This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, headlines feature a pair of downgrades from Standpoint Research, which is ratcheting back ratings on both Delta Air Lines (DAL +2.62%) and Guess? (GES +0.00%). But the news isn't all bad. So before we get to those two, let's take a look at why one other analyst sees...
Boeing flying higher
Confirmation that United Continental has resumed flights aboard upgraded and verified-not-likely to-combust Boeing (BA +1.95%) Dreamliners is sparking (sorry -- poor choice of words) some enthusiasm on Wall Street today. Analyst Oppenheimer has reportedly upped its price target on the already buy-rated stock, and now thinks Boeing shares are going to $120. And while I'm not entirely convinced that $120 is the "right" number for Boeing, I do agree that on balance, the stock does look buyable today.
Why? Let's take a look at the numbers.
Boeing shares currently cost just under 19 times earnings. The stock pays a 2% dividend, and is pegged to grow earnings at roughly 14% per year over the next five years. So far, this suggests a stock that's fairly modestly overpriced -- but wait. We're not done.
Boeing currently generates about $1.32 in free cash flow for every $1 it gets to report as "net income" under GAAP accounting standards. As a result, its real cash profit is significantly bigger than its P/E ratio lets on. Indeed, if I value the stock on free cash flow, Boeing shares look fairly priced today based on their growth prospects alone. That's before you factor in the $2.6 billion in net cash on Boeing's balance sheet, and before you count the 2% dividend yield.
Result: I think Boeing shares still have room to rise. Maybe not by the 20% that Oppenheimer projects, but by some amount, certainly.
Delta grounded
If only I could say the same thing about key Boeing customer Delta Air Lines. Standpoint Research pulled its buy rating on the stock this morning, noting that while "DAL still looks attractive at 6 times estimates for next year ... the estimates for 2014 may be a bit speculative at 50% above trailing twelve months earnings and the company is carrying a lot of debt."
I'll say. Delta's debt load right now is about $9.4 billion, net of cash on hand. And if it's trading for six times what it might earn next year, one thing's for certain already -- Delta shares cost more than 17 times the earnings it actually made over the past year. You know, facts as opposed to guesses.
Now granted, most analysts have high hopes for Delta, and project the company will earn a lot next year, then keep on growing earnings at about 24% per year over the next five years. That's fast enough growth to justify even a 17 P/E, but for one thing: Delta's earnings aren't all they seem to be.
Real free cash flow at the company is just $441 million, or less than half reported GAAP profits. As a result, the company's price-to-free cash flow ratio is a shockingly high 35.1, and when you factor debt into the picture, Delta's enterprise value-to-free cash flow ratio rises to a whopping 61.1.
Suffice it to say that when the valuation numbers on a company get this big, I think it's time to start pulling in the bull's horns, and choose caution over aggression. Standpoint's right to downgrade Delta.
Guess this one won't be going up anymore
Shifting away from aerospace in our final ratings review, Standpoint also downgraded shares of Guess? Thursday. Quoted on StreetInsider.com, Standpoint's Ronnie Moas noted that the stock is "fairly valued" at 14 times earnings -- and indeed, as of this writing the stock actually trades a bit above 14 times earnings on both trailing and forward bases. So does this mean it's time to sell?
Standpoint thinks no, and is only downgrading the stock to "hold." But I'm inclined to go a step further and say the stock does look sellable today. Projected long-term growth at Guess? is only 9% at this point, and while the stock's 2.7% dividend yield is certainly tempting, combined, these two numbers still don't add up to anything big enough to justify a 14 P/E.
Factor in now the fact that Guess?, like Delta, doesn't generate as much real cash profit as it reports for net income, and the stock's arguably even more overvalued than it already looks when valued on P/E.
Long story short, Standpoint's right to downgrade. The only question is whether the analyst cut Guess? far enough.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Guess?. The Motley Fool owns shares of Guess?.
