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 include a belated upgrade for Zipcar (UNKNOWN:UNKNOWN) and a more optimistic one for Medtronic (NYSE:MDT). On the other side of the billboard, though...
Clear Channel catches a sell rating
Investment banker Wedbush announced this morning that it's cutting its recommendation on Clear Channel Outdoor (NYSE:CCO) all the way to "underperform" -- Wall Street-speak for "sell." The analyst is also setting a $6 price target on the stock, saying it sees "reward/risk skewed to downside on soft U.S. billboard ad growth checks and small prospect of valuation support from REIT conversion or similar transaction."
That's the direct quote, courtesy of StreetInsider.com. Now here's what it means: What Wedbush is saying here is that in a multimedia world, fewer advertisers are hanging their signs on highway billboards. That's bad news for Clear Channel, which currently struggles under the weight of a hefty debt load ($4.2 billion net of cash) and an unprofitable business -- one that few analysts believe will improve much in 2013.
While currently cash-profitable, CCO still only generated about $66 million in real free cash flow over the past year -- not nearly enough to justify the stock's $2.5 billion market cap. As such, even conversion of the business into a real estate investment trust may fail to improve the stock's profitability. In order to pay the strong cash dividends common among REITs, you have to be bringing in cash in the first place.
Zipping back to neutral
Speaking of sell ratings, news that Avis Budget Group (NASDAQ:CAR) has decided to buy Zipcar upset Wall Street's applecart. Already, Oppenheimer has responded to the news by dropping coverage of Zipcar. MKM Partners had to close out its sell rating on Zipcar a bit earlier than planned, when against all odds, the shares zoomed 48% on the buyout announcement.
Some investors are going even further, with at least one of my Foolish colleagues positing the possibility that a bidding war could erupt over Zipcar. Personally, though, I think that unlikely. While technically a profitable operation, as GAAP accounting methods calculate such things, Zipcar is actually a bit of a gas-hog, cash-wise, burning through $44 million in negative free cash flow over the past 12 months.
If you ask me, Avis got stuck with a lemon on this deal, and it's unlikely other potential bidders will be foolish enough to pay even more for Zipcar. And with the stock currently trading below Avis' offer price, it appears most investors agree that no better bid will be forthcoming.
So what's that leave us with, buyability-wise? Well, Mizuho thinks Medtronic looks pretty good right now. The stock sells for less than 13 times earnings, generates gobs of cash -- more than $3.9 billion over the past 12 months -- and pays a respectable 2.5% dividend yield. Mizuho thinks these kinds of numbers justify a buy ... but I disagree, and I'll tell you why.
Basically, the case against Medtronic boils down to two words: growth and debt. Growth-wise, Medtronic is looking kind of poky, with few analysts expecting it to grow much faster than 5% per year over the next five years. Meanwhile, the stock carries a heaping helping of debt -- about $8.8 billion net of cash on hand.
Sadly, that debt load pretty much cancels out any brownie points Medtronic earned from generating superior free cash flow. It results in an enterprise value-to-free cash flow ratio of just over 13 -- meaning the stock really is about as expensive as its 12.9 P/E ratio suggests. While objectively not a large number, Medtronic's 13-ish-times multiples to both earnings and free cash flow probably require that the company grow at least in the double digits to be worth buying. As such, the 5% growth Medtronic actually is expected to produce just doesn't cut it.
Result: This stock's no buy. It might even be a sell.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Medtronic and Zipcar and has the following options: short MAY 2013 $44.00 calls on Medtronic. Motley Fool newsletter services recommend Zipcar.