What better time to refocus on risk than in the wake of an enormous six-week rally? The market has come a long way since early October, sparking huge moves in countless stocks that were on the ropes not so long ago. Investors might be feeling better as a result, but that doesn��t mean it��s safe to take your eye off the ball.
Europe remains an accident waiting to happen, leaving open the possibility of a meaningful slowdown in growth in the year ahead. If the recession scenario does in fact play out, companies that have little financial wiggle room are likely to see their stocks obliterated. As a result, this is no time to take a chance on stocks of companies with excessive levels of debt.
DineEquity (NYSE:DIN) is a prime example of a stock that could be vulnerable to a sudden downturn in growth. It seems un-American to pan the stock of a company that brought us the Rooty Tooty Fresh N��Fruity, but the owner of the IHOP and Applebee��s chains is in a tenuous position. The company has a massive debt load of $1.5 billion due to its leveraged buyout of Applebee��s in 2007, which dwarfs its annual free cash flow of $177 million. The company has been actively reducing debt by moving to a franchise model, but more than 95% of its restaurants are now franchised — indicating that this strategy is nearing its limit.
Click to EnlargeNotably, DineEquity has the 20th-highest debt-to-equity ratio (14.8) of all publicly traded U.S. stocks, according to ycharts.com, and it is seventh among those with market caps of over $500 million. It also is the highest in the restaurant sector, ahead of Sonic (NASDAQ:SONC) at 10.3 and Morton��s Restaurant Group (NYSE:MRT) at 4.8. DIN shares are down 11% year-to-date, while Sonic is off 28% and Morton��s has fallen 22%.
Sales at Applebee��s and IHOP fell 0.3% and 1.5%, respectively, during the third quarter, and the company lowered its forecasts! for 201 2. Because of its focus on the low-end market, both chains are primed for further weakness if the economic backdrop worsens in the months ahead. With food costs rising and a large debt load to maintain, DineEquity can ill afford slower top-line growth.
During the last recession, the stock fell from a peak near $70 to a low in the mid-single digits — indicating the potential danger of owning this stock when economic growth is weak. DineEquity shares might look tempting now that they��re off over 25% from their high for the year, but with so many stocks to choose from in the casual dining sector, there��s no reason to shoulder the risks that come with owning this name.
Naturally, there also is the distinct possibility that Europe will manage to contain its problems and we will ease into an environment of slow, steady global growth. In that scenario, DineEquity — and other heavily indebted, higher-risk stocks — likely would provide investors with robust returns in 2012. In addition, DIN has a high short interest (14.2% of shares outstanding on Oct. 31), providing some added fuel if there��s better-than-expected news.
But why take the chance? At a time when the ��tail risk�� is substantial, there��s no sense rolling the dice on a stock with above-average downside potential.
As of this writing, Daniel Putnam did not own a position in any of the aforementioned stocks.
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Tags: 2012 Growth Stocks ,Growth Stocks 2012 ,Growth Stocks To Hold ,Growth Stocks To Hold In 2012 ,Top Dividend Stocks 2012
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