Wednesday's Top Upgrades (and Downgrades)

Analysts shift stance on Hertz, JetBlue, and UnitedHealth Group.

Apr 16, 2014 at 2:14PM

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 new buy ratings for Hertz (NYSE:HTZ) and JetBlue (NASDAQ:JBLU). The news isn't all good, though, so before we get to those two, let's take a quick look at a...

Poor prognosis for UnitedHealth Group
Most stock market indexes are glowing a healthy shade of green Wednesday. But one stock that's sitting out the rally is nation's biggest health insurer UnitedHealth Group (NYSE:UNH) -- down 1.4% in noon-day trading. For this, you can thank the analysts at Citigroup, who removed their buy rating from UnitedHealth this morning and downgraded to neutral.

Citi's cautious note comes just one day before UnitedHealth is expected to report its Q1 earnings, and is not entirely expected. After all, the insurer's shares have outperformed the stock market by 10 percentage points over the past year, and sit 33% higher than their lows of last summer. Profits like these are not to be parted with lightly, and Citi's decision to take chips off the table may be easily explained as discretion winning out over valor.

Valuation-wise, the stock's 14.2 P/E ratio looks reasonable. But even after this month's strong Obamacare enrollment results, analysts who follow the stock fear UnitedHealth will be hard-pressed to achieve more than upper-single-digit earnings growth over the next five years. That being the case, 14 times earnings isn't exactly a cheap valuation, either. With no compelling value case for buying the stock, Citi's probably right to sit on the sidelines through earnings season. Should Thursday's results turn out to be better than expected, it can always reattach a buy rating to the stock after the good news is out.

Hertz so bad
Less explicable is today's endorsement of car rental company Hertz Global by the analysts at Gabelli. According to StreetInsider.com, Gabelli initiated coverage of Hertz with a buy rating this morning. SI doesn't say why Gabelli likes the stock, however -- and I'm at a loss, too.

Priced at 35 times earnings, Hertz seems an exceedingly pricey stock -- even before you notice that the quality of Hertz's earnings is not particularly good. Free cash flow produced over the past 12 months amounted to only $241.5 million -- or about $0.70 in real cash profit for every $1 the company claimed as GAAP earnings. Hertz also sports a boatload of debt -- about $15.7 billion net of cash, which is more than the company's own market capitalization. And with much of its earnings earmarked for debt repayment, the stock, of course, pays no dividend.

About the only thing Hertz has going for it, from an investor's perspective, is a red-hot projected earnings growth rate -- 23.6% according to Yahoo! Finance. But between the weak free cash flow and the sky-high valuation, I fear that growth alone won't tip the scales in this stock's favor. Gabelli is wrong to urge investors to hitch a ride with Hertz.

Why drive when you can fly?
Last but not least, we come to JetBlue Airways, our final ratings review of the day. This one comes out of stock shop Argus Research, which recommends JetBlue as a buy and a play on route expansion and revenue growth.

At first glance, Argus appears to be on to something. Pegged for 22.5% long-term earnings growth (not much slower than Hertz), JetBlue shares sell for the apparently attractive valuations of just 16.7 times GAAP earnings and 21 times free cash flow. Relative to the growth rate, both these ratios look good, even if JetBlue pays no dividend.

The problem with JetBlue, in a word -- and the reason I disagree with Argus' decision to recommend the stock -- is debt: With nearly $2 billion more debt than cash on its books, JetBlue is much more heavily leveraged than fellow discount flyer Southwest, and this debt load holds the potential to limit its growth prospects. Furthermore, factoring debt into the stock's valuation, we find JetBlue selling for enterprise values closer to 26 times earnings and 37 times free cash flow.

Even at 22.5% growth, these valuations look too high to be sustainable, and suggest Argus is wrong to recommend the stock as a buy.

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 UnitedHealth Group and owns shares of Citigroup and Hertz Global Holdings. 

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