Thursday's Top Upgrades (and Downgrades)

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 lowered price targets for Oceaneering International (NYSE: OII  ) and Transocean (NYSE: RIG  ) , but a much-improved target for Spirit Airlines (NASDAQ: SAVE  ) . Or put another way...

One (better price target) if by air...
Let's start the day on a high note, with Imperial Capital's bullish prognosis for Spirit Airlines. This morning, Imperial added $10 to its price target for the discount flyer, predicting that within a year, Spirit shares will fetch $58 apiece.

Given that Spirit sells for only $51 today, you'll not be surprised to learn that Imperial also recommends buying the stock. But why? Well, for one thing, Spirit announced Q4 earnings yesterday that greatly exceeded estimates. The company had been expected to report $0.50 per share for its fiscal fourth quarter, but delivered a $0.56 profit instead. Revenues fell just short of estimates -- but given that revenue for available seat mile, or RASM, was up 3% and that Spirit enjoyed success in filling more seats on its planes and wringing more money out of each passenger flying, it seems the company's growth thesis remains intact.

Analysts on average expect to see Spirit grow earnings at about 25% annually over the next five years. That seems more than fast enough to justify the company's P/E ratio of 21. My only real reservation here is that free cash flow at Spirit looks a bit light -- just $105 million in cash profits collected last year, versus $177 million in reported "net income." When you consider that rival discount flyers such as JetBlue Airways (NASDAQ: JBLU  ) and Southwest Airlines (NYSE: LUV  ) are both reporting free cash flow numbers superior to their better-publicized GAAP earnings, I'm more inclined to look at an investment in one of those two than at Spirit -- Imperial Capital's recommendation notwithstanding.

...but two (worse price targets) if by sea
So much for the "air" part of this column. Now let's lower our sights to the seas and take a look at two ocean-going stocks that Wall Street's less keen on. We'll start with Oceaneering International.

The submarine robotics and construction company reported strong results Tuesday -- earnings of $0.86 that were $0.02 ahead of estimates and sales of $895 million that blew away the anticipated $830 million. Regardless, Cowen & Co. is cutting its price target on the stock by 12.5%, to $92 per share. Why?

One reason might be Oceaneering's Q1 guidance, which promised investors no more than $0.80 per share -- where analysts had been hoping to see $0.82. That's certainly disappointing. But if Q1 guidance looks a bit light, Oceaneering is still promising to earn between $3.90 and $4.10 over the course of this year, in line with expectations. And priced at less than 21 times earnings, with a projected growth rate in excess of 21%, the stock looks no worse than fairly priced -- and probably even a bit of a bargain.

The key thing to keep in mind here is that Cowen & Co. is still recommending buying the stock. Cowen's just trimming its price target a bit, and promising investors a bit less profit from an investment in Oceaneering. I think that's the right call. While arguably a bargain, the stock doesn't look capable of delivering the near-50% profit that Cowen's old price target implied. If the analyst was wrong to be so enthusiastic before now, at least it's right to be tempering expectations today.

Rig for rough sailing?
And finally, our other nautical stock of the day -- Transocean, the deep-sea driller. For a change of pace, this one has not released earnings yet. Transocean is actually not expected to report until close of trading Wednesday. But that's not keeping Cowen in check. Following its reduction in price target on Oceaneering International, the analyst slashed expectations for Transocean as well -- by more than 13%, to $52 per share.

At first glance, this may seem unfair. After all, why punish the stock before it's done anything wrong?

Well, in a word, the reason to punish Transocean for offenses not yet committed is: valuation. Priced at less than 10 times earnings today, Transocean stock looks cheap, but it really isn't. Trailing free cash flow at the company shows Transocean to be a company barely keeping its head above water. Free cash flow over the past 12 months amounted to a mere $121 million, and a mere fraction of the $1.6 billion in GAAP profit the company claims to have earned.

This is a steep reduction from Transocean's FCF numbers in recent years, and suggests the company's not doing nearly as well as it appears to be on the surface. Indeed, unless Transocean gets its cash production engine back in gear soon, investors might begin to question the company's ability to keep paying out its above-market 5.2% dividend yield.

In short, there's real reason to worry about this stock. For this reason, I don't dispute Cowen's decision to cut its stock price target. What has me wondering is why the analyst continues to rate Transocean an outperform at all -- because that's the last thing I expect to see this stock do: outperform the market.

Rich Smith has no position in any stocks mentioned, and doesn't (always) agree with his fellow Fools. For example, The Motley Fool recommends Oceaneering International, but it also owns shares of Transocean. 


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