Shares of plumbing and heating parts distributor Wolseley (LSE: WOS) have risen over 20% since early November as the combination of the weak pound and renewed hopes for a major infrastructure investment plan in the US, its largest market, made analysts bullish.
This rally means the company’s shares now trade at 17 times forward earnings, which I believe is too lofty of a valuation for what is a relatively slow growth, highly cyclical business whose fate is tied closely to that of the US housing market.
For sure, the US housing market is still looking relatively robust with Wolseley posting a solid 4.2% rise in like-for-like US sales in Q1 2017. But the rapid rise in value of the company’s share prices since before the US election makes it clear that investors are already pricing-in a Trump-led infrastructure investment plan and concurrent rise in housing completions.
This seems foolhardy to me given that the president hasn’t proposed anything concrete and the chances of his getting such a bill past Democrats and fiscal conservatives in Congress is anything but assured.
There is also the added wrinkle of the poor performance of the company’s divisions in other regions. In Q1 these operations posted a 2.9% drop in like-for-like sales as Canadian, British and Nordic division all struggled. Profits from each of these three regions also fell by double-digits in the period due to compressed margins.
None of this means the company is poorly run, but I believe prospective investors should be cautious given the share’s pricey valuation and the highly cyclical nature of the US housing market. Should Trump not put forward his much anticipated infrastructure plan or the domestic economy take a turn for the worse, Wolseley shares could sell-off quickly.
Another share beginning to look over-bought to me is information service provider Relx (LSE: REL), which is still better known by its former name Reed Elsevier. Shares of the company now trade at 19 times forward earnings, which is pricey for a company that has only grown sales by 3%-4% a year over the past half decade.
But more worrying than a lofty valuation is my fear that the market is underestimating the rising threat to the company’s academic publishing business. The scientific, medical and technical journals Relx owns make up 34% of group sales and 40% of operating profits. Not only are margins for this division higher than group average but 70% of sales come from recurring subscription fees, which is something businesses always want.
Yet as someone who’s recently completed degrees in both the US and UK I’ve witnessed a growing hostility amongst students, academics and administrators to the astronomical fees companies such as Relx charge for access to its journals. Investors need look no further than Pearson and the problems that firm has had with customers who have finally said no more to price hikes for key academic texts.
Should the increasing movement among academics and students to avoid pricey journals continue to gain momentum, I believe Relx could face a dangerous threat to its most profitable business line. This long-term problem, combined with slow growth, makes me believe the company’s shares could be in for a reversal in 2017.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.