Monday's Top Upgrades (and Downgrades)

Analysts shift stance on FedEx, Allegheny Tech, and bebe.

Jun 30, 2014 at 12:22PM

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 raised price targets at both FedEx (NYSE:FDX) and Allegheny Technologies (NYSE:ATI). But before we get to the good news, let's take a quick look at why...

bebe's crying
Struggling fashionista bebe stores (NASDAQ:BEBE) announced last week that it's going to try to shave $9 million-$10 million off its annual cost of doing business, closing tis "2b" mall-based store chain and doubling down on efforts to reinvigorate its core brand. This will entail at least $5 million in charges for restructuring, however, and won't happen fast enough to prevent bebe from reporting "low single digit" negative same store sales for fiscal Q4 2014, rising levels of inventories, and a "mid-teen" per-share loss for the company -- none of which news made analysts at B. Riley happy.

This morning, Riley threw in the towel on bebe stores, reducing its rating to neutral and cutting its price target by more than half, to just $3.40 per share. Riley's right to do so.

Unprofitable ($60 million in losses over the past year) and burning cash (free cash flow of negative $36 million for the same period), bebe is certainly struggling. But despite being a far worse than average retailer (as an industry, retailers remain profitable), bebe's stock sells for only about a 35% discount to the average price-to-sales ratio of 0.84 in this industry.

The stock does have some potential, don't get me wrong. For one thing, bebe is still sitting on more than $127 million in cash at last report, and has no debt. But at the very least, we're going to want to see the company begin generating positive free cash flow before buying into a turnaround story. Because the longer bebe burns cash, the smaller its bank account is going to get. For now, Riley's right to sit on the fence, and see how things play out with the turnaround.

FedEx is flying
Turning now to happier news, shares of FedEx got a nice lift when the company reported Q4 earnings that exceeded expectations by a good $0.01 per share. Shares rose 6% in the aftermath of earnings, have continued drifting upwards since -- and according to analysts at Oppenheimer, could go up even more from here.

Oppenheimer, which rates FedEx an outperform, increased its price target on the stock to $168 per share today. If it turns out to be right, this will equate to an 11% return on the shares for investors who buy FedEx today, with a 0.5% dividend yield tacked on for good measure.

But here's the thing: The sum of anticipated growth in the stock price, plus the dividend, still works out to not much more than the stock market's average long-term growth of 10% and change. And given the evident overvaluation of FedEx stock, I'm not sure it's worth the risk for only a chance at "average" returns.

FedEx's valuation of 28.6 times earnings more than prices in growth prospects of 15% annually over the next five years. What makes the stock look even more expensive, though, is the fact that with only $731 million in trailing free cash flow (according to S&P Capital IQ data), FedEx is actually much less profitable than the $2.1 billion in "GAAP earnings" shown on its income statement make it appear. In fact, I calculate the company's enterprise value-to-free cash flow ratio at more than 63.8 -- far, far too much to pay even for a 15% grower like FedEx.

Long story short, while FedEx is a great company, with a moat around its business that is well nigh on unassailable, it's still possible to overpay to own it. Oppenheimer may think that's a risk worth taking. I disagree.

Allegheny Tech-nically overvalued
Finally, we come to Allegheny Technologies -- which despite the name, has very little to do with the "tech" industry at all, and is in fact a specialist in steel, titanium, and alloys. The stock costs a bit less than $45 today, and has been performing well over the past year (up nearly 70%). That said, the stock's sharp run-up has drawn it close to Stifel Nicolaus's old $45 price target, and with momentum showing little sign of slowing, the analyst decided today to raise the roof a bit.

Suggesting a $50 target price for Allegheny Tech, Stifel is predicting investors can earn about a 12% return on their money if they buy today. Factor in Allegheny's 1.7% dividend yield, and what you wind up with is an anticipated total return of about 13.5% -- more than Oppenheimer is promising from FedEx. So is Allegheny Tech a buy?

Hardly.

In fact, if you ask me, Allegheny Tech stock looks like an even riskier investment than what we saw at FedEx. Consider: Priced north of 38 times earnings, Allegheny carries a higher P/E ratio than does FedEx -- despite being pegged for the slightly slower growth rate of 13.8%. What's more, while FedEx is generating a lot less free cash flow than it reports as net income, Allegheny is currently generating no free cash flow whatsoever. Indeed, S&P Capital IQ data show the company burning cash at the rate of nearly $200 million per annum.

Once again, Wall Street and I don't see eye to eye. Stifel looks at Allegheny, and sees modest growth justifying Allegheny Technology's very high P/E ratio. I see cash burning by the bail-load, and earnings that simply aren't high enough to support the stock price. In short, it's simply not a stock I'd want to own.

Rich Smith has no position in any stocks mentioned, and doesn't always see eye-to-eye with the other Fool analysts, either. Case in point: The Motley Fool recommends FedEx.

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