Tuesday'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, with the summer travel season getting under way, Wall Street is taking a peek at a couple of America's premier travel websites -- and advising investors to buy shares of both Expedia (NASDAQ: EXPE  ) and Orbitz (NYSE: OWW  ) . But the news isn't all good. Before we get to those two stories, let's take a quick look at why...

AeroVironment just got downgraded
News last week that oil giant BP has received approval from the FAA to begin using drones from AeroVironment (NASDAQ: AVAV  ) to monitor the company's operations in Prudhoe Bay, Alaska, set off a surge of new enthusiasm for the maker of tiny robotic aircraft. Today, however, with the stock up nearly 3% from before the news broke (and up more than 75% over the past year), Benchmark pulled in its bullish horns on the stock, downgrading AV to hold.

It's a smart call. A 75% one-year profit is not easy to come by, after all. And with AV shares now looking overvalued in the extreme, Benchmark is right to advise investors to take some profit off the table.

AeroVironment shares sell for more than 150 times earnings. Despite producing free cash flow ($10.3 million) superior to reported generally accepted accounting principles earnings ($4.9 million), the company doesn't exactly look cheap when valued on free cash flow, either. Its price-to-free cash flow ratio of 72 would be expensive even for a strong double-digit grower, but S&P Capital IQ figures indicate most analysts think AV is likely to grow profits only in the single digits over the next five years.

No need to belabor the point here. This stock is clearly overpriced. Benchmark is right to downgrade it.

Up on Expedia
Moving to the travel sites stories, we begin with Expedia, just upgraded to "positive" by Susquehanna. According to StreetInsider.com, Susquehanna argued that analysts are lowballing the likely earnings at Expedia in both this year and the next. "Even using conservative assumptions," says the analyst, Expedia is likely to beat earnings by a good 3% to 4% in each year. Susquehanna said that should be good enough to push these shares as high as $90 over the course of the coming year.

If Susquehanna is correct, that should work out to about a 17% profit for investors who buy Expedia at today's prices -- plus an extra 0.8% from the dividend. Not a bad profit at all, then. But is Susquehanna right?

It very well might be. I'll explain: Valued at 33 times "earnings" today, Expedia shares don't look particularly cheap on the surface. But the company generates significantly more free cash flow from its business than shows up on Expedia's income statement as GAAP "net income." Free cash flow for the past year amounted to $571 million, which was about 77% ahead of net income. It has also helped Expedia to build up an enormous cash stash. At last count, the company had nearly $1 billion more cash than debt on its balance sheet.

This works out to a company that trades for an enterprise value of just 15.3 times annual free cash flow, which is cheap if Expedia hits consensus growth targets of 17% annualized (as reported by S&P Capital IQ). It's even cheaper if Susquehanna is right that analysts are lowballing the growth number. Factor in the modest dividend yield on top of the undervalued shares, and I think Susquehanna just might have found itself a winner here.

Can Orbitz run circles 'round Expedia?
Meanwhile, at the same time as Susquehanna was recommending that investors buy Expedia, rival investment banker UBS was urging investors to pile into shares of Expedia competitor Orbitz. Quoting from StreetInsider.com again: "We believe Orbitz provides investors with exposure to a leading player in the domestic online travel market, with a long runway ahead for its hotel business, particularly given the recent introduction of a new loyalty rewards program. ... Visitors to Orbitz's sites come with a strong intent to purchase travel. ... Additionally, Orbitz's unique loyalty program encourages increased mobile (lower remarketing costs) & hotel bookings (higher take rates)."

Like Susquehanna on Expedia, UBS argued that the Street is underestimating Orbitz's growth potential. UBS projected revenue growth alone of 7% annualized over the next few years. Estimates for earnings growth, as cited on S&P Capital IQ, call for 18% compounding growth over the next five years -- an even faster rate than is projected for Expedia.

Perhaps best of all, while Orbitz, like Expedia, looks overpriced when valued on P/E, the company generates so much more free cash flow ($95 million over the past year) than it reports as net income ($13 million) as to make Orbitz arguably an even better bargain than its rival. Value the company on free cash flow, as Orbitz shares sell for a price-to-free cash flow ratio of less than 10. On 18% growth, that sounds like a huge bargain.

Granted, Orbitz has a couple of negatives that don't afflict Expedia. Orbitz pays no dividend, and its balance sheet shows more debt than cash. But on balance, the stock still looks like a winner.

Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool both recommends and owns shares of AeroVironment. 

 


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