why.
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Recovery unlikely in 2018
Frontline stock has lost well over half of its value since December 2015. Unfortunately, there don't appear to be any major catalysts on the horizon. You could even argue things may get worse before shares have a shot at a recovery.
The shipping stock has struggled along with collapsing day rates for the industry. While falling crude oil prices and greatly altered global trade flows (see: American shale) were the main culprit a few short years ago, other factors have kept the industry underwater lately. Namely, an influx of newly built tankers, which has flooded the market with spare capacity at exactly the wrong time.
Consider that in 2017 the global tanker fleet added 56 new vessels -- a multiyear high. The result: Shipping rates collapsed to nearly one-third of their 25-year average. That led to Frontline outright rejecting contracts last year, assuming it was better off taking it on the chin financially with idle capacity in the short term to hold out for higher rates in the long term. Management is probably right, but that doesn't mean a recovery is in sight.
The number of global tanker additions is expected to fall to 33 in 2018 and even further in 2019, but there's simply more capacity than demand right now. In other words, investors hoping Frontline stock has bottomed out may be in for an unpleasant surprise.
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Suffocating debt
Poor decisions from past management teams continue to haunt Ferrellgas Partners. While the company brought back its namesake founder as CEO, it has an awfully big hole to climb out of. The propane distributor's foray into midstream operations -- transporting crude oil from field to processing centers -- was ill-timed, which has been all the more painful thanks to the nearly $1 billion in debt needed to build the business.
There are some signs that Ferrellgas Partners is in the early stages of a turnaround. The arctic blast that engulfed much of the United States this winter resulted in a significant increase in the volume of propane consumed by residential customers for heating, which should result in one the best fiscal second-quarters in recent memory. It's doubling down on the non-heating fuel propane market. And improving crude oil prices and steadily increasing production volumes in major American energy regions should translate into improved performance for the midstream business.
That said, the toxic balance sheet won't be cleaned up after a solid quarter or two. The effort will likely take years. Consider that at the end of October 2017, Ferrellgas Partners boasted a debt-to-assets ratio of 127% and shareholders' equity of negative $790 million. That's...pretty awful. Since cleaning up the balance sheet is the first step required to trigger an increase in quarterly distribution payments, and that will be a critical catalyst for regaining the trust of Wall Street and investors, the stock isn't likely to leave its misery behind anytime soon.
Image source: Getty Images.
Don't get caught off guard
Unlike Frontline and Ferrellgas Partners, Chemours stock has absolutely crushed it in the last couple of years. The business has been greatly aided by skyrocketing prices of titanium dioxide, an important pigment for which the company is a leading global manufacturer. Titanium dioxide provided 47% of revenue and 58% of adjusted EBITDA through the first nine months of 2017. Prices appear poised to keep rising, too. So what's not to like?
Well, the company's second-most-important segment produces waterproof coatings and refrigerants using fluoropolymers. The materials are incredibly useful to modern civilization, would be difficult to replace, and are at the heart of multiple blockbuster consumer products, such as Teflon nonstick coatings for cookware. Unfortunately, the same chemical properties that allow them to perform above and beyond any other materials also make them incredibly toxic to human and environmental health.
That has put Chemours in a tricky situation, especially with state and federal regulators. Case in point: Despite pledging to stop discharging wastewater containing byproducts from fluoropolymer manufacturing at its U.S. facilities, detectable levels of the chemicals still greatly exceed acceptable limits. The U.S. Environmental Protection Agency isn't taking the situation lightly. After scrutinizing water around a major facility in North Carolina, in early 2018 the regulator sent a letter to the company asking it to test water in Ohio and West Virginia.
Considering that the fluoroproduct segment was at the center of a $670 million legal settlement for the very same reasons, investors shouldn't shake off the mounting risks posed by further (and potentially harsher) regulatory action. Worse yet, there's a treaty in place that could result in a global phaseout of fluoropolymers altogether, which subjects a large chunk of the company's business to uncertainty. Additionally, given that management is well aware of the health risks posed by the chemicals it discharges into public waterways, this stock doesn't rank very highly in the "socially responsible investing" category. That's why I'd avoid Chemours stock.
Investor takeaway
Most of the time, a weak or flawed business is what keeps me on the sidelines. Even if the situation is temporary, investors are often better off owning great companies rather than hoping for a timely turnaround with a troubled business. With so many publicly-traded companies in the markets, why invest in ones with significant question marks?
