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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)
Given this, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.
Today, we're going to take a look at three high-profile moves on Wall Street: A big buy rating for UGGS-maker Deckers Outdoor (NYSE:DECK), balanced out by equally big downgrades at Arcelor Mittal (NYSE:MT) and Vertex Pharmaceuticals (NASDAQ:VRTX). Let's dive right in.
Good news first
First up is Deckers, a stock that's sorely disappointed investors this past year, shedding nearly three-quarters of its market cap, and underperforming the S&P 500 by about 88 percentage points. The upside to this bad news, of course, is that with its stock fallen so low, Deckers shares now look incredibly cheap -- at least to one analyst.
This morning, Jefferies announced it was reinitiating coverage of Deckers, arguing there's "significant upside in coming quarters due to improving performance of the UGG brand ... Further, we expect growth from the retail store rollout, int'l expansion, brand extensions, and the smaller brands." StreetInsider.com puts the analyst's new target price at $50 -- a potential 67% gain from where the shares were trading pre-upgrade.
Could it happen? Perhaps -- but only if a lot of things work out right. Currently selling for 6.5 times earnings, Deckers appears bargain-priced for the 7.6% long-term growth rate Wall Street gives it. The main problem here is that while Deckers claims to have earned $31 million over the past year, its cash flow statement showed it was still burning cash at last report. If Deckers can start generating cash again, therefore, I'd say the stock's valuation is probably attractive even given the modest growth rate.
But if it can't, it isn't.
If Wall Street's feeling more favorable toward Deckers, though, may prove less enthused over the numbers Arcelor Mittal reported earlier this week. News that the steelmaker, which had been expected to earn a profit, instead lost $0.43 per share (and cut its dividend to boot!) drove Arcelor shares down more than 4% in Friday trading.
Analyst reaction to the bad news has so far been muted, but that may only be because the patient is still in shock. This morning, we got a taste of what may lie ahead when analysts at Natixis cut their rating on Arcelor shares to "neutral," but subsequent ratings changes may not be as mild.
Why not? It's more than just the fact that Arcelor is GAAP unprofitable. (Primarily because of a big loss in Q4 of last year, but also because of this more recent loss). It's more than the fact that the company carries a debt load as big as its own $23.6 billion market cap. The real problem is that all year long, Arcelor's continued to burn cash in 2012, despite reporting $261 million in year-to-date profits. Unless that changes soon -- as in, this very quarter -- the stock's on track to end the year with a FCF loss.
For a company with tons of debt to pay off, failure to generate the cash needed to pay it down could prove a big problem indeed.
Vertex goes straight down
Speaking of companies with problems, or final big ratings change of the day happened at Vertex Pharmaceuticals, where Goldman Sachs just assigned a "sell" rating to the stock.
Saying it's "more cautious" about Vertex's drug pipeline, Goldman runs down a list of clinical trials Vertex drugs are undergoing, ticking each off, one at a time, and explaining why it sees none of them as likely "catalysts" to drive the stock upwards. The analyst isn't particularly enthused over Vertex's "recently announced cross-company collaborations" with Johnson & Johnson (NYSE:JNJ) and GlaxoSmithKline (NYSE:GSK) either, arguing that these arrangements "do not change the fundamental value of VRTX's nuc (VX-135)." (That's Vertex's hepatitis C drug).
But what about the value of the stock? At 23 times earnings, Vertex doesn't look particularly expensive for a drug stock (many of which have no profits at all, and so no P/E ratios). That said, if Vertex only grows earnings at 19% per year going forward, the consensus estimate for such growth, then 23 times earnings may in fact be a bit too expensive for the growth rate. What's more, Goldman thinks Vertex will struggle to hit even the 19%. Looking out toward fiscal year 2015, Goldman says it's expecting revenues will grow no faster than at 10% ... and perhaps won't grow at all, but rather shrink 2%.
Conclusion: If everything goes wrong, and Vertex "misses" its numbers, the stock's badly overvalued. If everything right, and Vertex meets expectations, the company's only slightly overvalued. Suffice it to say that this does not bode well for investors.