5 Overvalued US Stocks

THE VALUE INVESTOR: The rout in commodity markets and ongoing challenges in the finances services sector mean some companies in these sectors are looking overvalued

Karen Kwok 26 February, 2016 | 3:48PM
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Problems in global commodity markets, ongoing challenges in the financial services industry and changing consumer habits can create problem for companies in these sectors. Morningstar analysts have tried to identify stocks that are trading at significantly more than their fair value and highlight issues investors need to be aware of.

Morningstar star rating can help investors determine whether a particular stock or company is overvalued. If a stock has a low star rating, that means Morningstar equity analysts think the shares are overvalued, and the share price could drop in the future.

The stock star rating is a forward-looking rating that takes into account both  quantitative and qualitative factors. There are currently 13 stocks in the US that Morningstar analysts rate one star, and we highlight five out of the list.

Southern Cooper Corp (SCCO)

Southern Cooper is the world’s largest copper miner by reserves, among the largest by annual output, and among the lowest by cost. It also produces molybdenum, zinc and silver. The company’s segments include Peruvian operations, Mexican open-pit operations, and Mexican underground mining operations. The firm is in solid financial health. At year-end 2015, Southern Copper had $878 million in cash and short-term investments against $6.0 billion in debt. Mexican conglomerate Grupo Mexico (BSMX) owns 86% of Southern Copper's outstanding shares. The stock is an overvalued stock rated by Morningstar analyst with a one star rating.

Production growth partly offset falling copper prices in Southern Copper’s fourth quarter, much as it had in prior quarters, Morningstar analyst Daniel Rohr says. A significant portion of Southern Copper’s growth will come from expansion at existing mines, which is a lower-risk path to growth. Also Southern Copper’s Mexican and Peruvian mines are low cost, which is a dependable source of free cash flow in nearly any copper price environment. The company therefore is better positioned than peers Freeport-McMoRan (FCX) and First Quantum (FQM) to endure low prices.

However, Rohr questions the logic that would see Southern Copper shares outperform falling copper prices. No matter how low its operating costs and how manageable its debt load, the stock is a leveraged bet on the metal. Weaker Chinese demand and a bumper crop of new mines boosting supply are likely to affect  copper prices. Yet the company is heavily investing to increase copper volume at this time. The company is also highly exposed to political climate and the labour unrest within the countries it operates in.

As a result, Morningstar analysts see the stock significantly overvalued despite the company’s assets are good.

Jack & Henry & Associates Inc (JKHY)

Jack & Henry is one of the leading providers of core information processing systems to domestic banks and credit unions. The company also provides ancillary products, such as Internet banking, cheque imaging, and remote deposit capture. It serves about 1,200 banks and 800 credit unions.

Morningstar analyst Brett Horn believes the company can continue to grow at a higher rate. Aside from some accounting issues, Jack Henry has been performing very well recently, achieving both strong sales growth and significant margin improvement. As banks have progressed past the financial crisis, bank technology providers have seen growth pick up a bit, and Jack & Henry has come off the mark much faster than its larger peers.

The company is also shifting away from license sales and toward support and service revenue, a trend Horn believes will continue positively, as support and service revenue is both recurring and sticky.

However, another banking crisis could lead Jack Henry's customers to defer purchases, and banks could also fail in large numbers, according to Horn. Government intervention in the banking system could lead to a shift in the structure of the industry, and if this were to occur, the effect on Jack Henry's business would be difficult to predict. Any shift in deposits from small and midsize banks to large banks would hurt the company. Finally, Jack Henry processes sensitive information, and any breach of its systems could damage its reputation and lead to lawsuits. Jack Henry recently was forced to change its revenue recognition policies, which could create some noise in near-term results. The stock is rated by Morningstar analyst as an overvalued stock.

Dr Pepper Snapple Group Inc (DPS)

Dr Pepper Snapple manufactures and distributes non-alcoholic beverages in the US, Canada & Mexico. Its products include carbonated soft drinks and non-carbonated beverages such as ready-to-drink teas, juice drinks, mixers and waters. The Beverage Concentrates segment accounts for 20% of revenue, but more than half of the company's segment operating profit. Dr Pepper Snapple is rated as an overvalued stock by Morningstar analyst.

