Wednesday's Top Upgrades (and Downgrades)

Analysts shift stance on Yelp, ExxonMobil, and Chevron.

Apr 9, 2014 at 3:31PM

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today, we'll be looking at a pair of new ratings out of Jefferies, as it initiates coverage on the oil and gas sector, giving Chevron (NYSE:CVX) the thumbs-up but ExxonMobil (NYSE:XOM) the thumbs-down. But, first, the latest news on Yelp (NYSE:YELP).

More help for Yelp
On Wednesday morning, yet another banker joined the crowd of analysts shouting in chorus, "Buy Yelp!" If you're counting, then combined with the upgrade to outperform from Oppenheimer Monday and the upgrade to buy from SunTrust yesterday, this makes a total of three analysts recommending Yelp shares in the past three days.

As with the other analysts' recommendations, today's buy argument from CRT Capital is elegant in its simplicity: "Since reaching a record high of $101.75 on March 5, 2014, YELP shares have fallen as much as 33%. With no real fundamental reason for the precipitous drop in stock price... We now view valuation as somewhat more attractive."

This raises the obvious question, though: "More attractive than what?" Sure, CRT is right about Yelp shares being cheaper today than they once were. But as I've said twice in as many days already, the fact that Yelp is not earning profits is generating almost no free cash flow and sells for a triple-digit multiple to the profits that it might (or might not) earn next year all suggest this is one extremely overpriced stock -- even if it is 33% less extremely overpriced than it was a few weeks ago.

Indeed, CRT's own argument in favor of buying the stock, that it sells for such ridiculously pricey valuations as "11x 2015 Price/Sales" and costs "49x EV/EBITDA" suggest there's little fundamental reason to want to own this stock, other than the fact that it's a bit cheaper today than it once was. That still doesn't make Yelp shares cheap. And it's still not a good reason to buy them.

A bargain in oil and gas?
So where should investors look for bargains? According to Jefferies, one place to start looking might be the oil and gas sector.

This morning, Jefferies initiated coverage on Chevron with a buy rating, setting a $140 price target on the stock. StreetInsider.com quotes the analyst arguing: "We believe that Chevron has the best medium-term growth prospects in the integrated oil sector, its valuation parameters are attractive, and the dividend provides downside support. Chevron's growth projects have high margins that are accretive to its industry-leading position."

Strangely, though, if you compare Chevron's projected five-year earnings growth rate (5.6%)to the average growth estimates in its industry (16.9%), the company doesn't actually appear to fare so well. Comparing growth to valuation, the result is similar, with Yahoo! Finance figures showing Chevron to have a five-year forward PEG ratio of 1.9 -- nearly identical to the 1.92 PEG for the oil and gas industry as a whole.

Granted, when you add Chevron's 3.4% dividend yield to its expected rate of earnings growth, you wind up with an expected 9% total return from the stock. That looks like an argument in the stock's favor, up until the point when you notice that Chevron's free cash flow -- never a really strong point in the stock's favor -- recently plunged deeply into negative territory. While the company's income statement still shows Chevron producing good ($21.4 billion) in GAAP profits, Chevron's cash flow statement clearly shows that the company is burning cash -- and, arguably, a much worse value than what Jefferies makes the stock out to be.

Is bigger better?
In contrast to its enthusiasm over Chevron, Jefferies takes a dim view of the prospects for larger oil major ExxonMobil. Initiating coverage of this stock with only a $96 price target (less than Exxon shares sell for today), Jefferies rates Exxon only neutral, pointing out that "relative to other integrated oil stocks Exxon is expensive, lags in growth prospects and offers the lowest dividend yield."

And this time, Jefferies is right on the money. Exxon's 2.6% dividend yield does lag the payout of its rivals. Its projected growth rate is an anemic 3%, and at 13.2 times earnings, the stock looks overpriced relative to the competition. In Exxon's defense, the company is generating positive free cash flow, but the $11.2 billion it pumped out of the ground last year falls far short of the $32.6 billion it claims to have earned under GAAP accounting rules.

In short, if Chevron isn't generating enough cash from its business to justify the buy rating Jefferies graced it with, then Exxon probably doesn't deserve even the neutral rating the analyst reluctantly assigned it, either.

Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case(s) in point: The Motley Fool recommends both Chevron and Yelp.

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