Three stocks to sell as US Fed starts cutting bond purchases

Analysts from Morgan Stanley, Charles Schwab, Reuters recommend investors cut their holdings in Wayfair, Royal Caribbean and Carnival as US borrowing costs rise.

The US Federal Reserve starts reducing its bond purchases today, adding to upward pressure on companies' borrowing costs. The practice, known in financial markets as tapering or quantitative tightening (QT), highlights the need for investors to regularly mind their portfolios.

The right move here might be to cut one's exposure to heavily indebted companies that are likely to see their interest expense rise.

We ran ETrade's stock screener to find companies on which Morgan Stanley is recommending investors reduce their holdings. Another criteria in our search was a negative rating from Thomson Reuters, and the highest debt-to-capital ratio among companies with a market capital of at least US$2 billion. Here are those three stocks:

Wayfair posted worst revenue decline in industry

Wayfair Inc. (W) operates an e-commerce platform that offers products for your home ranging from furniture to plates. The online retailer's debt-to-capital is the highest within the department store industry, according to Refinitiv. Its revenue declined more than 13% from a year earlier, the poorest performance among its peers.

Even if sales flip to growth from a projected decline, "profitability is not certain," according to a Morgan Stanley report in early May, after the company's results were released.

"Active customers are sequentially declining and order count continues to decelerate," Morgan Stanley analysts said. "This would suggest the platform is not building truly loyal customers and may need to step up advertising, or lower prices — and give up margin either way — to continue taking market share."

Even Market Edge is recommending that investors avoid Wayfair while Charles Schwab is saying clients should sell. Those who hold on to the stock may pay a price, with its return on assets at negative 10.4%, while the return on equity is languishing at zero.

Royal Caribbean's aggressive use of debt to finance growth

Royal Caribbean (RCL) has been burning cash since the pandemic when cruise line operations were suspended. While cruises have resumed and the company expects to reach full capacity by the summer, gross margin has lagged behind the industry average for each of the past five years, according to Refinitiv.

The company had a debt-to-equity ratio of 5.64 times in its most recent quarter, which signals that "it has been more aggressive in using debt to finance growth than 94% of its peers in the hotels, motels and cruise lines industry," according to data on ETrade's website.

Refinitiv has a fundamental rating of 1 for Royal Caribbean, which is significantly more bearish than the hotels and cruise lines industry average of 4.3.

"We are cautious of the cruise industry in general and underweight RCL shares as we think the industry's return to normal will take longer than expected, high supply growth may dampen pricing power, leverage is high," Morgan Stanley analysts wrote in a note in early May.

To view the stock's performance, see our dedicated guide here.

Carnival's high refinancing cost

Carnival Corp. (CCL), which operates cruise lines including its namesake brand, Princess Cruises and Cunard, has seen its outlook dim over the past three months. Analysts cut their target price on the stock by 19% over that period, according to Refinitiv. Its financial results have disappointed the US market in each of the past four quarters, with the latest numbers missing estimates by 21%.

The company has a debt-to-capital ratio of over 70%. On May 26, it closed a private offering of US$1 billion in notes due 2030 that will pay a coupon rate of 10.5%. The funds will be used primarily to refinance debt maturing next year.

"The expensive coupon suggests there is now little if any refinancing upside left at the company, as it was paying 10% to 11% for the post-Covid debt raises," Morgan Stanley analysts said in a note on May 18.

Even technical charts are going against Carnival, with moving averages suggesting that investors sell the stock, according to TradingView. MarketEdge said clients should bet against the stock, while those holding bullish bets should either close their position or monitor it closely to watch out for potential losses.