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 for both Sprint (NYSE: S) and Micron (NASDAQ: MU). But the news isn't all bad, so before we get to those two, let's start out with why one analyst is...
Tuning into Sirius XM Radio
The new year is starting off right for shareholders of Sirius XM Radio (NASDAQ: SIRI), who just received word that analysts at Evercore Partners are upgrading their stock. Shares are up a good 2% in response to the news that Evercore thinks Sirius is overweight, and that the shares -- currently at $3 and change -- will hit $4.50 within a year. But how likely is that, really?
At first glance, you'd probably think such a steep rise in share price unlikely. Priced at nearly 49 times earnings already, Sirius doesn't look like a particularly cheap stock. And yet, looks can be deceiving.
While it only reported earning $468 million in generally accepted accounting profit over the past 12 months, Sirius generated nearly twice as much cash as it reported "earning" over the past year -- $895 million in trailing free cash flow. As a result, the stock's price-to-free cash flow of 24.3 is just half its supposed "P/E" ratio. Meanwhile, analysts who follow Sirius seem convinced that the company will continue growing in profitability at a rate in excess of 28% annually over the next five years.
An ambitious target? Certainly. However, if the analysts are right, then 24 times FCF hardly seems too much to pay for 28% growth. So long as Sirius delivers on its promise, I think Evercore is right to recommend buying it.
Smaller prospects for Micron
Turning to the stocks that Wall Street is less enthralled with, we begin with computer memory specialist Micron. This morning, investment banker RBC Capital cut its rating on Micron stock to sector perform, arguing that "MU valuation appears ahead of fundamental improvements."
StreetInsider.com quotes RBC worrying over "risks" looming for Micron in the first half of this year. In particular, RBC points out that "MU's DRAM segment ... is susceptible to a -30% Q/Q order reduction at Apple in CQ1." Meanwhile, industry overcapacity of other memory products, such as NAND flash memory, threatens "above-seasonal pricing erosion" for Micron's other products.
RBC isn't the only analyst predicting tough times for Micron, either. Overall, analysts who track the company predict we'll see only 5.5% annualized earnings growth over the next five years. Indeed, the company's weak free cash flow (just $567 million, versus reported earnings of $1.19 billion) may already be foreshadowing a decline in GAAP profit. Given this, Micron's near-19 P/E ratio, and a price-to-free cash flow ratio pushing 39, both look too aggressive for the company's weak expected growth rate.
Long story short, with Micron's shares having tripled in value over the course of 2013, now might be an excellent time to cash in some profits. RBC is right to recommend that investors back away from this stock today.
Sprint: Don't walk. Run away.
Finally, we come to what's probably the most serious analyst warning of the day: the double downgrade of Sprint shares to sell.
This morning, analysts at both Stifel Nicolaus and S&P Capital IQ tagged Sprint with the dread label, with Stifel in particular warning that Sprint operates at a permanent operational disadvantage relative to larger rivals AT&T and Verizon -- an advantage that not even a putative tie-up with T-Mobile would erase.
With no profits to its name -- no profits earned at any time in the past seven years, in fact -- Sprint is clearly not a winner in the telecom sphere. The company carries $26 billion in net debt on its balance sheet and would likely incur more debt in the event of a T-Mobile purchase. Meanwhile, it's proven itself incapable of generating cash from its business, burning through nearly $3 billion in negative free cash flow over the past 12 months alone.
With the company pposed by strong cash producers AT&T and Verizon, it's hard to see how Sprint survives this contest -- much less thrives in such a way as to make its stock look attractive. Given this, Stifel's and S&P's advice to just sell the stock and move on to something better seems like good advice to me.
Motley Fool contributor Rich Smith owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Sirius XM Radio.