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Don't Be Fooled by These 3 Value Traps

Published 03/29/2023, 01:35 AM
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  • Value traps are equities that appear to be inexpensive because they have low valuations, but their financials are less than stable.
  • Thor’s cyclicality, RV part shortages and drastically weakened financials outweigh the low price tag.
  • Viatris has a slumbering portfolio of branded and generic drugs and faces rising competition, leaving little hope for growth.
  • Analysts are projecting a 38% drop in earnings this year for Tegna as revenues slow and costs rise.
  • A wolf in sheep’s clothing. Mediocre Easter chocolate in a shiny wrapper.

    Sometimes things aren’t what they seem.

    In stock investing, these are called value traps. Value traps are equities that appear to be inexpensive because they have low valuations. Under the surface, however, lie fundamental weaknesses that tell a different story. Their financials are less than stable.

    Stocks with low price-to-earnings ratios sometimes earn them because the market recognizes underlying flaws. Combined with weak outlooks, such stocks trade where they are for good reason. Investors that buy into the allure of value traps can lose money if the stock declines further.

    Approximately one out of every ten U.S. listed stocks have a positive P/E ratio less than 10. Some are justifiably cheap. Others, like these three stocks, are merely fool’s gold.

    1. Thor Industries

    Thor Industries (NYSE:THO) is trading around 5x trailing earnings. It is less expensive than General Motors (NYSE:GM), Harley-Davidson (NYSE:HOG) and several other automakers. The recreational vehicle (RV) manufacturer also looks dirt cheap relative to its five-year average P/E of 12x. However, shift perception to fiscal 2023 earnings, Thor doesn’t look so appealing.

    In the first two quarters of FY23, Thor’s profits have fallen off a cliff. Consumer demand for RV excursions has waned after a pandemic boom which, along with a discretionary spending pause, are crushing sales. At the same time, supply chain disruptions are persisting and costs are climbing. These pressures caused management to slash its FY23 earnings per share (EPS) forecast from roughly $8.00 to $5.00. The revision equates to a 76% earnings plunge from FY22.

    Over the next four quarters, analysts are forecasting EPS of $5.69. This gives Thor a forward P/E ratio around 13x, a valuation that is above its long-term average. The board raised the dividend in October 2022 but this reeked of a desperate attempt to regain investor interest after the stock price was halved. Thor’s cyclicality, RV part shortages and drastically weakened financials outweigh the low price tag. Don’t get taken for a ride.

    2. Viatris Stock

    At less than 6x trailing earnings, Viatris (NASDAQ:VTRS) is the cheapest large-cap pharmaceutical stock. Why pay higher multiples for Pfizer (NYSE:PFE), Merck and Eli Lilly (NYSE:LLY)? Well, their fundamentals are healthier.

    Viatris has woefully underperformed the market. Since it began trading in November 2020, the stock is down 40% while the S&P 500 is up 11%. This is primarily because the company owns a portfolio of mature, off-patent medicines including Lipitor, Viagra and Lyrica that are facing generic competition and slowing sales. Sales fell 9% in 2022, marking the third straight year of sales declines.

    A strategic shift toward developing or acquiring higher-margin drugs makes sense but has yet to yield strong results. Meanwhile, management’s decision to divest its biosimilars business continues to draw criticism because it eliminated a valuable growth driver. Left with a slumbering portfolio of branded and generic drugs and facing rising competition, there’s little hope for growth.

    Consensus estimates for 2023 imply 4% and 13% declines in revenue and profits, respectively. An influx of new growth products could spark upward revisions, but it's best to take the placebo over Viatris.

    3. Tegna

    Local TV broadcasting pure-play Tegna (NYSE:TGNA) trades around 6x earnings. It appears to be a bargain, especially compared to fellow broadcaster Fox Corp. which trades at 12x. But that’s not the case.

    Tegna is a unique case because it agreed to be acquired by Cox Media over a year ago for $24.00 per share. While the deal is consistent with the consolidation taking hold in the media industry, it is struggling to get approved by the FCC and antitrust regulators. The FCC has raised concerns about increased charges to cable providers leading to higher consumer prices.

    The deadline for sale was March 27th, after which Cox Media parent Standard General is expected to request a special hearing on the proposed takeover. With the deal premium now wiped out (and then some) and uncertainty still swirling, it’s hard to get excited about Tegna’s low valuation.

    Adding risk to the pot, Tegna is struggling with increased programming fees and acquisition costs related to buyouts of its own — not to mention secular headwinds tied to cord-cutting. Analysts are projecting a 38% drop in earnings this year as revenues slow and costs rise. A total debt balance that has swelled to $3.1 billion (nearly 90% of Tegna’s market cap) is another fundamental concern.

    In the near-term, Tegna will likely continue to move on takeover developments, which could produce a wild swing in either direction. But until growth resumes and the balance sheet is strengthened, investors should tune out this stock.

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