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 upgrades for both Denny's (NASDAQ: DENN  ) and Green Dot (NYSE: GDOT  ) . But stocks can reach buy ratings in ways other than actual upgrades. So before we get to those two, let's first take a quick look at why ...

Hudson Square just rang up T-Mobile
Deutsche Telekom announced today that the merger of its T-Mobile USA subsidiary with MetroPCS Communications is complete -- and the newly merged company will now begin trading on the NYSE as T-Mobile US (UNKNOWN: TMUS.DL2  ) . No sooner had it done so than out came Goldman Sachs with a buy recommendation.

According to Goldman, the new T-Mobile "is likely to attract ... interest" from potential entrants into the U.S. communications market looking to buy a company. What's more, StreetInsider.com explains that Goldman is also looking at T-Mobile as "a business emerging from its trough on a number of metrics, with several positive inflections ahead," and therefore buying in its own right, and not just as a potential buyout target. But is Goldman right?

Well, let's see here. According to S&P Capital IQ, the new T-Mobile is a company with $19.7 billion in annual revenue, and $4.9 billion in earnings before interest, taxes, depreciation, and amortization, or EBITDA. That's about a 24.9% "EBITDA margin," which sits right in between the 22.7% EBITDA margin at AT&T and the 26.9% EBITDA margin at Verizon. So quality-wise, T-Mobile looks all right.

That being said, I wouldn't go out and buy the stock on Goldman's say-so alone. Nobody seems to have a firm handle on T-Mobile's valuation just yet. Yahoo! Finance hasn't yet been able to figure out the new company's market cap. Nor has S&P Capital IQ. Until we know the cost of the company, it's too soon to say whether its only average profitability offers superior value for the stock's investors. For the time being, let's just keep an eye on T-Mobile, but not buy just yet.

Order up at Denny's
I'm more confident, though, in the upgrade to "buy" we saw at Denny's today, from the analysts at Feltl & Co.

Denny's just got finished reporting an earnings beat, which is certainly a good start. And if the stock appears a bit pricey at 25 times earnings, I think Denny's superior free cash flow (which at last report was running about twice as high as reported "net income") and strong 19% predicted profits growth rate suffice to make the stock look attractive.

Up-to-date free cash flow numbers aren't out at Denny's just yet, but based on the $45 million in annual FCF it was generating as of last quarter's report, I'd say the stock looks cheap at a price-to-free cash flow ratio of less than 12, and even at an enterprise value-to-free cash flow ratio of close to 16. Nineteen percent growth is fast enough to erase a multitude of overvaluation sins -- and so long as Denny's can maintain a growth rate such as it's projected to produce, I'd say Feltl is right: The stock looks buyable.

Green Dot upgrade is on the mark
Wrapping up with probably the trendiest, "sexiest" name on today's Wall Street buy list, we find prepaid card pioneer Green Dot shares skyrocketing on an earnings beat, raised guidance, and today, an upgrade to "buy" from Compass Point.

Compass loves the fact that Green Dot's "Wal-Mart linked revenue increased 11% from the prior year quarter following 14% growth reported in 4Q'12 -- despite facing competition from American Express in each quarter."

Sure, at 16 times earnings, the stock looks a wee bit overpriced relative to 14% growth assumptions. But as Compass points out (and I agree), "the shares still screen cheap at 8.6x our estimate of this year's EPS excluding unencumbered cash and at 9.4x our estimate of this year's free cash flow adjusted for unencumbered cash." Green Dot, by the way, produced free cash flow of $48 million over the past 12 months, comfortably ahead of its $46 million in reported net income. According to the company, its "unrestricted cash" -- what Compass calls its "unencumbered cash" -- came to $370 million.

Back that cash out of the firm's market cap, and you'll quickly see: Green Dot is fully as cheap as Compass says it is.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends American Express.

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  • Report this Comment On May 14, 2013, at 8:18 PM, EllenBrandtPhD wrote:

    *** Some ill-advised funds made Short bets on DENN right before the earnings report, which was very good, and the announcement of a bigger buyback, which is even better.

