Thus far, earnings season has yielded considerably better results than expected and the broad-based S&P 500 continues to tackle new multi-year highs. 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. Clinical-stage biotechnology company MAP Pharmaceuticals (NASDAQ: MAPP) soared nearly 60% yesterday after agreeing to be purchased by collaborative partner Allergan for $958 million. MAP has been working on an inhaled migraine medication known as Levadex, which is widely expected to gain FDA approval following the addressing of manufacturing concerns raised by the FDA.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
The kiss of death
Sometimes you have to take a step back and not allow a company's brand name to wow you, otherwise you could wind up getting burned. Such is the case with confectionery giant Hershey (NYSE:HSY), which could be setting its investors up for the "kiss" of death.
The primary factors Hershey investors need to be concerned with are the input prices of cocoa and sugar (its primary ingredients) and the overall consumer demand for chocolate. All have been generally working in its favor, with sugar prices hovering at levels not seen since August 2010, cocoa grind volumes rising for the first time since late 2011, and consumer demand for chocolate peaking around Valentine's Day.
On the flip side, Hershey is now trading at a robust 22 times forward earnings -- a lofty valuation for a company expected to grow sales by only 6% in the upcoming year. Also, sugar prices have kept a pretty steady trend over the past decade of retracing about 50% from their highs before rebounding. At approximately $0.18/lb., we're pretty close to the end of that retracement pattern. Finally, consumer demand could wane as the end of the payroll tax holiday forces consumers to spend more wisely. I definitely like the product, but now is not the time to be falling in love with the company.
If you build it, I won't buy it!
The rapid rebound in the housing sector has created no shortage of investment opportunities in companies that supply materials and appliances used in new homes. But I have to wonder exactly what sort of opportunity really exists for water heater and boiler manufacturer A.O. Smith (NYSE:AOS) to really boost its bottom line?
In A.O. Smith's most recent quarter, it delivered a 12% increase in revenue to $462.2 million as profits topped Wall Street's estimates by $0.03 and advanced 22% from the year-ago period. Dig a bit deeper, and you'll discover that AO's purchase of Lochinvar actually contributed $63 million in revenue, meaning, on an organic basis, the company's revenue actually shrank by 3%. This is yet another example of a company growing by acquisitions because it's exhausting its organic avenues to growth.
Also consider how weak (3%) organic growth appears when housing sales have so decisively bounced off their lows! A.O. Smith is valued at nearly 20 times forward earnings yet is only expected, even with its recent acquisition, to grow sales by 8.5% in 2013. To me, without any major catalysts, that seems like a far-fetched price to pay for water heaters and boilers.
A failure here will sting
Unlike Hershey or A.O. Smith, where I struggle to find avenues of growth, the path for AcelRx Pharmaceuticals (NASDAQ:ACRX) is very clear: get its late-stage post-operative pain management treatment, Sufentanil NanoTab PCA, approved.
AcelRx is currently running three trials on its system, which is administered under the tongue as opposed to through an IV, an often painful and uncomfortable medication delivery path. Results from the first trial, released in November, demonstrated clear-cut non-inferiority and statistical significance for Sufentanil NanoTab. AcelRx, however, is still running two additional trials with data expected sometime this quarter.
My concern stems from multiple points, such as its lack of a development partner, the length of time it'll take to get its next-most-advanced drug to market if the FDA either rejects Sufentanil NanoTab or gets picky about the delivery or manufacturing aspects of the drug, and the company's propensity to issue shares to raise cash, which will ultimately dilute shareholders.
At its current price, even with fantastic late-stage results, a new drug application filing in the third quarter won't result in a decision until early next year. That's very little wiggle room to the upside, and a lot of downside room if Sufentanil NanoTab doesn't kick butt in trials! Don't count out big medical device makers like Hospira (NYSE:HSP) or Baxter International (NYSE:BAX), which are the dominant manufacturers of the current IV PCA delivery system that AcelRx is trying to replace. They'll fight tooth and nail with their expertise and wallets to retain their market share.
This week I encourage you not to get blinded by improving sector fundamentals. Cocoa grind sales may be up for Hershey, and housing starts may be at a five-year high, which is good for A.O. Smith, but can they really grow any faster than they are now? As for AcelRx, what catalyst can really push it past $6? Nothing that I can see.
Fool contributor 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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