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 T-Mobile (TMUS 0.32%) and Krispy Kreme (KKD +0.00%), but a lower price target for Annaly Capital (NLY 1.38%). Let's dive right in, beginning with why...
T-Mobile gets put on hold (and that's a good thing)
Last week's news that T-Mobile has begun adding net new subscribers for the first time in four years -- and begun stealing customers from AT&T to boot -- is forcing a bit of a rethink on Wall Street. This morning, analysts at Oppenheimer relented on their "underperform" rating, and upgraded T-Mobile shares to "perform," essentially a hold rating.
Why? According to Oppenheimer, T-Mobile has just about completed phase 1 of its LTE network upgrades, which could slow down its costs-growth. The analyst also likes the fact that customer churn is down at the company, and to top it all off, the valuation doesn't look half bad. Two of those comments are valid. Unfortunately, the point about valuation isn't one of them.
By all indications, business is indeed turning around at T-Mobile. And yet, the company remains a money-losing operation, and while costs may come down in the future, right now, T-Mobile's cash flow statement is still showing negative free cash flow at the company.
Fact is, even if you take Oppenheimer's statement at face value, and assume T-Mobile will reduce capital spending to, say, the $2.8 billion annual level it was spending from 2010 to 2012, that still only gets T-Mobile up to perhaps $800 million to $900 million in annual free cash flow. Factoring in the company's debt load, that's a 27 times free cash flow valuation at best. I think that's too high a price to pay for the 12% annualized growth that analysts expect T-Mobile to produce over the next five years. Long story short, while I'm a very satisfied T-Mobile customer myself... I would not buy the stock.
Don't get upset. Here... have a doughnut
Is there a better bargain out there? Actually, maybe, yes. Or at least, Janney Capital Markets thinks it has found one. This morning, Janney announced it is upgrading shares of Krispy Kreme Doughnuts to "buy."
According to Janney, Krispy Kreme is blowing revenue predictions out of the water, with second-quarter sales up perhaps 10.5%, or nearly twice the 6% the analyst had been expecting. Profits are also on the upswing, with Krispy Kreme hiking its full-year guidance to as much as $0.63 per share back in May, and Janney suggesting even $0.64 isn't out of the question. The analyst sees big things coming down the pike, as well, saying next year's earnings could be $0.73, and predicting additional stores-growth through 2017 will keep the growth machine going.
All of this optimism is having exactly the effect you'd expect it to have on the stock, with Krispy Kreme shares up nearly 8% in midday trading. And yet, with the shares now costing 70 times earnings (and a less expensive, but still pricey, 34 times free cash flow), I have to say -- it's starting to look to me like stock in this fresh, hot doughnuts vendor is getting a bit overheated.
Many analysts agree with Janney's predictions for Krispy Kreme's future profits, and yet, the consensus still adds up to "only" 25% annualized profits growth for the next five years. While that's certainly an admirable pace, I have my doubts about its ability to support a 34 times price-to-free cash flow ratio -- much less a 70 P/E. Seems to me, savvy investors are better advised to use the price spike resulting from Janney's upgrade as an opportunity to cash in some chips.
Annaly going down?
And finally, we come to the big "bad" news of the day -- and the news investors seem to be studiously ignoring, as they bid up Annaly Capital Management shares by nearly 0.8%.
Last week, as you may recall, Annaly Capital announced it had earned $0.47 pro forma in second-quarter 2013, or $0.15 ahead of analyst estimates. CEO Wellington J. Denahan warned that a "sell-off in the bond market put pressure on asset values during the 2nd quarter," yet argued the company remained in a strong position to keep earning profits because of its "focus on prudent risk management and the evolution of our capital allocation strategy." Nonetheless, analysts at Wunderlich decided this morning to cut a dollar off their price target on the stock, lowering it to $12.50.
So far, investors appear to be siding with management and against the analyst call -- and it's not hard to see why. At a P/E ratio of just 3.5, Annaly shares hardly look expensive today, especially not once you factor in the stock's mammoth 13.4% dividend yield. On the other hand, most analysts tend to agree that there are risks in Annaly shares, and predict we will see earnings decline, not grow, for the foreseeable future -- averaging 4.3% declines each and every year over the next five.
Still, bad as that sounds, a 13.4% dividend should pay for those earnings declines quite handily, assuming Annaly can keep up the payments. For now, I have to say I'm more inclined to side with Annaly's fans than with its detractors.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days.