    *** And note that it is the next two quarters which are historically best, especially the end of the second quarter and the beginning of the third quarter.

    *** Feltl upgrade and upped Target caused the first rally in this 92 percent institutionally-owned stock.

    *** There was also a stealth ratings upgrade by B. Riley before their all-important annual conference next Monday-Wednesday in Los Angeles, at which DENN is one of very few stocks in its group invited to appear.

    *** I calculate that 3 or 4 of the 7 analysts covering the stock - and more could come in - still need to up Targets.

    *** If B. Riley ups its rating further to Strong Buy after its conference and ups its Target to the mid-7s - which it now well may do - expect yet another strong leg up in DENN's rally to maybe 6.70 - No, I am not whistling Dixie. Could very well be.

    *** Most importantly, casual Shorts have learned their lesson here. Turnaround is for real. Influential funds are strongly behind it. And stock is following the trajectory of near peer SONC, which has tripled in the past three years and may quadruple from its start point by autumn.

  • Report this Comment On May 18, 2013, at 7:23 PM, EllenBrandtPhD wrote:

    Posted on Saturday, in wake of Silly Baby Comments from Silly Baby Daytraders on Yahoo board:

    Once again, B. Riley conference is Monday to Wednesday.

    DENN will be one of only a handful of restaurant companies asked to present.

    B. Riley has extremely active restaurant coverage and is influential in this sector, in leisure and consumer discretionary generally, in unheralded midcaps, and in stocks of companies with a strong California presence. Most clients are well-heeled investors, family offices, and specialty funds based in Western US.

    B. Riley has already quietly changed its rating from Hold to Buy, with new Target clearly pending.

    If Riley goes from Buy to Strong Buy, raises its Target above 7 - maybe to 7.25 or 7.50, as some have done - or BOTH, DENN could soar again later this coming week, if the general market cooperates.

    I don't say that cavalierly.

    Take a look at B. Riley's last few Ratings/Target raises of unheralded - "quiet" - stocks. One zoomed up, I kid you not, 30-plus percent!

    That won't happen to DENN, because it already had some of its post-earnings surprise move. But its touching 6.40 or 6.50 next leg up is entirely possible - again, if the general market cooperates.

    We don't know how much of that based-on-faulty-intelligence increased Short bet, added a day or two before earnings, which these particular Shorts expected to be bad, has been covered yet. It wasn't hefty. But it was large enough that they will probably want to cover it, so they can deploy their Short oriented money somewhere much better than this one.

    So let us see what we will see. If anyone attends B. Riley, they might want to write up a report for Fool.com. I thought of attending, but decided not to. I am very interested in following their picks now, though. Their record has been truly stellar in these "unheralded" midcaps, which many of us like.

  • Report this Comment On May 23, 2013, at 6:08 AM, EllenBrandtPhD wrote:

    Posted on Thursday:

    We should know within the next few days if B. Riley - and maybe others? - have decided to up ratings and targets. B. Riley conference was Monday through Wednesday.

    Simply practically, it's a great time to do it, if they are thinking of doing it, since S&P may be under pressure. This group in general begins to OUTperform the S&P right about now, as everybody and his media brother starts to do stories on "summer seasonality plays."

    The upshot is that this is one of the "good places to hide" sectors, anyway. And DENN's Short contingent is really not that strong anymore, after making a totally wrong call on earnings last time out.

    In any case, let's see what the B. Riley conference has brought us.

    (I must add that already, there are inaccuracies in old DENN stories from Insider Monkey and a coupla others re ratings position now. B. Riley had lowered earlier in the year, but is now back to a Buy, with no target rejiggering, I believe, since last earnings and the increased share buyback.

    (If B. Riley - and/or anyone else - EITHER goes to a Strong Buy OR raises their target over 7, we should see a nice jump against the general market.

    (Let us see if it pans out.)

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