Another week of new all-time highs for the Dow Jones Industrial Average coupled with a good start to earnings season has given optimists little reason to fret. 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. Life sciences company Life Technologies jumped to new highs this week following word that Thermo Fisher Scientific will make a bid for the company, and that other private-equity firms are finalizing their bids. With Life Technologies having publicly announced a strategic review in January, it seems like a long-awaited buyout could be right around the corner for shareholders.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Leave the wrapper on
The returns on confectioner Tootsie Roll Industries (NYSE: TR ) have certainly been sweet for investors over the past year. You have to go back to the summer of 2010 to find sugar prices that were as low as they are now, which has played a good part in helping Tootsie Roll keep that aspect of its costs down. But taking a bigger view of what's going on with Tootsie Roll and comparing that to its current valuation creates a sour taste in my mouth.
To start with, Tootsie Roll's fourth-quarter results actually showed a decline of 0.5% in revenue despite those aforementioned reduced sugar prices. Net profit did rise 29% to $0.22 due to cost trimming, but actual candy volume sold dipped. Tootsie Roll CEO Melvin Gordon noted that rising input costs from multiple sources have necessitated price hikes, which helped boost its annual net sales, but even then Tootsie Roll shareholders were only privy to 3% sales growth the entire year.
Tootsie Roll is crawling along with low-to-mid-single-digit sales growth while it trades at 25 times forward earnings and 18 times cash flow (which amazingly enough is actually below its five-year average according to Morningstar). These figures just don't add up! A more health-conscious society with fewer dollars to spend because of higher payroll taxes is not a recipe that's going to make Tootsie Roll a winner.
Hardly what I'd call a pandemic
Every few years a new strain of flu virus seems to mutate and reveal itself somewhere in the Asia-Pacific region, instilling fear that the next pandemic may be on the way. This time it's the avian influenza H7N9 virus, which has gone relatively undetected in most fowl and has caused the death of nine people in China thus far. What hasn't been proven to this point is whether or not human-to-human contraction is possible. Based on the early estimates from the World Health Organization, that would be a no, which makes the likelihood of the Chinese government -- or any government, for that matter -- asking Novavax (NASDAQ: NVAX ) to make a vaccine for the virus quite low.
Novavax has had its chance to shine in previous vaccine scenarios, and it didn't -- despite having the technology capable of delivering a virus in a shorter amount of time than most vaccine manufacturers. Even if Novavax invests heavily in research and develops a vaccine, the amount that would be purchased wouldn't be meaningful enough to put it in the black. At Novavax's current burn rate, according to my calculations, it has in the neighborhood of eight to 10 quarters before it runs out of cash. This means the possibility of further share dilution, especially with no FDA approved products on the market.
Until we have consistent cash flow from Novavax, it's not worth even speculating.
On the wrong track
Small-cap Rentrak (NASDAQ: RENT ) has done quite well for itself and shareholders over the past 12 months. As a marketing and entertainment information provider to the TV, movie, and advertising industry, Rentrak has witnessed its share price rise as the outlook for the overall economy continues to improve. But beyond the surface, Rentrak looks like a brutally overpriced research and information company with few growth catalysts.
Historically, Rentrak isn't a growth story by any means. Since 2005, annual revenue has been essentially stagnant, between $91 million and $106 million. Part of this has to do with the recession in 2009, but it also relates to the tepid advertising budgets in the television and movie industries. Let's not forget that box office ticket sales have been on an almost steady decline since 2002, according to box office research website The Numbers.
Another factor to consider is that half of Rentrak's revenue is made up of its home entertainment business, which is particularly weak at the moment because of tighter household budgets. Tax refunds were delayed longer than normal this year, and government budget cuts are causing businesses to temper back the need to use Rentrak's proprietary customer-tracking software.
I believe firmly that if these media companies are developing quality movies and series, and are willing to listen to the wants and needs of their consumer base, that Rentrak's technology is more or less unwarranted. Truth be told, at 186 times forward earnings and 45 times cash flow, this stock is for mature audiences only since things are probably going to get ugly if its bottom line doesn't improve rapidly.
Foolish roundup
This week it's all about "show me the growth!" Tootsie Roll appears to lack the innovation to drive volume growth, Novavax lacks an FDA-approved product to drive any revenue growth, and Rentrak has been struggling to grow its proprietary software for nearly a decade now.
I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question is: Would you do the same?
One potential highflier that could head even higher
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