For a well-diversified portfolio, it always makes sense to have a mix of high and low beta stocks. When markets are in an uptrend, high beta stocks help in maximizing returns. On the other hand, when markets are bearish, low beta stocks help in capital preservation. At the same time, there might be high-risk stocks that can potentially damage the portfolio returns. Therefore, small companies need a higher due diligence. There are seemingly attractive high-risk stocks that need to be avoided.
This column will discuss four high-risk stocks that have under-performed in the recent past. It’s likely that these stocks will continue to be under-performers.
Let’s look at the following high-risk stocks:
- Transocean (NYSE:RIG)
- Canopy Growth Corporation (NYSE:CGC)
- American Airlines (NASDAQ:AAL)
- NewAge (NASDAQ:NBEV)
4 High-Risk Stocks Not Worth the Trouble: Transocean (RIG)
With the price of oil sustaining at relatively lower levels, one of the worst hit sub-sectors in the energy space is offshore drilling. RIG stock has slumped by 83% in the last year and might look interesting at $1.10. However, I believe that the overall risk is significantly high even at current levels.
Recently, the Federal Reserve announced that near-zero interest rates will remain through fiscal year 2023. Clearly, economic recovery is likely to be slow. Considering this factor, it’s unlikely that oil will trend meaningfully higher from current levels. This is negative news for the offshore drilling sector.
It’s worth noting that companies like Seadrill and Diamond Offshore have already filed for bankruptcy. Companies in the offshore drilling sector are fighting for survival. Even if Transocean survives, I expect leverage and equity dilution to keep the stock depressed.
Transocean does have an order backlog of $8.9 billion with investment grade companies. However, the backlog is spread over several years and the company is likely to continue reporting operating level losses. Further, new contracts are coming at a lower day-rate and this will have a negative impact on the EBITDA margin and cash flows.
Overall, RIG stock is a fallen angel and it’s risky to try and catch a falling knife. Investors are better off without exposure to the offshore drilling sector.
Canopy Growth Corporation (CGC)
Cannabis stocks witnessed irrational exuberance early in FY2019. Most cannabis stocks peaked out by April 2019. In the last year, CGC stock has further declined by nearly 40%.
I still have a relatively optimistic outlook for the industry in the long-term. However, I believe that Aurora Cannabis (NYSE:ACB) is a better bet than CGC stock. It’s worth noting that CGC has a beta of 2.27 as compared to a beta of 1.33 for ACB stock. With markets near all-time highs, it makes more sense to consider exposure to the latter.
In terms of growth and value creation, I see the following challenges:
- The company is still at an operating level loss. With positive EBITDA not on the horizon, I expect equity dilution to negatively impact CGC stock.
- The medicinal cannabis industry has failed to gain traction. Growth is unlikely in medicinal cannabis until claims are backed by research. Canopy Growth is undertaking clinical trials. However, it might be years before a cannabis drug is approved.
- In the recreational cannabis segment, Canopy Growth is looking to increase the portfolio of value-added products to improve margins. However, Aurora Cannabis has a similar strategy. It remains to be seen if these products can boost top-line growth and margins, amidst competition. Considering these factors, I believe that CGC stock should be avoided.
American Airlines (AAL)
With the novel coronavirus pandemic likely to have a lasting impact on the travel and tourism industry, I would avoid high-risk stocks like AAL. The stock has plunged by 55% in the last year. However, there are ample negative triggers that can take the stock lower. AAL stock also has a high beta of 1.75, which is an indication of the exposure risk when broad market valuations look stretched.
Talking about the industry, Boeing (NYSE:BA) warned in July 2020 that recovery can possibly take three years. The international air transport association also believes that global passenger traffic will not return to pre-COVID levels until FY2024. Clearly, the industry is likely to face a few years of pain and this will be associated with cash burn for American Airlines.
American Airlines has ample liquidity to navigate the coming quarters. However, the balance sheet is already stressed. Further leveraging or equity dilution will depress the stock. I am reminded of Warren Buffett’s comment on the airlines industry way back in FY2007. Buffett wrote in the shareholder letter that investors in businesses like airlines “poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”
Of course, it’s an unfortunate scenario for the airlines industry. However, the coming years will be characterized more by money infusion in the business than shareholders being rewarded. Amidst uncertainties, it’s best to avoid AAL stock.
NBEV stock has been a market under-performer with a decline of 43% in the last year. A small-cap stock with a market capitalization of $175 million might attract investors. However, I would avoid this high beta stock with a seemingly attractive business.
From a business perspective, the company operates in the segments that include ready-to-drink tea, energy drinks, premium bottled water, and kombucha. The biggest challenge for the company in the coming years is likely to be the competition it faces from the likes of The Coca Cola Company (NYSE:KO) and Starbucks (NASDAQ:SBUX), among others.
To remain competitive, the beverage company is likely to compromise on margins and therefore profitability. It’s worth noting that the company’s operating losses have widened in the first six months of FY2020 as compared to the prior year comparable period.
With cash burn, I don’t expect value creation to happen anytime soon. Furthermore, it remains to be seen if NewAge can deliver organic growth on a sustained basis.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.