These Turkeys Will Turn Your Stomach

WHO SAYS AMERICAN car makers can't compete? General Motors (GM) and Ford (F) this year have been in fierce competition — for a spot on SmartMoney.com's Turkey Shoot Screen.

Our turkey shoot is an opportunity to use our stock-screening tool to track down companies to avoid. Like their namesake bird, turkey stocks are known for their inability to get off the ground. Much like having wings too small to lift their rotund bodies, these companies have shrinking margins and negative free cash flow, neither of which helps support their heavy debt and burdensome costs.

A disclaimer is needed. We don't recommend short-selling in these companies, even though most of them are already experiencing a fair bit. Selling stocks short exposes you to the risk of losing a lot more than what you put up. There's something called a short squeeze that may sound cute and cuddly, but can leave you standing with empty pockets turned inside out like rabbit ears, wondering where all your savings went. So leave shorting to the pros.

Our suggestion with regard to corporate turkeys is this: Sell 'em if you've got 'em, and avoid 'em if you don't.

Oh, and to America's actual turkeys: We mean no disrespect. We think you're beautiful. At times, we break into Adam Sandler's turkey song just thinking about you.

On to the shoot. We searched through 8,300 companies for those with negative free cash flow, the money left over after paying normal operating costs. We also looked for shrinking operating margins and rising debt. Finally, each company's cash stockpile had to be more than its market capitalization.

We know that last one sounds like a desirable attribute, but we think it's lousy. Companies are meant to be conduits of profits flowing toward shareholders, not hoarders of cash. Those with negative cash flow, shrinking profits, rising debt and no cash are probably already teetering on bankruptcy. Those with a few bucks still left in the bank merely show they've got money left to lose.

From our list we removed the four that had already filed for bankruptcy, and any trading at less than $1 a share. We were left with nine tryptophan-laced stinkers. Let's lay a few out buffet-style.

Cash Gobblers: General Motors and Ford
There's no need to choose; both of these names turned up on our list. And don't let the year-to-date bounce in these stocks — 15% for GM and 36% for Ford — fool you. Investors who have held these jalopies over the past five years have lost 30% and 60%, respectively — even after the recent bounces.

Ford has shown a slight pick-up in earnings recently, but Deutsche Bank analyst Rod Lache isn't impressed. "Ford's earnings improvement over the past three quarters has come from accounting adjustments, as opposed to real improvements in the company's underlying profitability," wrote Lache in a Nov. 14 research note. (Lache doesn't have a position in Ford; Deutsche Bank has an investment-banking relationship with the company.) More than 100%, he says, can be attributed to a reversal of warranty accruals, nonrecurrence of a lawsuit accrual, lower loan-loss provisions, higher derivatives earnings and securitization gains — all things that have to do with Ford's financing unit, not with selling cars and trucks. Worse still, dealers say Ford's new F-150 truck, priced $1,200 higher than its predecessor and expected to haul in margin improvements, is already being heavily discounted to compete with peers.

Take Ford's downside risks from financing and add older products with deeper discounts along with potential losses from a mortgage business, and you've got General Motors. GM will replace only 20% of its vehicles in 2003 and 14% in 2004, compared with 25% and 28% for Ford, industry watchers say. And GM's prices have recently dropped 1.75% year-over-year, compared with 0.30% for Ford. Also, about 40% of the earnings from GMAC, GM's financing unit, come from mortgage refinancings, which are down 75% from their peak this year. A car maker that has to sell mortgages to make money? Now that's a turkey.

Pass on These Wings: Continental and Delta
Forget about checking airline pilots for booze; someone should test the blood-alcohol levels of the analysts who are recommending these airline stocks. Delta (DAL) shares have four Strong Buy, two Buy and seven Hold recommendations; Continental (CAL), three Strong Buys, six Buys and four Holds. Neither has any Sells.

Now, some sensitivity is required here, because we all know that airlines' woes in recent years have been exacerbated by savage terrorist attacks. And here's wishing the remaining major carriers (United declared bankruptcy on in December 2002) a full recovery.

But the fact is, even under normal conditions, major domestic airlines are tough businesses to operate. There's volatile fuel prices, huge capital investments and, worst of all, a lousy relationship between management and labor. A house divided against itself, remember, can't even stand, much less put planes in the air at profit.

The sudden popularity of these stocks is even more reason to stay away. The last thing a struggling airline needs is high expectations. Delta isn't forecast to make a profit this year or next. Analysts project Continental will post earnings before special charges of 72 cents a share next year. The stock trades at 25 times that figure with an anticipated long-term earnings-growth rate of just 8%. That makes for a price/earnings-growth ratio above 3, compared with the S&P 500's 1.7. We'll pass, thanks.

Assorted Trimmings
Lest you think we're only bad-mouthing American auto makers, note that Fiat (FIA), the Italian manufacturer of zippy cars under its own name and the parent of Ferrari, is parked squarely on our list. And speaking of Ferraris, with no profits in sight and $2 billion in negative free cash flow last year, this company is enough to make a $180,000 sports car look like a good investment.

Kansas City, Mo.-based Aquila (ILA) runs electric and natural-gas operations in North America and the U.K. One thing it's not generating is profits. On Nov. 13, the company announced it would unload 12 power plants, part of a $905 million asset sell-off, and use the proceeds to pay down some of its $2.3 billion in long-term debt. Analysts figure the stock is worth the value of its remaining assets — about $4 a share, right around where it trades. With a negative $848 million in free cash flow in the past year, that value may continue to dwindle.

Three other stocks made the list: Telewest Communications (TWSTY), a British broadband concern (we chose that word carefully); Morgan's Foods (MR), a debt-saturated operator of KFC, Pizza Hut and Taco Bell franchises; and Riviera Holdings (RIV), a Las Vegas-based casino owner that's hardly worth the gamble. Treat each of them like you would a candied yam that has fallen on the dining-room floor.

For the full spread of turkey stocks, click here.