News Analysis date published New: 
Thursday, July 12, 2012 - 08:30
New Date created: 
Wednesday, August 22, 2012 - 11:36
New Date last updated: 
Thursday, July 12, 2012 - 08:30

Whatever You Do, Avoid These 3 Stocks

Thursday, July 12, 2012 8:30 AM

When Patriot Coal (NYSE: PCX) announced plans to file for bankruptcy, investors should not have been surprised. After all, shares had fallen from $20 to $2 in the past year, signaling potential financial distress in the days and weeks ahead. In fact, expectations that Patriot Coal would lose $2 a share in 2012 and again in 2013 should have warned you that a turnaround was quite unlikely. Still, for those who still owned the stock at $2 on Monday morning (July 9), the pain has been significant -- a 100% eventual loss when shares finally become worthless (they currently trade for 12 cents).

Unfortunately, this won't be the last time we hear about a major bankruptcy this year. Many other companies are burning through cash right at a time when it's increasingly difficult to raise fresh funds.

How to spot these troubled companies? Look at the stock price charts. Any stock that has fallen sharply during the past few years and now trades in the low single-digits is signaling more distress to come.

Here are a few examples…

1. A123 Systems (Nasdaq: AONE)
This company promised to revolutionize the battery industry and spent hundreds of millions on research and development efforts. Yet, even though A123 has been public for less than three years, its future as a public company is quite dim. Simply put, the company is unlikely to make money any time soon -- no matter how impressive its technology base may be.

The advanced battery market is very competitive, and rivals in Asia are far better equipped to absorb further losses until this market finally matures. A123's $116 million cash balance may appear adequate, but this company has burned through at least $300 million in each of the past two years. Management won't likely wait to declare bankruptcy until the money is gone. Instead, it may seek protection from creditors during the months ahead while it still has financial resources to work with.

2. Zale (NYSE: ZLC)
This jewelry retailer has $37 million in the bank. Considering that Zale generated negative $67 million in free cash flow in fiscal (July) 2011 and a cumulative $350 million operating losses in the past three years, the cash balance doesn't provide a lot of breathing room -- especially for a company with $446 million in long-term debt.

In a sign of Zale's financial distress, the retailer had to agree to pay 15% interest rates on a fresh credit line, and that credit line is backed by the company's inventory, which tells you that lenders want a lot of return for their risk, even with the inventory locked up.

To its credit, Zale's same-store sales have begun to improve. The question is how much of an improvement. It pays to dig though the company's fiscal fourth-quarter results, expected to be released late in the summer, as any further deterioration in the balance sheet likely means an eventual date with bankruptcy court.

3. Clearwire (Nasdaq: CLWR)
Roughly nine months ago, I made a bold prediction for this stock. I thought shares might be worthless by this fall. Though shares initially moved higher, they have since resumed their downward trajectory.

In broad terms, this wireless services company has $1 billion in cash and $4 billion in debt. For a company that has bled at least $1 billion in annual free cash flow in each of the past five years (and roughly $9 billion during that period), that cash level is hardly assuring.

Clearwire's management has done an impressive job of perpetually selling stock and issuing yet more debt to keep money in the bank, but it concedes that the task is getting ever tougher as investors and lenders balk at pouring even more money into this sinkhole.

By some estimates, Clearwire has at least three more years of losses ahead of it. Will this stock really be around long enough to witness the move into profitability? The stock price chart suggests that will be quite difficult.

Risks to Consider: These stocks are tricky to short, as stopgap funding efforts tend to lead to sharp short-covering.

Action to Take --> In a slow economy, bankers tend to shun making new loans and become less inclined to look the other way as existing loans start to look doubtful. These companies are carrying high debt loads at precisely the wrong time in the economic cycle. Avoid these stocks at all costs.

P.S. These certainly aren't the only companies that could go belly-up this year. But there's one group of stocks that are almost guaranteed to never go bankrupt. They're called Forever Stocks. These are the kinds of stocks you can buy, hold -- and maybe even profit from for the rest of your life. For the names and tickers of several of these unique stocks, click here.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.