This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today, we'll be looking at new buy ratings for Amazon.com (Nasdaq: AMZN) and Limited (NYSE: LTD), alongside a downgrade for Target (NYSE: TGT). Let's dive right in.
Roll on, deep river
At a nosebleed P/E ratio of nearly 180, it's hard to argue Amazon.com is a particularly "cheap" stock. But that didn't keep analysts at Lazard Capital from recommending it this morning. Initiating Amazon at a "buy" rating, Lazard predicts we will soon see these shares rocket from today's share price of $216 all the way up to $240.
What could spark this run? One obvious catalyst is Amazon's Q2 earnings report, due out next week. But not everyone's convinced that Amazon's report will be as big a blowout as Lazard seems to think. Cowen & Co., for example, just released a report that the ratings watchers at StreetInsider.com characterize as being undermined by weaker-than-expected Kindle Fire sales. According to Cowen, Amazon will only sell about 12 million Fire units this year, rather than the 14 million units Cowen was previously anticipating. This has the analyst lowering revenue estimates for both this year and the next.
The good news? Since Amazon prices its Kindles at or below the cost of production, selling fewer of the things might actually be good for Amazon's profits in the short term. For a company that's currently eking out just a 1.1% net profit margin, that's not necessarily a bad thing.
Does Limited have boundless potential?
In theory, e-commerce retailers like Amazon (so-called "e-tailers") are supposed to have lower costs, and higher profit margins, than their bricks-and-mortar competitors. But apparently not all their competitors.
One company soundly thrashing Amazon on the margins front is Victoria's Secret owner Limited Brands, recipient of an upgrade to "outperform" from analyst R.W. Baird this morning. With an operating profit margin north of 14%, and a net margin of nearly 8%, Limited is arguably a much more profitable operation than Amazon, albeit one more, er, "limited" in size. It's also a whole lot cheaper for investors, with a P/E ratio of less than 18 -- about one-tenth the valuation at Amazon. But is this cheap enough to make the stock the "buy" that Baird says it is?
In a word: No. Cheaper than Amazon, Limited might be. But 18 times earnings is still quite a pretty penny to pay for a company that, according to most Wall Street analysts, will only grow its earnings at about 12% per year over the next five years. When you consider further that Limited only generates about $0.76 in actual free cash flow for every dollar it claims to be earning under GAAP, Limited is actually significantly more expensive than it looks. Buyer beware.
A Target on its back
Smack-dab in the middle between low-margin e-tailer Amazon and high-margin retailer Limited lies Target, whose 4.2% net profit margin almost precisely splits the difference between its rivals' profit margins. Unfortunately for shareholders, Target is getting short shrift on Wall Street this morning, as Citigroup downgraded the stock from "buy" to "neutral."
What's Citi got against Target? According to StreetInsider.com, Citi's mainly worried about the company's ability to keep growing sales to a stretched U.S. consumer. The analyst just cut its estimates for July comparable-sales growth from a 3%-to-5% range down to 1%-to-3%, and cut $0.11 off its estimate for fiscal year 2013 profits as well.
Why is this bad? Well, most analysts today have Target pegged for profits robust enough to give the stock about a 12.6 forward P/E ratio. Problem is, if Citi's right and everyone else is wrong, then Target's really only going to earn enough to win itself about a 14.4 P/E -- meaning the stock's significantly more expensive today than a lot of investors think it is. That may not sound like a big difference, but for a stock that's only pegged for about 11% annual profits growth over the next five years, the difference between a 12.6 and a 14.4 P/E is the difference between the stock being worth buying or not.
Fool contributor Rich Smith holds no position in any company mentioned above. The Motley Fool owns shares of Amazon.com and Motley Fool newsletter services have recommended buying shares of Amazon.com.
