Wednesday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines include a pair of downgrades for WellPoint (NYSE: WLP  ) and Fossil (NASDAQ: FOSL  ) . On the plus side, though, one analyst thinks that ...

Norwegian Cruise Line is bound for richer shores
The day begins on a bright note for shareholders of cruise ship operator Norwegian Cruise Line (NASDAQ: NCLH  ) , which this morning received a price target hike -- and a reiteration of its "buy" rating -- from ace analyst Stifel Nicolaus.

Norwegian reported strong earnings earlier this week, reporting on Monday that its Q4 earnings per share were $0.04 -- four times higher than the Street consensus of just a penny-a-share. Revenues came in a bit light, granted ($503 million versus the estimated $513 million). On the other hand, Norwegian said it's likely to earn no less than $0.02 per share this current quarter, and perhaps as much as a full nickel -- either of which result would easily trounce analysts' estimate of a penny-a-share loss. This news prompted won Norwegian an upgrade to "buy" from Nomura Securities yesterday, and today Stifel's also doubling down on the stock. But if you ask me, that's a mistake.

Why? Simple: The stock costs too much.

Consider: With $0.94 a share in 2012 profit, Norwegian now costs a bit more than 30 times trailing earnings. If the company can maintain the 32% profits growth rate it showed in 2012, that might look attractive -- but 30%-plus growth rates are dreadfully hard to maintain over long periods of time.

Plus, Norwegian's P/E ratio of 30 doesn't factor in the company's nearly $3 billion net debt. It doesn't consider the fact that Norwegian's real free cash flow is just $95 million -- just 56% of reported net income. Valued on enterprise value and free cash flow, rather than market cap and earnings, Norwegian actually looks very expensive indeed, at an EV/FCF ratio of 90. It's so expensive, indeed, that even if the company could grow at 30% a year for the next five years, I'd say this stock is still overpriced.

Fossil should be buried
Speaking of overpriced stocks, a couple days ago we took a look at the downgrade Benchmark Capital assigned to Fossil ahead of Q4 earnings. Now that Fossil's numbers are out -- $948 million in quarterly revenue, and earnings of $2.51 per share -- Fossil's catching another downgrade today (to underperform) from the folks at FBR Capital.

And rightly so. With $343 million in annual profit for 2012, Fossil shares now sell for just under 19 times earnings. That's a bit more than investors should ordinarily want to pay for the 18% annual growth Fossil is expected to produce over the next five years. And while it's certainly possible that Fossil generated enough free cash flow to make up the difference last year, and transform a slightly overpriced-looking stock into a bargain... I'm not optimistic. At last report, remember, free cash was lagging reported net income rather badly.

Long story short -- I'm willing to suspend judgment on Fossil for the time being, seeing as the company hasn't yet produced a 10-K filing, or included its cash flow numbers in yesterday's earnings report. There could be good news in there, and we'll want to wait to see what the news is before rendering a final verdict on the company's performance. Then again, if the cash flow news was good enough to make a difference, don't you think they would have told us about it already?

Street questions WellPoint's prognosis 
Finally, we come to WellPoint, downgraded today to "neutral" by analysts at Monness, Crespi, Hardt. This ratings shift is a strange one, seeing as the news at WellPoint this week has generally been of the positive variety. StreetInsider.com tells us that the company reaffirmed its guidance for fiscal 2013 yesterday -- $7.60 in per share profit. Also yesterday, WellPoint announced that it's picked a 20-year veteran of the health care industry -- Joseph Swedish -- to become its new CEO.

Monness may not be impressed, but to my Foolish eye these look like positive developments. And with WellPoint shares currently costing less than eight times earnings -- but projected to grow earnings at 12% per year over the next five years, and paying a 1.7% dividend -- the stock looks cheap to me. While I'd much prefer to see WellPoint generating better free cash flow than it currently does (only $2.2 billion or just 83% of reported net income), the number's still high enough to make WellPoint a buy.

In my opinion, at least. Just not in Monness'.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Fossil and WellPoint. The Motley Fool owns shares of Fossil and WellPoint.


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