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 big dividend payers getting upgrades -- Verizon (NYSE:VZ) and Dominion Resources (NYSE:D). Also, we've got one dividend-less wonder getting downgraded:
Under Armour (NYSE:UAA)
Shares of sportswear company Under Armour are under pressure this afternoon, down more than 2% as of this writing, and most likely in response to a downgrade to "neutral" out of Credit Suisse.
According to CS, UA shares have only "limited potential... over the next 12 months due to the company's current premium valuation." Priced at a lofty 63 times earnings -- and a nosebleed-inducing 120 times its inferior levels of free cash flow -- UA shares appear vastly overpriced, even for their projected 20%-plus projected long-term earnings growth rate.
Incidentally, despite downgrading the shares, CS agrees that UA has a "good long-term revenue and earnings growth outlook," and is benefiting from "multiple expansion in the athletic sector." But there's a limit to how far such things can expand. Even giants of the industry, like Nike and Adidas, only cost 25x and 31x earnings, respectively, while Columbia Sportswear sells for a modest 19 times earnings.
Costing multiples 2x to 4x what its competitors' earnings fetch, UA shares are priced to go nowhere for some time to come -- or even to fall.
Verizon places a collect call
Speaking of stocks that look like they cost a lot of money -- Verizon -- the nation's second biggest telco by revenues, costs a staggering 88 times earnings today, or more than three times the P/E at larger competitor AT&T. And yet, this morning, we find analysts at Evercore recommending that investors buy Verizon. Why?
As you can probably guess, Evercore sees Verizon's acquisition of total control over Verizon Wireless as a big plus for the company -- and it may be right about that. Although Verizon will be taking on a heaping helping of debt to finance its purchase of Vodafone's (NASDAQ:VOD) share of VW, what it gets out of the purchase may be worth even more.
According to S&P Capital IQ, Verizon Wireless earned $16.7 billion last year, and generated nearly that much cash profit, as well -- $16.3 billion. That's more than 10x the GAAP profit of its new sole owner, and nearly as much free cash flow as Verizon-proper generated, as well. Focusing only on GAAP earnings, post-merger, we should be looking at a company earning enough profit to give it a debt-adjusted P/E of less than 15 (and an even cheaper P/E if you don't count the debt -- which you should).
Long-term growth rates are expected to approximate 10%, and the company pays a 4.6% dividend yield. Assuming these numbers, too, hold true post-merger, the stock looks, at-worst, fairly valued. If free cash flow comes anywhere near the levels I expect a Verizon-in-full-control-of-Verizon-Wireless to produce, the stock could be even cheaper than it looks.
In the kingdom of high, P/Es, Dominion's the king
Want to see a company that makes even Verizon's 88 P/E look reasonable, and Under Armour's 63 P/E look almost quaintly "cheap?" Take a gander at electric utility Dominion -- recipient of an upgrade of its own today, this time, from JPMorgan.
Dominion's price-to-earnings ratio simply staggers the mind, coming in at 142 -- and this for a rather mundane utility stock that's expected to grow earnings at a plodding 7% pace over the next five years. Free cash flow at the firm... well, I'd tell you about it if there was one. But over the past 12 months, Dominion's actually burned cash -- and, indeed, it's been a consistent cash burner since way back in 2002. (This fact lends itself to all sorts of wild imaginings about how the company really generates its electricity -- but I'll leave those aside for now).
What's significant here is that, despite a consistent failure to generate real cash profit from its business, Dominion shares have held up well, and indeed climbed pretty steadily over the past decade -- a fact that's been helped by the company's continued payouts of strong dividends, which currently yield about 3.9%.
JPMorgan seems to think the company will be able to keep this game running, and maybe even improve its business, now that Dominion has won permission from the U.S. Department of Energy to begin running liquefied natural gas exports out of its Cove Point LNG facility on the Chesapeake Bay.
Are they right? I don't think so. Personally, if looking for a good, dividend-paying utility play, I'd be more inclined to invest in something like Duke Energy (NYSE:DUK), which at least produces a free cash flow-positive year every now and again, helping it to pay out even bigger dividend checks than Dominion produces (and at a trailing P/E of only 23, to boot). But to each his or her own.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Dominion Resources, Under Armour, and Vodafone. The Motley Fool owns shares of Under Armour.
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