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This Just In: Upgrades and Downgrades

By Rich Smith - Updated Apr 5, 2017 at 8:00PM

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Soleil takes a shine to Omnicare.

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
"Best" is becoming ever more the relative term on Wall Street these days, as big-name investing houses from JPMorgan to Citigroup to UBS engage in a race to the bottom of the CAPS rankings, thanks in part to the plunge in the stock market overall. One stock shop that's holding its own, though (if just barely), is Soleil Securities, an "an aggregator and distributor of intellectual content" serving the buy side of the market. And wouldn't you know it? Soleil Securities just weighed in yesterday with an upgrade to "buy" on Motley Fool Inside Value recommendation Omnicare (NYSE:OCR).

Why you should care about Omnicare
Now, Soleil isn't the brightest star in the sky. But it's doing well enough on its better guesses to maintain outperformance of the S&P 500 despite getting more picks wrong ...

Company

Soleil Said:

CAPS Says (out of 5):

Soleil's Pick Lagging S&P by:

Array BioPharma (NASDAQ:ARRY)

Outperform

*****

21 points

Southwest Airlines (NYSE:LUV)

Outperform

***

13 points

United States Steel  (NYSE:X)

Outperform

***

9 points

... than right ...

Company

Soleil Said:

CAPS Says:

Soleil's Pick Beating S&P by:

Amylin Pharmaceuticals 

(NASDAQ:AMLN)

Underperform

***

35 points

International Business Machines 

(NYSE:IBM)

Outperform

****

30 points

Kellogg  (NYSE:K)

Outperform

****

8 points

As you can see, though, Soleil has both winners and losers in its health-care portfolio -- just as in the other industries in which it looks. Overall, this analyst only gets about 47% of its picks right. It's only the fact that its winners tend to do "more better" than its losers do poorly that keeps Soleil shining up there in the top 20% of investors ranked by CAPS. For instance, its best pick, Netflix, scored 113 points of outperformance, while its worst one, AK Steel, underperformed by 83 points.

But does Omnicare have the potential to (a) become one of the winners, and (b) rack up enough points of market outperformance to help keep Soleil in the winner's circle? According to Soleil, this stock's a buy for three key reasons:

  • First, Omnicare is the proverbial 800-lb. gorilla of the pharmaceutical benefits industry, owning a (to mix my zoological metaphors) mammoth 46% share of the market.
  • As such, Omnicare is uniquely positioned to benefit from the growing trend of Omnicare clients ordering lower-cost, higher-margin (for Omnicare) generic drugs instead of their high-priced, patent-protected name-brand analogs. Says Soleil, 72% of the time a generic drug is available to substitute for a name-brand analog, its customers go with the generic. By 2013, Soleil expects this proportion to rise to 87% -- adding as much as $200 million to Omnicare's annual profit.
  • Third and finally, Soleil expects Omnicare to cut its operating costs even as its revenue rises, adding perhaps another $100 million or so to annual operating profit.

So?
So, consider: Omnicare looks awfully expensive right now at a 25.4 P/E. But if you value the business on its free cash flow as opposed to its accounting profits, it's actually selling for something closer to 15 times enterprise value-to-FCF. Obviously, that's cheaper than the stock looks based on P/E. The question is, is it cheap enough?

Buy the numbers
If Soleil is right in its assumptions, then we're looking at about $177 million in extra operating profit in five years' time. This equates to roughly 7.4% compound annual earnings growth -- so right there, you've got a bit more than half of analysts' projected 14% long-term earnings growth accounted for. Add in the propensity of an aging population to increase pharmaceutical consumption faster than the general population, Omnicare's ability to grow market share, and any other actions it might take to boost profits in coming years, and I'd say 14% looks eminently attainable.

Foolish takeaway
Even so, in this Fool's opinion, the prospect of 14% growth just isn't enough to compel my buying into a 15 times EV/FCF equation. The margin of safety is there, sure, but it's more the breadth of a sidewalk crack than the Grand Canyon-sized discounts being offered elsewhere in this market (General Electric, anyone?)

My take: Omnicare could be a good deal, but it's a stretch. If Mr. Market's handing you more obvious bargains on a proverbial silver platter, why work any harder than you have to?

Fool contributor Rich Smith does not own shares of any companies named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 726 out of more than 120,000 members. The Fool has a disclosure policy.

Omnicare is a Motley Fool Inside Value pick. JPMorgan is an Income Investor selection. Netflix was chosen by Stock Advisor.

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Stocks Mentioned

Omnicare Inc. Stock Quote
Omnicare Inc.
OCR.DL
International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$132.61 (0.10%) $0.13
Southwest Airlines Co. Stock Quote
Southwest Airlines Co.
LUV
$39.08 (0.70%) $0.27
Kellogg Company Stock Quote
Kellogg Company
K
$74.68 (-0.48%) $0.36
United States Steel Corporation Stock Quote
United States Steel Corporation
X
$23.69 (1.59%) $0.37
Accuray Incorporated Stock Quote
Accuray Incorporated
ARAY
$2.14 (-1.38%) $0.03

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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