This Just In: Upgrades and Downgrades

• Email
• Share
• Print

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
As America was gathering 'round for its national feast Wednesday, Wall Street banker UBS slipped something unpleasant onto the table. No, it wasn't candied yams. (Blame Citigroup for that one.) What UBS brought to table was a pre-Thanksgiving downgrade for NRG Energy (NYSE: NRG). 

Why downgrade a utility that's apparently so nice, they named it thrice? Given the amount of attention it garnered, you might think it was NRG's purchase of a solar farm from First Solar (Nasdaq: FSLR) that cooked its goose. Or perhaps NRG's decision to pay out a $10-per-share dividend to holders of its preferred stock. But in fact, UBS's beef with NRG was much more banal: They think persistently lower prices on natural gas will pinch NRG's profits. (45% of NRG's U.S. power plants are gas-fired.)

Let's go to the tape
But wait a minute. If gas prices are low, I get why that would mean lower revenues when NRG sells the stuff to its customers -- but don't low nat-gas prices lower the cost of NRG's inputs as well? Net, net, shouldn't the price of gas all balance out?

You might think so. I might think so. But the fact of the matter is ... probably neither of us thinks as well about these kinds of things as UBS. Over the past three years that we've been tracking this company's performance on CAPS, it has consistently outperformed the market across the three major sectors of the energy utility industry -- Gas, Electric, and Multi, and outperformed the market on the majority of its predictions:

	UBS Says	CAPS Says	UBS's Picks Beating (Lagging) S&P by
Enersis S.A. (NYSE: ENI)	Outperform	*****	45 points
Public Service Enterprise (NYSE: PEG)	Outperform	*****	22 points
FPL Group (NYSE: FPL)	Outperform	*****	15 points
Equitable (NYSE: EQT)	Outperform	***	6 points
Exelon Corp (NYSE: EXC)	Outperform	*****	(8 points)

Moreover, among the three energy utility sectors named, UBS's record is strongest in -- you guessed it -- natural gas specialists like NRG. In short, when UBS tells you NRG is no longer worth buying, there's plenty of reason to take that advice.

And here's a little more
Listen, Fools -- I know that at first glance, NRG looks terribly attractive. The P/E is less than 6, for crying out loud, while most analysts on Wall Street see NRG's profits growing at 9% per year for the foreseeable future. Who wouldn't like that?

Well, me for one. NRG's low P/E notwithstanding, I have to side with UBS on this downgrade. Because of the analyst's record in gas utilities, of course -- but also because when I look a little closer at NRG's valuation, it begins to lose its glow for me.

Why? For one thing, free cash flow at the company comes to just over $800 million, or barely 71% of what the company reports as "net earnings" under GAAP. Plus, NRG carries a boatload of debt -- about $6.5 billion once you net out its cash. Put those two numbers together, and you'll find that while the P/E at NRG is "less than 6," this company's enterprise value-to-free cash flow ratio sits a fair sight higher: The enterprise is valued at roughly 17 times its annual cash earnings. (And did I mention -- even though this is a utility stock, it pays no dividend.)

Foolish takeaway
Dividend-less (for common stockholders, at least) but set to deplete its cash hoard with a preferred dividend, heavily in debt, and less profitable than it looks, I agree with UBS: NRG is no bargain.

(But if it's bargains you seek, we actually do know of some. Grab yourself a free trial to Motley Fool Income Investor now, and let us tell you about our favorite dividend-paying, debt-un-laden, utility recommendations.)