By Rob Carroll
Even the best companies face significant challenges from time to time, and while most, if not all of them eventually deal with those challenges just fine, it’s our job as investors to decide whether or not we want to weather that storm with them. Whether due to the rising cost of commodities, unforeseen accidents or, simply put, poor management, the following nine blue chips are each weathering their own storm at the moment. While it’s ultimately up to you whether or not you continue to hang on, here are a few of the main reasons some top investors have already jumped ship.
Kraft Foods, Inc. (KFT): Already hampered by a weak economy and rising commodity costs, Kraft now faces additional challenges as CFO Tim McLevish steps down amidst the acquisition and integration of Cadbury and its operations, a process his departure will further complicate. Kraft has raised prices in order to account for elevated input costs, but consumers--now increasingly more likely to consider price rather than brand--may turn to lower-priced private-label offerings instead. With international sales accounting for more than 50% of the firm’s consolidated sales, Kraft also faces exposure to foreign currency fluctuations. Short interest sits at 1.10%.
General Mills Inc. (GIS): Faced with many of the same problems as Kraft, General Mills must figure out a way to maintain profitability in the wake of unprecedented increases in commodity costs at a time when consumer spending is soft. To make matters worse, General Mills management expects cost inflation for commodities such as energy and dairy to increase 4%-5% in 2011. Like Kraft, General Mills has raised prices to account for these costs, but they may be working against themselves here. Increased promotional spending across the packaged food industry has conditioned consumers to expect lower prices, and with cheaper alternatives readily available, consumers may say good-bye to their favorite brands if it means paying more for them. Short interest is now at an even 1%.
Kellogg Co (K): The third and final food packager on our list has struggled as of late and now holds a short interest of 1.79%. Like the first two companies above, rising input costs have plagued Kellogg as commodities like wheat cocoa, soybean oil, sugar, and dairy remain elevated above long-term averages. Accounting for these costs has proven the most difficult for Kellogg, which has started to buckle under intense competitive pressures. Fourth-quarter sales fell 0.5% from the prior-year quarter and the negative impact of the firm’s recent cereal recall is still being felt. All at a time when Kraft is expanding and General Mills is investing in new product lines for cautious consumers.
BP Plc (BP): Provider of fuel, energy, and heartfelt apologies, BP hopes only two of those three commodities will be necessary in the future. New CEO Bob Dundley--who took over for Tony Hayward less than three months after the July 15 Macondo spill--is moving quickly to reinvent BP’s safety culture and rebuild its reputation, but with significant damage already done, his efforts could take years before regulatory confidence returns. On the financial side of things, challenges continue to present themselves. Already tasked with funding oil cleanup and the settlement of a $20 billion claims fund for post-bill investigations and government-assigned responsibilities, management must now secure funding for future spill-related costs and claims by selling $25-$30 billion in assets. Potential legal penalties and regulatory fines may add to the bill. And if that weren’t bad enough, BP’s pending deal with Russian oil company, Rosneft, has recently run into some notable opposition, forcing BP to look at alternatives. Still, short interest remains low at 0.18%.
ExxonMobil Corp (XOM): Resource nationalism has always been a challenge for international oil companies (IOC’s) and their ability to grow production, but now that the majority of the world’s remaining resources are government controlled, that challenge is quickly increasing. Large oil providers like ExxonMobil need sizable projects in order to operate at the level they are accustomed, but with oil-rich nations continuing to favor national oil companies (NOC’s) over international ones, fewer projects exist. While ExxonMobil would make a great partner for the NOC’s, partnerships are less profitable and harder to secure, to the point, some would argue, of being uneconomical. Due to their long development times, investing exclusively in “megaprojects” is risky; therefore, management must make the decision to take on more projects at less favorable terms or pursue frontier locations. Short interest is at 0.56%.
Avon Products Inc. (AVP): Following several years of rapid international expansion, Avon is now working tirelessly to rid itself of all the inefficiencies created by that very same expansion, including a bloated management structure and poor supply chain. Incurring $700 million in restructuring costs in 2010 alone, CEO Andrea Jung must fix these follies fast, as tight consumer spending and execution issues in developing markets continue to stall sales growth as is. Given that about 80% of Avon’s consolidated sales are international, the company faces significant exposure to currency fluctuations. Also, key markets in Japan will be hit especially hard due to the crisis following the March 11 earthquake and subsequent tsunami. Some investors now wonder if the full benefits of Avon’s restructuring will take longer than initially forecast. Short interest is 2.00%.
American Express Co (AXP): In stark contrast to their lend-centric competitors like Visa and MasterCard, Amex has always been spend-centric, relying on merchant fees--instead of loan rates--to account for most of their earnings. In order to increase those earnings, they encourage the use of their cards. But while it may sound okay to entice cardholder spending, Amex was doing so pre-2008, at a time when the housing market was booming and cards were in the hands of high-spending clients who were spending beyond their means. Then came the 2008 financial crisis, which rocked Amex so hard it shook the putty from every little crack in their business model. Three years later, the card lender is still patching holes. In an effort to speed up repairs, Amex has recently opened their “closed-loop” model by partnering with banks and third party lenders in an attempt to build their client base, but concerned investors wonder if it is smart for Amex to look for growth outside its core clientele of high-net-worth individuals. Other risks concerning investors: Amex will continue to struggle as long as the unemployment rate remains high; the company still faces regulation. Short interest: 0.78%.
Goldman Sachs Group Inc. (GS): Once a high-flying investment firm, the Goldman Sachs of today can only look back in fondness at its high-risk, high-reward glory days now that its wings have essentially been clipped. Now a bank holding company, GS is actually dealing with safer, more reliable investments, but safe and reliable is not what made them profitable with investors. Returns on equity of more than 25% are likely a thing of the past, and now that the firm is regulated by the Federal Reserve and their capital adequacy requirements, Goldman must increase the amount of capital it must maintain in case of loss, further lowering their financial leverage and ability to invest. Headline risk is always a concern with firms receiving government support as this opens them up to considerable scrutiny regarding operations and activities, and Goldman Sachs is no exception. The short interest is at 0.93%.
Bank of America Corp (BAC): After years of expansion under CEO Ken Lewis, new leader Brian Moynihan hopes to transform Bank of America from a random collection of businesses into one cohesive whole, but this will not be easy, especially as the firm continues to integrate Merrill Lynch and Countrywide. Already suffering from supbar profitability and capital problems, BAC still faces significant litigation risk, the threat of a double-dip recession, and negotiations regarding a settlement about its questionable foreclosure practices. Investors wonder whether Moynihan can streamline BAC’s operations enough to the point that the stock will produce. According to analysts, the firm must prove it can maintain reasonable growth rates, strong cost controls, and low credit losses before it sees any significant gains. It’s no surprise then, that the Federal Reserve rejected BAC’s plan to increase dividends in the second half of 2011. The short interest is 0.78%.