by Jeff Reeves | December 16, 2011 3:15 pm
I am optimistic for what lies ahead in 2012 for the economy and the stock market. While we are indeed in challenging times, a host of great companies are out there doing great things. You just have to know where to find them. Plenty of low-risk dividend stocks are also out there with stable operations and reliable paydays that will do right by investors in the year ahead.
However, it would be naïve to think it’s all smooth sailing from here. Lots of stocks are more likely heading for a big fall in 2012, especially as the pressure builds from the euro zone debacle. And as Netflix (NASDAQ:NFLX) proved to us earlier in 2011, even Wall Street darlings can crash and burn in spectacular fashion.
Here are five stocks I think are staring at a breakdown in 2012:
Cabot Oil & Gas.
One lesson investors should learn as they read all the year-end and look-ahead stories is the old adage that “past performance does not guarantee future returns.” Case in point: Last year’s darlings included Crocs (NASDAQ:CROX), Netflix and Green Mountain (NASDAQ:GMCR). Check the performance of those stocks this year, and you’ll see that their track record has taken a decided turn for the worse. So while some may be skeptical about a bearish call on Cabot Oil & Gas (NYSE:COG) after it doubled in 2011, you should review these flops as proof that what goes up also comes down.
Back to Cabot: COG has a nosebleed price/earnings ratio of about 57 based on 2011 numbers, and even if you use the $2 earnings per share for fiscal 2012, you’re still at a rather pricey PE ratio of over 37. Shares have more than doubled since mid-2010, but earnings and sales have grown at a modest pace. Other oil and gas exploration stocks are also seeing those huge premiums — Range Resources (NYSE:RRC) has a forward PE of almost 42, for example – but you have to wonder if the rush to natural gas stocks is premature.
Critics have raised serious concerns over the environmental impacts of “fracking,” a controversial drilling method, after a recent Environmental Protection Agency report linked the practice to water pollution. Regulations could curtail growth for Cabot and others.
I have been leery of Chipotle Mexican Grill (NYSE:CMG) for some time. And while I admit my recent bearish call on Chipotle was a bit premature — CMG stock always seems to fight back after a slide — I see plenty of reasons the stock will be down for the count in 2012.
For starters, Wall Street is littered with the wreckage of hot restaurants that expanded rapidly to deliver big revenue gains and a quick double or triple to shareholders. Krispy Kreme (NYSE:KKD), Cheesecake Factory (NASDAQ:CAKE), P.F. Chang’s China Bistro (NASDAQ:PFCB) and Ruby Tuesday (NYSE:RT) are a just a few
Besides, almost every ingredient Chipotle uses is suffering from inflation – squeezing margins. And if you’ve ever been inside a Chipotle, you know that portion control isn’t exactly its thing. McDonald’s (NYSE:MCD) has burger “manufacturing” down to a science, but CMG hasn’t figured this out yet.
Chipotle’s growth is indeed impressive. Its five-year growth rate is over 38%, and the next three years should see annual EPS growth averaging about 18%, according to Standard & Poor’s. But the problem isn’t growth, it’s expectations. Based on 2012 forecasts of $8.22 in EPS, CMG has a ridiculous forward PE of 39 — by comparison, McDonald’s (NYSE:MCD) is just 17. Don’t think MCD is a fair comparison? OK, consider fast-growing small-cap Panera (NASDAQ:PNRA), which has a forward PE of 24.
Chipotle stock with a PE of 24 gets you to a little under $200 a share. That’s almost 40% down from here. Ouch.
Sure, Amazon (NASDAQ:AMZN) stock is perennial outperformer. Shares have doubled since 2008 levels, and the company is one of the few real success stories across the financial crisis and recession.
But a trailing PE of 96 and a forward PE of 91? That seems a bit rich — especially when you consider Amazon’s net profit is normally about 5% of revenue, thanks to rock-bottom pricing that’s squeezing competitors and giving AMZN its low-cost appeal. It’s great that customers visit Amazon first to compare prices, but there’s not a lot of room for error with margins like that — especially now that Amazon is eating more costs via Amazon Prime free-shipping deals to preferred customers.
And let’s not forget the huge gamble Amazon is making on the new Kindle Fire. The company is bleeding cash on the low-cost tablets in an effort to jump into the market dominated by Apple (NASDAQ:AAPL) and the iPad. Amazon’s research, production and subsidies for the tablet will result in a huge step back for fourth-quarter earnings that normally account for about 40% of Amazon’s annual profits.
That’s fine if the device catches on, but some negative reviews are popping up on tech forums, and Amazon’s lack of transparency on Kindle sales figures should make some investors leery. In fact, one group of analysts says Kindle sales will actually boost iPad sales by familiarizing consumers with the technology and prompting them to eventually upgrade.
And by the way, holiday sales numbers may not be all they’re cracked up to be. That doesn’t paint a great picture for Amazon in 2012.
Office Depot (NYSE:ODP) has been stuck in a tailspin for some time, logging a 60% slide in 2011 and a gut-wrenching 95% drop since 2007 levels. Expect more of the same in the New Year.
Office Depot’s revenue totaled $15.5 billion in fiscal 2007 and has steadily declined to about $11.5 billion for fiscal 2011. After seven straight quarterly losses in 2008 and 2009 the company managed to break even in 2010 — but is forecast to finish fiscal 2011 operating at a loss again. So much for blaming previous troubles on the recession…
The lack of business spending on office supplies is only part of the story. Rival Staples (NYSE:SPLS) is the No. 2 online retailer in the U.S. by many measures, second only to e-commerce king Amazon and in front of gadget powerhouse Apple. Office Depot just doesn’t have the online competitive edge of Staples and can’t seem to turn a profit.
The idea of a big-box office-supply store in general is a tenuous bet these days. It’s hard to compete with Walmart (NYSE:WMT) and other discounters on back-to-school supplies and the like, and ODP will never have the selection that Internet electronics retailers offer. Sure, the stores also offer business-card printing and other services — but FedEx (NYSE:FDX) offers the same things at its Kinkos outlets, with a fraction of the square footage and almost as many locations.
What’s to like about Office Depot?
Ford (NYSE:F) was in the right place at the right time as General Motors (NYSE:GM) and Chrysler went belly up. The carmaker gobbled market share, benefited from government meddling at competitors and managed to win both car and truck of the year at the 2010 Detroit Auto Show.
2011 hasn’t been as kind. Ford stock is off almost 40% year-to-date, despite reinstating its dividend to appeal to shareholders and despite the fact that overall vehicle sales are looking to grow by almost 10% this year over 2010.
Why the tumble? Well, irrational exuberance for one reason. Ford peaked at over $18 a share this year, more than double its 2007 stock price, even though revenue was off over 25% from that same period. Returning to profitability was nice, but Ford got there by cuts — not by growth. What’s more, although Ford managed to avoid bankruptcy, thanks to timely debt restructuring just before the financial crisis, its total long-term debt totals over $100 billion. That’s more than Ford’s current market capitalization!
One could argue that the worst is over for Ford after a nearly 40% flop so far in 2011. However, it’s decelerating in the U.S. and, like most major automakers, is engaged in a massive China gambit. That’s all well and good if China keeps booming, but a shock in China or disappointments in Asia could send this automaker reeling.
Jeff Reeves is the editor of InvestorPlace.com. Write him at email@example.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.
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