Shorting stocks can be a risky business. Especially in a runaway market like we have seen over the past six months. While fundamental analysis and valuation techniques are helpful over a long period of time, short term market movements can turn the plans of even the most well respected analyst into dust. But despite the challenges, it still makes sense to understand fundamental concepts behind price movements. I can guarantee you that at some point, the pendulum will swing and prices will once again be affected by prospective earnings and less by investor psychology.
CH Robinson Worldwide (CHRW) is one of the stocks that I want to be holding short when that transition takes place. Sure, the $9.8 billion dollar company has a 1.6% dividend yield and no debt. But the current stock price simply cannot be justified by the fundamentals of the company.
For starters, the company is simply too big to grow by leaps and bounds. I find plenty of companies with a strong business model who can grow annual revenue from $150 million to $500 million in a relatively short period. The market cap for these turbo-charged growth names can increase five-fold or even ten-fold in a year or two due to the leverage built into the financial structure of the company. But at some point, successful companies will get to a size where the potential for growth on a percentage basis is much more subdued.
Over the last four quarters, CHRW pulled in nearly $7.8 billion dollars in revenue. I simply can’t imagine that this level will double in the next two or three years. (quite possibly not in the next decade) Earnings are stable, but rapid growth is simply not a way to describe the earnings power of this giant. And yet investors are paying nearly 25 times next year’s expected earnings in order to own the stock. This seems like an outrageous multiple for a large cap freight company growing by maybe 10%.
One reason investors may prefer this stock is that the company offers a relatively healthy amount of safety. While revenue and earnings are certainly affected by economic activity, the company can usually forecast these fluctuations as contracts are often predictable. Prices can be adjusted to help with lack of demand, and the company can also simply take trains off the track in order to preserve costs during a slow period. There is certainly something to be said for stability, but I have a hard time paying 25 times earnings for this peace of mind.
A second positive behind this company is that a recovery in the economy would certainly mean more freight movement throughout international markets. Since most investors appear to believe the economy is on it’s way to happy days again (just look at the movement in the S&P), I guess it makes sense that CHRW would be a popular pick. But despite the sunny forecast that has become so widespread, significant dangers still remain. Issues like unemployment, consumer credit, destruction of wealth, regional bank charge-offs, and government debt could easily send us back into a double dip recession and punish investors who jumped back into risky positions at the wrong time.
CH Robinson is a healthy company with a strong track record. Given their stability I would love to own the stock at 12 to 15 times this year’s earnings. At that price, I could collect my dividends (which would be at least a 3% yield) and wait for long-term gains. Unfortunately, that price is $25.80 to $32.25 – a far cry from the current price in the upper $50’s.
I am not short CHRW… yet… The momentum in this name is too strong and if optimism continues to be the theme for another month, we could see the stock break through $60. But I am watching the trend very carefully and will be looking to pick up short exposure as soon as it appears that the bulls have run their course. CHRW is yet another strong company which has the potential to disappoint bullish investors.
FD: Author does not have a position in CHRW
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September 21st, 2009 at 6:34 pm
Remember that the company has an unlevered ROE of over 30% that is unlikely to decrease due to the variable cost nature of their business model. In addition, since they have approximately 4% market share of the 3rd party trucking business (this includes traditional brokers) it is really hard to determine the ceiling of potential growth. It would seem that there are a lot of lower quality companies to short than one that has been taking market share – witness the most recent quarter.
The stock has traded at 15x earnings only once in the last 8 years. That occurred for a month this past February.