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 upgrades for both Quest Diagnostics (NYSE:DGX) and Panera Bread (NASDAQ:PNRA). The news isn't all good, however, so before we get to those two, let's find out why one analyst is...
Short-circuiting Tesla's run
Amidst all the enthusiasm (shares up 14%) over Tesla's (NASDAQ:TSLA) announcement yesterday that it achieved a 22% "non-GAAP gross margin" in the second quarter, one analyst is striking a sour note this morning. Reminding investors that indeed, yes, Virginia, valuation still matters, Barclays Capital announced this morning that it's downgrading Tesla shares to "equalweight."
Personally, if I were writing the report, I'd probably have downgraded even further than that. But at the very least, Barclays looks to be on the right track here.
Why? Let's look at just one little detail in Tesla's report, which seems to me just a wee bit hinky. According to Tesla, the second quarter saw the company hit 22% gross margins for the first time -- if, that is, you exclude the effects of not only ZEV credits, but also all "costs related to deliveries of Model S during the period not recognized in automotive cost of revenues but recorded in operating lease vehicles, net."
One effect of this caveat is to remove $123.9 million in costs from the "cost of automotive sales" line in Tesla's income statement. One more important effect is that it permits Tesla to claim it achieved a 22% "non-GAAP" gross margin, while a more traditional calculation of gross margin might show the company to be earning negative 5.3% gross margins. Combine this fact with the fact that Tesla showed negative operating cash flow for the second time in three quarters during the second quarter -- guaranteeing negative free cash flow for the company -- and at the very least I would say that "caution" should be the watchword for Tesla investors.
Barclays' downgrade is appropriate.
Quest for bargains
Happier news awaited investors in medical lab test company Quest Diagnostics this morning, as analysts at Maxim Group announced an upgrade to "buy," sending shares up 1.8%. Maxim sees Quest shares hitting $73 within a year. I don't know about that, but I do agree that the shares are undervalued.
Priced at 18 times earnings today, but only 11 times free cash flow, Quest shares are bargain-priced for analyst expectations of 12% annualized earnings growth over the next five years. Throw in a modest 2% dividend yield, and the stock's undervaluation only becomes more apparent.
Although I admit to having some reservations over Quest's $3.5 billion debt load, on balance, I think the shares are attractive -- certainly more attractive than Tesla.
Panera Bread: Stale, or a steal?
I wish I could say the same about today's other upgrade, but I can't. Early this morning, Wunderlich Securities announced that it is upgrading Panera shares from "hold" to "buy" and assigning a $212 price target. Problem is, Panera shares are already overvalued at $175 -- much less $212.
Panera's share price today values the company at 27.5 times earnings. Although it's true that analysts expect Panera to grow earnings in excess of 17% per year over the next five years, 27.5 times earnings is still a pretty high price to pay for that growth rate -- a price that may even be higher than it seems, given that over the past year, Panera has really only generated about $121 million in free cash flow -- $0.65 in actual cash profits for every $1 that the company claims to have "earned" under GAAP accounting standards.
Long story short, I think Wunderlich is giving too much credence to Panera's GAAP profits, and not paying enough attention to the company's (lack of) cash profits. Honestly, this is one stock I'd be more inclined to sell than to buy.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Panera Bread, Quest Diagnostics, and Tesla Motors. The Motley Fool owns shares of Panera Bread and Tesla Motors.