Wednesday'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 a pair of new upgrades out of Deutsche Bank, which is now rating both WhiteWave Foods (NYSE: WWAV  ) and SunPower (NASDAQ: SPWR  ) at "buy." But before we get to those two...

A few words about Sirius XM
The recent revelation that satellite radio operator Sirius XM Radio (NASDAQ: SIRI  ) is amending its credit agreements to permit it to take on more debt for share repurchases is having the opposite effect that you'd expect today. Ordinarily, news that a firm thinks its own stock is cheap and wants to buy more of it would be expected to boost said stock, and create more demand for it among investors. Instead, though, we learned this morning from Briefing.com that analysts at Wunderlich have decided to cut their price target on Sirius (to $3.50 per share) and reiterate their hold recommendation.

But Wunderlich is right to be cautious.

The fact that Sirius seems intent on taking on new debt makes the stock a riskier play. The fact that management has decided to take on this new debt to buy shares that already look pretty expensive only compounds that risk.

Consider: At a market cap of $19.3 billion, with more than $3.5 billion in net debt (and more on the way), Sirius currently sells for an enterprise value-to-free cash flow ratio of 24.3 today -- and a P/E ratio of more than 52. These seem very high multiples to be paying, given that most analysts on Wall Street today agree that the stock will only grow earnings at about 20% annually over the next five years.

Mind you, I wouldn't object to seeing Sirius buy its stock back when the shares are undervalued, even at the cost of taking on more debt (at least not in today's low-interest-rate environment). But taking on debt to pay for overpriced shares? That just not a very bright idea.

A wave of approval
Turning now to the upgrades: Shares of diversified packaged foods maker WhiteWave Foods are dodging the downturn on markets today, and moving up more than 1.7% in response to a positive note from German banker Deutsche Bank. As quoted on StreetInsider.com today, Deutsche is picking WhiteWave to outperform the market on a belief that "in the current industry environment ... a portfolio of leading brands focused on fast growing heath & wellness categories" will help the company "to achieve robust top and bottom line growth over the next several years."

It's not an uncommon assumption. In fact, most analysts who follow WhiteWave today agree that the company is likely to grow its earnings at better than 18% over the next five years -- four points better than its processed foods peers. The problem, however, is that at a valuation of more than 50 times earnings, WhiteWave shares appear to have all of this growth (and more) built into their stock price already.

When you consider further that WhiteWave's profits are of pretty low quality -- the company generated only $53 million in real free cash flow last year, versus reported GAAP earnings of $99 million, the stock's overvaluation grows only more apparent. Long story short, WhiteWave is a fast-growing company, yes. But it costs far too much for investors to have any hope of profiting from that growth. In my book, Deutsche is wrong to recommend it.

Will SunPower shine?
Deutsche goes even farther astray, however, with its second big pick of the day: solar power systems manufacturer SunPower. Quoting again from StreetInsider.com: "We believe risk-reward for SPWR shares is becoming more attractive" because it plays in the "accelerating growth" market of America, and in the strong Japanese market as well, while its business is less dependent on Chinese solar power projects. Deutsche also sees promise in SunPower's ongoing efforts to reduce costs.

To be fair, Deutsche does have a point on the costs front. Gross margins at SunPower have been expanding for two years already, and operating profit margins recently turned positive as well. Plus, last year, for the first time in three years, SunPower managed to close out its year with a positive free cash flow number.

But even so, free cash flow at this company -- which claims to have earned more than $95 million under GAAP accounting rules last year -- amounted to less than $10 million in 2013. So if you think SunPower looks expensive today at 46 times earnings, you're really not going to want to hear how much the stock costs if you value it on its real cash profits. (Hint: The number's in the triple digits).

Long story short, even if the analysts who follow this company are right, and even if it's able to grow its earnings at 30% annually over the next five years (according to Yahoo! Finance figures, the best SunPower managed to grow earnings over the last five years was 0.5% annually), this stock is still too expensive to buy.

And once again, I believe Deutsche Bank is wrong to recommend it.

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 WhiteWave Foods, and it owns shares of both WhiteWave Foods and Sirius XM Radio.

 


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 07, 2014, at 7:42 PM, jargonific wrote:

    Do you promote short selling? We are continuously robbed by organized short selling and they are cued through media.

    We have positions in both SPWR and WWAV and are hopeful.

    Short sellers have ravaged sunpower for years. Time to show them the door.

  • Report this Comment On May 07, 2014, at 7:43 PM, jargonific wrote:

    By the way.

    Sunpower is primed and ready with product and has best performing equipment to help homeowner's cope with rising utility rates.

    Then there is climate change.. problems with air quality... LOTS of reasons to go long on Sunpower.

  • Report this Comment On May 08, 2014, at 7:37 AM, jargonific wrote:

    White Wave earnings came in showing excellent growth, higher every way as expected:

    WhiteWave Foods beats by $0.03, beats on revs; guides Q2 EPS in-line; raises FY14 EPS above consensus

    Font size: A | A | A

    6:37 AM ET 5/8/14 | Briefing.com

    Reports Q1 (Mar) earnings of $0.22 per share, excluding non-recurring items, $0.03 better than the Capital IQ Consensus Estimate of $0.19; revenues rose 36.5% year/year to $830.2 mln vs the $786.9 mln consensus.

    Co issues in-line guidance for Q2, sees EPS of $0.21-0.22 vs. $0.21 Capital IQ Consensus Estimate. Co issues raised guidance for FY14, sees EPS to $0.95-0.98 from $0.90-0.94 vs. $0.92 Capital IQ Consensus Estimate. Adjusted Operating Income Grows 35% to $64 Million; Operating Margins Expanded in Historical Businesses, Excluding Earthbound Farm. "The strength of our results reflects impressive organic growth across our historical businesses, plus the strategic addition of Earthbound Farm to our portfolio...All of our brands delivered strong volume growth, which in turn fueled category expansion. Our China joint venture is progressing on-track, and we are excited about the opportunities that entry into this market provides. I am pleased with our strong start to the year, along with the expected continued momentum that has led us to increase our forecasts for 2014."

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