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 feature a downgrades for both Intel (NASDAQ: INTC ) and ON Semiconductor (NASDAQ: ONNN ) . But the news isn't all bad, so before we address those two, let's start on a bright note.
Treasure in trash
Markets are up modestly in early trading Monday, and one company leading the way upwards is trash collector Waste Connections (NYSE: WCN ) . Up nearly 39% over the past year, and up nearly twice as much as the S&P 500, Waste Connections got a further boost today when analysts at Stifel Nicolaus raised their price target on the stock to $47 a share.
With the shares currently trading for $42 and change, that works out to about 11% upside for buyers today -- which, when combined with Waste Connections' modest 1% dividend yield, makes for a tidy little potential profit. But what are the chances Waste Connections stock will produce this profit?
Not great, I fear. Selling for 31 times earnings, and expected to produce 11% annual growth over the next five years, Waste Connections looks pretty expensive at first glance. Granted, the company generates a lot of cash -- free cash flow for the past 12 months came to $286 million, which is quite a bit more than the company reported for net income. But this still leaves the stock trading for 18 times free cash flow, and for more than 25 times FCF if debt is factored in.
On 11% growth, that's simply too high a price to pay, Stifel Nicolaus's endorsement notwithstanding.
Time to turn ON off?
Turning now to the day's "bad" news, analysts at Evercore cut their rating on ON Semiconductor to "equal weight" this morning, removing their "overweight" endorsement of the stock, and cutting 20% off their price target (which now stands at $8 a share). Investors promptly took Evercore's advice to heart, and assuming the worst, bid ON shares down to within a penny or two of the new price target. Were they wrong to do so?
I don't think so, no. Starting right off the bat, any investor can see that ON is currently an unprofitable company, having suffered a steep slide since 2010, culminating in reported losses of $96 million over the past 12 months. As with Waste Connections, the truth isn't quite as bad as the headline number. Free cash flow at the company was actually positive $57 million for the past year -- but with ON currently costing $8 and change, that's still far too little cash being produced to support the company's $3.6 billion market capitalization.
Long story short, this is an overpriced stock that doesn't deserve the 26% run-up in share price it's enjoyed over the past 52 weeks. Evercore is right to downgrade it.
Needless to say, this bodes poorly for owners of Intel stock -- which like ON, suffered a downgrade from Evercore today. And this time, it was a downgrade to "underweight."
Citing "structural concerns" and "weakening" trends in personal computer sales, Evercore warned that unit sales of Intel chips could be down as much as 10% this year. Add in the deleterious effect of falling average selling prices on the chips Intel does move, this suggests tough times ahead for Intel.
And yet, could it be that Evercore is too pessimistic? After all, most analysts still think Intel is poised to grow its profits at a respectable 11% clip over the next five years. Add in the beefy 3.7% dividend yield, and that seems to more than justify the modest 11.5 times earnings that Mr. Market is charging for Intel shares today.
The problem, however, is that already, Intel's financial statements are starting to show signs of weakness. Free cash flow at the company lags reported income by more than 3%, suggesting less-than-sterling quality of earnings at the company. If Evercore turns out to be right about the decline in ASPs and unit sales, the stock could turn out to be pricier than its historical results make it look.
Personally, I'm still optimistic about the stock, trusting in the consensus of the 40 analysts who follow Intel to be more likely right about the growth trends than the one analyst who's now warning of Intel's imminent demise. But if those promised 11% growth rates fail to emerge, look out below.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel.