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 feature a pair of downgrades for lululemon athletica (NASDAQ:LULU) and Roadrunner Transportation (NYSE:RRTS). But the news isn't all bad, so before we get into that news, let's find out first why one analyst thinks...
Green Dot hits the spot
Shares of prepaid card provider Green Dot (NYSE:GDOT) are leading the market downturn this morning, dropping despite a price target hike from research shop Compass Point.
Compass thinks that's a mistake. Green Dot announced yesterday that it's taking over General Electric's (NYSE:GE) GE Capital Retail Bank role of supporting reloadable prepaid cards branded for Wal-Mart (NYSE:WMT). Green Dot is buying the business's assets and taking control of all deposits underlying Wal-Mart's cards at par.
Compass Point likes the deal, for no sooner did the news come out than the analyst hiked its price target to $23. On top of the Wal-Mart deal, Compass Point notes that "1Q'13 EPS beat our expectations and the consensus earnings estimate." Meanwhile, Compass sees a buyout of Green Dot as distinctly possible, and at a higher valuation than the shares command today, based on the fact that "direct competitor NTSP was sold to TSYS in late February for $16 per share representing a valuation of 20x forward EPS and 13.9x trailing EBITDA."
Granted, at 18 times earnings and a projected long-term growth rate barely breaking 8%, the stock looks pricey in its own right. Under the buyout scenario, though, Green Dot's forward P/E is only 15. Thus, Green Dot shares could still have as much as 33% upside in them before they reach the valuation NTSP sold for -- and could be worth even more than the $23 that Compass Point now posits.
Is LULU a lemon?
Turning now to the bad news, yogawear maker Lululemon beat earnings estimates last night, but still managed to upset investors badly with news that its CEO is jumping ship. This has analysts at Sterne Agee and UBS turning bearish on the shares, and downgrading to "neutral." It also prompted cuts in target price -- to $87 apiece -- from Janney and Canaccord Genuity this morning.
My take: It couldn't have happened to a nicer (read: "more overpriced") stock.
Thanks to the costs incurred in pulling too-sheer pants off its shelves a few months ago, Lululemon showed no earnings growth whatsoever in the most recent quarter. But even assuming it gets its rear back in gear, and grows at the 23% annual rate that analysts are still predicting, the stock would look overpriced at 37 times earnings, and an astounding 50 times free cash flow. Long story short, there's no scenario -- growth or no growth -- in which I see these shares as costing anywhere near what they're really worth. Even after today's 17% tumble, the stock still has room to fall further.
Can Roadrunner escape the coyote's clutches?
Last but not least, we come to the very tricky question of whether Roadrunner can keep running. Over the past year, this "asset-light transportation and logistics service" has produced 66% profits for investors who've held it. Ace investment banker Stifel Nicolaus is downgrading the shares today to "hold," and taking profits on a "buy" rating that's worked out very well indeed.
But why? At 23 times trailing earnings, and analyst expectations of 65%-plus annualized profit growth (according to estimates here), Roadrunner still seems to sell for a hefty discount. And true, free cash flow at the firm is a bit weak -- about half of reported net income -- but a 65% growth rate can cover up a multitude of sins, low-quality earnings being one of them.
Could it be that Stifel is bailing too soon? I don't think so. Rather, I think the "65%" projected growth rate is due to some buggy data. Looking at estimates given by S&P Capital IQ, you'll find that most analysts there actually see Roadrunner growing earnings 21% this year, then 19% in 2014, then about 10% in 2015. Mind you, these are all entirely respectable growth rates. Still, they're a far cry from "65%" growth each year over the next five years.
When faced with such vastly different projections for a stock's future earnings, my instinct is to err on the side of caution. If Roadrunner somehow manages to produce 65% annualized growth -- all well and good. But if its growth rate falls closer to 20% or less, then Roadrunner stock appears overvalued at 23 times earnings, and even pricier at 40-plus-times free cash flow.
So my advice here would be to heed Stifel's advice, and stay away from the stock until the picture here gets a bit clearer.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends lululemon athletica. The Motley Fool owns shares of General Electric.