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 downgrades on both trucker Swift Transportation (NYSE: SWFT ) and hi-tech-er NVIDIA (NASDAQ: NVDA ) . But the news isn't all bad.
Level 3 is going up
The week began on a bright note for shareholders of Internet backbone operator Level 3 Communications (NYSE: LVLT ) , which received a boost to its price target from analysts at UBS. In a bow to investor sentiment that has jacked up Level 3's share by more than 60% over the past year, UBS raised its target price on the stock to $30 a share.
And yet, UBS still couldn't quite bring itself to recommend buying Level 3, which it left rated neutral. Why is that?
Several great reasons come immediately to mind. First and foremost, the fact that Level 3 still isn't profitable -- that it has not, in fact, earned any profit whatsoever in the past 15 years! True, Level 3 is generating positive cash flow from operations, and even generated a bit of free cash flow for its shareholders... in 2009. But Level 3 is not FCF-positive today. It remains mired in more than $8 billion net debt, and even if it does turn profitable at some point in the future, most analysts agree that long-term growth rates at the company won't exceed 4%.
Long story short, saying it's only neutral on the stock just might be the nicest thing UBS could say about it.
Will Swift stall?
It's certainly nicer than what Stifel Nicolaus had to say about Swift Transportation today. Worrying over the stock's "valuation," Stifel cut its rating on the Phoenix-based trucker one notch to neutral. And yet, when you look at it, neutral-rated Swift is actually a less bad (which is not to say "good") bargain than neutral-rated Level 3.
Swift shares currently fetch 23 times earnings on the open market, and are expected to grow these earnings at about 16% annually over the next five years. The company sports modestly better free cash flow ($145 million) than reported GAAP earnings ($139 million), suggesting a high quality of earnings at the company. On the other hand, Swift does carry a sizable slug of debt -- about $1.6 billion net of cash.
Weighing all these factors, I find I agree with Stifel's move to downgrade. This stock's 16% growth rate is certainly -- ahem -- "swift." But after the 165% run-up the shares have seen over the past year, I think most of the easy money in Swift has already been made. A ratings downshift is appropriate.
Envisioning a cheaper NVIDIA
Last but not least, we move to NVIDIA, the subject of an even more drastic downgrade -- to underperform -- from analysts at Morgan Stanley this morning. As StreetInsider.com relates, Morgan cut its rating on NVIDIA because it is "uncertain" that NVIDIA will achieve the 12% earnings growth rate that most analysts have the company pegged for.
But Morgan needn't worry so much. Over the past four quarters for which NVIDIA has filed cashflow statements, the company generated $660 million in cash profits. That number is significantly ahead of the $467 million in GAAP earnings NVIDIA reported in trailing profits for the past 12 months. Meanwhile, NVIDIA's sizable cash hoard gives the stock an ex-cash market cap (or enterprise value) of just $6.4 billion.
What this works out to is an enterprise value-to-free-cash-flow ratio of less than 10. Bolstered by a substantial 2.1% dividend yield, that should make the stock a pretty obvious bargain at consensus estimates of 12% growth. But in fact, even if Morgan Stanley is right and NVIDIA can't meet the growth target, there's a pretty decent-sized margin of safety built into this stock price.
I think the underperform rating is uncalled for. Even if you agree with the analyst that growth rates won't measure up, NVIDIA isn't any worse than a neutral in my book.
Motley Fool contributor Rich Smith owns shares of NVIDIA. The Motley Fool also recommends NVIDIA.