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 an upgrade for ExxonMobil (NYSE:XOM), balanced out with a lower price target for Republic Airways (NASDAQOTH:RJETQ), and a new rating from Goldman Sachs, which warns investors that ...
ANN ain't a bargain
According to StreetInsider.com, retail clothier ANN Inc (NYSE:ANN) is due to report its fiscal third-quarter 2013 earnings on Friday morning, Nov. 22. One analyst, however, isn't waiting around for the bad news to break, because Goldman Sachs just announced it's initiated coverage of the stock with a sell rating.
According to Goldman, ANN's got a lot of "excess inventory" lying around, and with little demand from consumers, in all probability has been forced to begin discounting its wares to move them out the door. The analyst warns that this "increased promotional activity ... at both Ann Taylor and Loft brands" will result in "significant gross margin pressure" when results come out next week.
If true, this will not be good news for ANN, whose gross margins have declined for three quarters straight -- both sequentially and year over year. Plus, it's not like ANN stock was any great bargain to begin with. Valued on GAAP earnings, the company's stock sells for 17 times annual profits today, which is a pretty high price to pay for the barely 10% long-term-earnings growth that most analysts expect ANN to produce over the next five years.
Worse, the quality of ANN's earnings is suspect, given that based on trailing free cash flow numbers, the company appears to be collecting only about $0.61 in real cash profits for every $1 it reports in GAAP "net income." Long story short, I think Goldman is right to be worried about ANN. Next week's news could be dismal in the extreme.
Does Republic Airways deserve to be grounded?
Speaking of news, last week consumer advocate Airfarewatchdog announced its ratings for the top 10 airlines offering the best customer service. No. 1 on the list was Frontier Airlines, which is owned by Republic Airways. And yet, just this morning, Imperial Capital announced that it is cutting its price target for Republic shares by 14% -- to $12 apiece. Is that fair?
Actually -- yes.
Priced at just 9.1 times earnings, Republic stock may not look expensive, but looks can be deceiving. Like ANN, you see, Republic is a company flagging in the free cash flow department. If the company only reported earning $24 million over the past year, then its free cash flow number is even worse -- just $18 million.
And things could get even worse. You see, Republic is considered by most analysts to be a business in decline. On average, analysts following the company say they expect to see earnings decline at about a 5% annual pace over the next five years. That's not going to make it any easier for Republic to pay down its debt load of $1.8 billion (net of cash).
Meanwhile, the stock's still up more than double over the past year, so if there were reason to expect prospects to improve at the company, chances are these prospects have already been priced into the stock. Personally, I think Republic's probably hit its maximum altitude already -- and Imperial is right that it will now be gliding back down toward earth.
Is ExxonMobil stock a tiger?
Finally, we come to one of the stock market's all-time favorite companies -- ExxonMobil. Currently No. 2 by market cap in all the world, one analyst, at least, thinks that Exxon will get even bigger. And so today, Argus Research stepped up and slapped a buy rating on Exxon.
As Argus points out, shares of "the tiger" have so far have gained only 5% since the company last downgraded it to hold back in February of last year. Meanwhile, the broader S&P 500 has roared ahead 35%! But now, Argus thinks that this stock, "among the worst-performing stocks in the Dow in 2013," is due for a turnaround. "3Q13 will mark the low point in the company's near-term results," predicts the analyst, praising Exxon's low debt, strong cash flow, and above-average operating profit margins.
And yes, these are all things to like about Exxon. I just think there are more things to dislike about the stock.
Things like: The fact that most analysts who follow Exxon predict it will struggle to grow earnings even 1% per year over the next half-decade. The fact that its 2.8% dividend yield lags the payouts at Chevron, Conoco, and BP. Or the fact that Exxon's $12.6 billion in positive free cash flow, while it sounds impressive, actually only backs up about 37% of the "profits" the company claims to be earning under GAAP accounting standards.
When you get right down to it, I think there's good reason for Exxon shares to have underperformed the rest of the stock market over the past couple years. I think there's plenty of reason still, for the shares to continue to underperform in the future.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Chevron and Goldman Sachs.