Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

"Is Cubic Corporation's Post-Earnings Sell-Off a Buying Opportunity?"

It's been a little less than two years since I posed that question -- the last time I wrote about defense contractor Cubic (NYSE:CUB). In the intervening months, Cubic shares have risen about 15% -- a respectable gain, but hardly a barn-burning pace. Today, however, investment megabanker Citigroup is predicting Cubic stock will do a whole lot better -- and a whole lot quicker -- and is urging investors to buy before the rally.

Here's what you need to know.

Sphere in a row of cubes

Image source: Getty Images.

Re-introducing Cubic

As I said, it's been a while since we last wrote about Cubic, so perhaps a brief reintroduction to the company is in order. Broadly stated, it's a technology company serving two primary markets through three divisions.

Cubic Transportation Systems, the flagship division, provides "automated fare payment, traffic management and enforcement solutions," including such technologies as facilitating fare payments and predicting when the next subway will arrive. With $671 million in trailing sales, CTS accounts for about 56% of Cubic's business.

Cubic Mission Solutions and Cubic Global Defense Systems, for the most part, service military customers, providing technologies ranging from training services to command and control, intelligence, surveillance and reconnaissance (C2ISR) technology. Combined, these two divisions account for about $532 million in trailing sales.

Out of Cubic's three divisions, the commercial-facing CTS division is by far the more profitable, generating operating profit of $60 million last year. Cubic as a whole, however, has not been doing very well in the profits department. The entire company -- worth $1.8 billion in market capitalization -- earned only $15.5 million, net, over the last 12 months. Profits were 20% less last year, and in 2017, Cubic reported a loss. Moreover, Cubic hasn't generated any positive free cash flow since 2016.

Check out the latest Cubic earnings call transcript.

Why Citi likes Cubic

Despite these less-than-attractive statistics, this morning Citi announced it is upgrading Cubic to buy and assigning a $75 price target -- more than 25% above where the stock trades today -- as reported by StreetInsider.com (subscription required).

Unsurprisingly, Citi believes that Cubic's CTS division will be the company's growth driver going forward, citing recent CTS contract wins in support of that argument. Combined with improvements in the defense business, Citi is forecasting a 10% organic sales growth rate for the company as a whole -- and believes it may further accelerate that growth through acquisitions.

While that may sound optimistic, Citi isn't the only analyst hewing to this view. Polling by S&P Global Market Intelligence shows that a majority of analysts following Cubic believe the stock will outperform the market going forward. After posting only a $0.29-per-share profit last year, the consensus among analysts is that Cubic will rocket to a $1.37-per-share profit this year, then nearly double that to earn $2.58 per share in 2020.

Should you like Cubic, too?

If those analysts are right, then Cubic at $60 today costs only about 23 times earnings two years out -- and two years out, the company will still be growing earnings rapidly. This then, in a nutshell, is Citi's theory: That Cubic is a stock in transition, and should be bought here on the cusp of its rebound.

But I have to tell you -- I'm not at all certain I buy that argument. Here's why:

For Cubic to report $2.58 per share in earnings in 2020, the company will need to earn net profits of about $82.5 million. Now, that's not entirely unheard of. In fact, Cubic earned more than $82.5 million as recently as 2011 (and 2012). Problem is, those were the only two years in which Cubic earned so much...this side of the millennium. More often, Cubic isn't nearly so profitable as Citi is projecting it will become.

As for Citi's predicted 10% organic growth rate, well, Cubic hasn't grown that fast since 2010. Meanwhile, its compound annual growth rate for revenue over the last five years has been a less encouraging negative 1.4%.

Topping it all off, it seems to me Citi clambered too far out on a limb when it argued that Cubic's $76 million in cash and investments constitutes the kind of dry powder that would permit the company to goose its growth rate even further through acquisitions, because the company also has $280 million in debt on its books, offsetting all that cash.

Long story short, I don't see Cubic's balance sheet as being as strong as Citi says it is, nor its growth rate as rapid, nor its valuation as attractive. Citi says you should buy this stock -- but I disagree.