I follow quite a lot of companies, so the usefulness of a watchlist to me cannot be overstated. Without my watchlist, I'd be unable to keep up on my favorite sectors and see what's really moving the market. Even worse, I'd be lost when the time came to choose which stock I'm buying or shorting next.
Today is Watchlist Wednesday, so I'm discussing three companies that have crossed my radar in the past week -- and at what point I may consider taking action on these calls with my own money. Keep in mind that these aren't concrete buy or sell recommendations, nor do I guarantee I'll take action on the companies being discussed. What I can promise is that you can follow my real-life transactions through my profile, and that I, like everyone else here at The Motley Fool, will continue to hold the integrity of our disclosure policy in the highest regard.
This week, I'm devoting my three picks to short sellers looking for high-risk, high-reward ideas.
Michael Kors (NYSE:KORS)
Trust me, I get it! Michael Kors looks completely unstoppable as it pushes further into Europe and opens up bricks-and-mortar stores left and right in the United States. Consumers' seemingly insatiable appetite for brand-name products at reasonable prices is what's fueled Kors to same-store sales growth in excess of 30% in numerous quarters -- and yet, I'd say it's time to rally the troops against this company.
In the first quarter, Michael Kors again delivered more of those stunning results: 27.3% comparable-store sales growth and 54% first-quarter revenue growth. However, these results will not stand the test of time as no retailer has been able to survive the fickle spending and buying habits of consumers for longer than a few years.
I'm certainly not going to take anything away from the extraordinary growth of Michael Kors, which is fueling its expansion entirely on operating cash flow, but I also know that many of the regions it's operating in are weak from a consumer spending perspective. Back-to-school sales in the U.S. have been awful this year while austerity measures in Europe will cripple spending for years to come. Even Asia is showing signs of slowing, with China's GDP growth backing off its historical average of 10%.
From a forward P/E basis, Michael Kors isn't as expensive as it once was, but its growth rate just simply isn't sustainable given the history of consumers' buying habits.
I honestly feel you could make this a 2-for-1 special and just lump rival Trulia (UNKNOWN:TRLA.DL) in here as well, but Zillow is just a bit more unnerving from a valuation perspective and gets my short-sale suggestion nod over Trulia.
The thesis against owning real estate information websites that provide tools to help prospective homebuyers and real estate agents locate homes for purchase or rent lies solely with the rising tide of interest rates. With the Federal Reserve hinting as early as May that it would soon be paring back its $85 billion monthly bond purchases, mortgage rates took off. In a span of a few months, 30-year mortgage rates spiked from below 3.5% to as high as 4.75%. By comparison, mortgage origination activity over that time fell in all but one week and is now more than 55% lower than at its peak in early May. In other words, higher mortgage rates have spoiled consumers and they're much less likely to purchase a home if rates keep rising, which will ultimately hurt Zillow's and Trulia's bottom lines. These companies will benefit from a rental market perspective, but their bread-and-butter business is based on the homebuying hunt.
Up until now, growth hasn't been an issue for Zillow, with its record 69% revenue growth and a 66% year-over-year increase in membership in the second quarter. The concern is that Zillow still isn't profitable thanks to pouring its cash flow into workforce expansion and website R&D. In fact, Zillow won't be profitable until next year when the Fed will almost assuredly be ending QE3. For me, this exposes Zillow and its forward P/E in excess of 180 as exceptionally overvalued.
The amazing thing -- and why I would choose to short Zillow over Trulia despite both being valued to the hilt -- is that Zillow only has $170 million in net cash despite being valued at more than twice the size of Trulia. By comparison, Trulia sports a net cash position of $206 million. Furthermore, Zillow is far scarier on a fundamental basis at 11.5 times book and 22 times sales compared to Trulia at 14.5 times sales and just under seven times book value.
It's no Sirius XM or anything, but a loan from Golden Gate Capital in 2010 has completely turned around the struggling jeweler to the point that it reported its first annual profit this past year since 2008. For fiscal 2013, comparable-store sales jumped 3.3% with Zale's branded stores delivering a 4.7% increase in sales. But rather than reaching for the buy button, I'd suggest rewrapping these shares and finding out what the return policy is on this stock.
The first concern I have with Zale relates to the price of diamonds. Since peaking in February 2012, diamond prices according to Diamond Search Engine have fallen by more than 8%. This drop has been partly masked by a retreat in metal prices, especially gold, which have helped boost Zale's margins. However, in recent weeks metals like gold are rebounding in a big way, which could put the margin pinch on Zale during the all-important Christmas season.
If you don't think there's any merit to diamond prices, take a closer look at higher-end diamond retailer Dominion Diamond (NYSE:DDC) (formerly Harry Winston Diamond), whose share price has almost perfectly followed the up and down movement of diamond prices over the past year. Higher diamond prices are indicative of better margins; conversely, lower prices mean potentially weak margins!
The other concern here is based on Zale's existing cash flow and debt. Zale's debt-to-equity of 221% indicates a big red flag because Zale's only produced positive free cash flow twice between 2006 and 2012. With nearly $400 million in net debt, Zale runs the risk of being unable to expand or even purchase new assortments of jewelry if it can't pay down some of its obligations.
Is my bullishness or bearishness misplaced? Share your thoughts in the comment section below, and consider following my cue by using these links to add these companies to your free, personalized watchlist to keep up on the latest news with each company:
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.
The Motley Fool recommends and owns shares of Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.