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 WellPoint (NYSE: WLP ) and VimpelCom (NASDAQ: VIP ) . But the news isn't all bad -- even when it looks that way.
Game over for Electronic Arts?
At first glance, you might think Electronic Arts' (NASDAQ: EA ) Q3 earnings report looked perfectly awful. EA lost money in the quarter, missed analysts' revenue estimates, and warned of another miss in the current fourth fiscal quarter. Reviewing the news this morning, AP called EA's results a disappointment -- but not everyone agrees. This morning, Merrill Lynch ran against the herd and instead of criticizing EA for its poor performance, upgraded the shares to buy. Why?
Well, for one thing, EA's own evaluation of its results suggests the news wasn't as bad as it looked. GAAP numbers aside, EA says its "adjusted" earnings were $1.26 per share, rather than a loss. Its adjusted sales were up 33% year over year.
I'm not ordinarily inclined to take a company's word for it about its own, self-generated adjusted numbers being more valid than GAAP financials. But in this case, there may be something to EA's argument. While according to GAAP, EA lost money over the past year, the company's cash flow statement shows that EA was nonetheless cash-profitable, generating positive free cash flow of $558 million. On EA's $7.7 billion market cap, this works out to a price to free cash flow ratio of less than 14 -- not bad for a stock that most analysts agree is capable of growing its profits in excess of 17% annually over the next five years. (And if you give the company credit for the net cash on its balance sheet, the stock is even cheaper than that.)
Long story short, Merrill Lynch may have good reason to be bullish about this one. Even if EA is technically "losing money," it's still rolling in cash.
Is all not well with WellPoint?
Turning now to the companies that Wall Street is not at all optimistic about, we begin with insurer WellPoint. The company just reported earnings for its fiscal fourth quarter, matching analyst estimates on profits ($0.87 per share) and missing slightly on revenues ($17.6 billion).
Analysts at Monness, Crespi, Hardt took a dim view of these numbers, downgrading the stock to sell. And they're not entirely off base. Insured members declined 1.3%, or 477,000 members. Profits were down 68% year over year. Free cash flow at the firm ($2.4 billion) also now lags reported net income ($2.5 billion). Combined with the revenue miss, I can see why Monness might feel discouraged.
And yet, I still see a lot more to love about WellPoint than to hate. The stock costs only 10 times earnings today, and is only slightly more expensive when valued on free cash flow. Projected growth rates are a respectable, not unachievable 8%, and the company pays a tidy 1.8% dividend yield to boot. Factor in WellPoint's sizable cash reserves -- $5.5 billion more cash than debt, or about 21% of market cap -- and the stock looks a whole lot more like a buy to me than a sell.
Honey? We shrunk the dividend
And finally, a few words about VimpelCom -- the erstwhile Russian mobile phone company that's now "really" international, with a headquarters in Amsterdam. VimpelCom got hit hard yesterday, losing about 13% of its market cap after announcing plans to skip its final dividend payment of 2013, slash future dividends drastically, and instead use the cash to pay down debt. Going forward, VimpelCom says it intends to pay only about $0.035 per share in dividends, down from $0.80 previously. (Yes, you read that right -- a 96% cut in the dividend.)
The stock is falling a further 3% today on news that analysts at HSBC have pulled their buy rating from the stock and downgraded it to neutral. Was that the right call?
For investors who bought VimpelCom for its 8%-plus dividend yield ($0.80 on a stock price of $10 or thereabouts), the drastic reduction in dividends is undoubtedly a disappointment -- and a good reason to flee the stock. But for long-term investors in the business, VimpelCom's move makes some sense. The company currently carries $24 billion more debt than cash on its balance sheet. Cutting dividends to the bone should free up in excess of $3 billion annually to direct toward paying down debt. Meanwhile, free cash flow at the company is currently $2.9 billion. Directing that cash to debt retirement could (should VimpelCom be so inclined) roughly double the rate of the paydown -- turning an eight-year slog into a four-year sprint.
Granted, at a valuation of more than 14 times free cash flow today, VimpelCom doesn't look particularly attractively priced. But as the debt level falls, the company should look more and more buyable with each passing year.