What’s common between American Airlines, Centurylink, Coty, Occidental Petroleum, and Harley-Davidson? They are all part of our high leverage portfolio where we advise investors to exercise caution. We identified this portfolio of The Leveraged 5: AAL, CTL, COTY, OXY, HOG – with debt being more than twice the market value. Notably, these stocks haven’t just done poorly during the Covid-19 crisis, but have been punished for years now. While this spells large risk, could this portfolio of 5 highly-leveraged stocks in fact turn the corner, survive Covid and in fact yield large upside for the brave?
Companies with such high debt load typically have an increased risk of default. However, we didn’t rely on just this one metric. We found remarkable similarities in the underlying financial metrics that verified our risk hypothesis.
- The market price of all 5 companies dropped by -25% to -35% between 2016 and 2019, with the onset of Covid-19 only making it worse. All 5 stocks fell sharply in 2020, with declines ranging between -20% and -50%.
- The stock price change was not surprising once we found that EPS of all 5 companies declined in the last 5 years despite an increase in revenue. In fact, 3 out of these 5 stocks have reported a net loss on 2 or more occasions in the last 5 years.
This is what ties these seemingly unnatural comrades – high leverage, consistent market price decline, and no signs of EPS growth. They’re all part of the S&P 500 and look like high-risk, high-return companies when it comes to potential returns in the long run.
American Airlines – From $51 in 2017, the company’s stock has fallen to a little over $13 today as of Jun 29, 2020. While revenue has grown consistently, the bottom line has been less than predictable, with EPS falling from $4.68 in 2016 to $3.80 in 2019. To make matters worse, the company’s demand has plummeted with Covid-19 bringing air travel to a screeching halt. We expect the company to lose 30% of its revenues this year, which could result in a cash outflow of $2.4 billion. This will only increase its debt load.
Occidental Petroleum – The company is engaged in oil and gas exploration and marketing, and manufacturing of chemicals. Its market price fell from $64 to just under $18 (as of Jun 29 2020) in a span of 2.5 years, despite revenue growing 60% between 2017 and 2019. However, influenced by oil price fluctuations, the company has struggled to manage its margins. It registered losses in 3 out of the last 5 years.
Coty – The company develops and markets beauty products such as fragrances, skincare products, and hair care products. While there continues to be strong demand for such products, and Coty acquired P&G’s beauty business in an aggressive move to expand, investors remain unimpressed. Coty’s stock stands at below $5 today (Jun 29 2020), which is just a quarter of where it was in 2017. The company has registered net losses in the last 3 years.
Centurylink and Harley-Davidson are facing similar problems. The latter’s outlook this year looks grim as consumers remain cautious about discretionary spending. In addition, its financial services arm remains exposed to macro trends impacting the global economy.
Well, that was all about risk, but we have a portfolio of low-risk high fliers too. Check out these 5 S&P 500 stocks that could be outperformers.