Through the company’s rapid continuous improvement program, Dr Pepper has driven best-in-class inventory turns, and operating profitability that surpasses rival PepsiCo (PEP), Morningstar analyst Adam Fleck says. The company generated positive growth in its non-carbonated portfolio in 2015.

Despite the company’s limited geographic reach and its partial reliance on competitors for bottling and distribution, its brands enjoy solid positions in their particular markets, Fleck says. The US makes up 89% of the company’s revenue, exposing the firm to a declining carbonated soft drink end market in this country. The decline is at a greater rate than Morningstar analysts have projected and this presents a key risk for the company.

Fleck also believes that brands such as Snapple and Hawaiian Punch offer more limited pricing power and growth potential than similar still beverages offered by peers, particularly if consumers' tastes could shift away from sugary beverages and move toward more healthy alternatives. This could give its’ Dr Pepper brand more limited sway than the brands of some of its competitors. Volatility in commodity prices, particularly for raw materials such as corn, juices, aluminum, and plastic resins, could also pinch the firm’s sales and profitability.

Hormel Foods Corp (HRL)

Hormel Foods manufactures, sells, and distributes a variety of food products, primarily pork and turkey. In addition to commodity meat sales and meat products, Hormel owns the Spam, Jennie-O Turkey, Skippy, Muscle Milk, and Applegate labels. The firm sells the vast majority of its products in the U.S., with 94% in 2015.

Over two thirds of Hormel’s fiscal 2015 sales came from perishable (53%) and poultry (primarily turkey; 19%) items, with the remainder from shelf-stable products. Hormel has a history of strong return generation and a conservative balance sheet, which Morningstar analysts expect it to continue. The company is rated as an overvalued stock with a one star rating.

Morningstar analysts believe Hormel will need to rely on acquisitions to achieve its objectives of 5% revenue and 10% earnings growth annually, as analysts forecast more modest annual increases of 4.4% and 6.3% respectively, over the next five years. Protein-rich foods continue to see increased demand, creating a favourable environment for meat processors, Morningstar analyst Zain Akbari says.

However, the sustainability of Hormel’s brand asset is threatened by increasing reliance on the centre of the grocery store, which itself is subject to increased competition, Akbari says. Livestock diseases may also lead to supply disruptions, which could derail Hormel’s ability to introduce new, innovative meat products and limit international growth prospects, given ensuing trade restrictions.

Mettler-Toledo international Inc (MTD)

Mettler-Toledo supplies weighing and precision instruments to customers in the life sciences, industrial, and food retail industries. Its products include laboratory and retail scales, pipettes, pH meters, thermal analysis equipment, titrators, metal detectors, and X-ray analyzers. Mettler leads the market for weighing instrumentation and controls more than 50% of the market for lab balances.

The company holds a top three position in every product line it manufactures. Its share in laboratory weighing instrument is nearly three times that of its biggest rival, Morningstar analyst Alex Morozov says.

Despite the 3% reported decline in revenue, Mettler still managed to boost its gross margin by 70 basis points on the strength of pricing (220 basis points in the quarter) and material cost reductions. The company is targeting another 150 basis points in pricing for 2016. Morozov says that while this is ambitious, considering the deflationary environment, it is deliverable, given the company's track record and good product mix.

However, the firm's fourth-quarter results continue to paint a challenging picture in a number of markets. Even after the increase in Morningstar analysts’ valuation, shares are likely to remain expensive. Therefore the company is rated as an overvalued stock with a one star rating.

Mettler has greater exposure to industrial end markets in China versus the rest of the world. With the slow China economy demand, the firm's competitive positioning could be at risk. Also Mettler's revenue growth is further hindered by the products' long life spans and a limited upgrade requirement, Morozov says. The firm may also feel the impact of higher raw-material prices, since price increases, especially on low-end products, are tough to obtain, given limited differentiation. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Freeport-McMoRan Inc51.53 USD0.64
Hormel Foods Corp35.11 USD1.04Rating
Jack Henry & Associates Inc168.61 USD0.17Rating
Keurig Dr Pepper Inc34.19 USD0.62Rating
Mettler-Toledo International Inc1,479.53 USD0.02Rating
PepsiCo Inc177.99 USD-0.71Rating
Southern Copper Corp117.51 USD0.82

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk

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