Please ensure Javascript is enabled for purposes of website accessibility

Thursday's Top Upgrades (and Downgrades)

By Rich Smith - Sep 26, 2013 at 3:40PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Analysts shift stance on Diamond Foods, Blue Nile, and Intrepid Potash.

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 new buy ratings for Diamond Foods (DMND.DL) and Blue Nile (NILE) -- but...

Not for Intrepid Potash
Might as well get the bad news out of the way first, and with its shares down 1.5% in midday trading, today does look likely to be a bad day for shareholders of Intrepid Potash (IPI 2.50%). StreetInsider.com is reporting today that BMO Capital just downgraded the stock to "underperform," even as it left its price target unchanged at $11 a share.

Why downgrade now, after the stock's already lost 25% of its value over the past year? Simply put: There's no time like the present.

You see, Intrepid Potash shares have experienced a recent surge from prices that began, in early August, very near to BMO's target price. Trading just shy of $16 today, the shares cost more than 16 times trailing earnings -- which may not sound expensive, but is, and for two reasons:

First, those earnings are expected to decline at Intrepid Potash. Most analysts agree the company is likely to experience about a 5% annual rate of profits shrinkage over the next five years. Second, even the profits Intrepid Potash currently reports as "earnings" may not be worth as much as you think. Despite reporting GAAP profits of $74 million over the past 12 months, Intrepid Potash actually experienced negative free cash flow of about $147 million. FCF was negative last year as well, and in truth, it's been about five years since the last time Intrepid Potash produced real free cash flow of close to the $74 million in GAAP profits it's claiming today.

Long story short, the stock's not as cheap as it looks. BMO is right to recommend selling it. So let's turn now to a couple of stocks that Wall Street believes are worth more than they now cost. We'll begin with:

Blue Nile 
...which just caught an initiation of coverage from B. Riley & Co. Riley thinks the stock, currently at $41 and change, will soon be worth $49 a share, and recommends buying it. I think they may be right.

Priced at 54.5 times earnings today, Blue Nile doesn't look cheap on the surface -- not even with a growth rate projected at "only" 21%. What's key here is that Blue Nile is one of those diamonds in the rough that generate more cash profit than they're allowed to report as "net income" under GAAP. To be precise, Blue Nile generated $22.9 million in positive free cash flow over the past 12 months, even as it reported "earning" only $9.7 million.

That works out to a price-to-free cash flow ratio of only 22.7, or an even more attractive enterprise value-to-free cash flow ratio of 19.7. (Enterprise value gives a company credit for any extra cash it has on hand, by deducting the value of that cash, minus any debt, from the market cap.)

Assuming Blue Nile achieves the 21% growth rate that Wall Street is giving it credit for, I think the stock's cheap enough to buy, and I think B. Riley is right to recommend it.

Diamond Foods -- less than sparkly
In contrast, I'm less enthralled with Diamond Foods, which despite being upgraded to "buy" at BB&T Capital Markets this morning, looks somewhat less than gem-quality to me.

Diamond's not currently profitable under GAAP accounting standards, although it does produce positive free cash flow -- about $10 million over the past year. If you ask me, though, that's still far too little cash to justify the stock's heady $553 million market cap -- or the $1.07 billion the enterprise is valued at, with debt included.

Adding to the reasons for caution, most analysts seem to have this food products stock pegged for just 7% annual growth over the next five years. (S&P Capital IQ is a bit more optimistic, quoting its analysts as projecting 12% growth, versus the 7% figure shown on Yahoo! Finance.) Whichever number you believe, though, it's not nearly fast-enough growth to support a 55 times price-to-free cash flow ratio, or the more than 100 times multiple you get when calculating Diamond's enterprise value.

My take: Diamond Foods may be valued like a Tiffany -- but the stock's 100% pure cubic zirconium.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Blue Nile.

None

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Diamond Foods, Inc. Stock Quote
Diamond Foods, Inc.
DMND.DL
Blue Nile, Inc. Stock Quote
Blue Nile, Inc.
NILE
Intrepid Potash, Inc. Stock Quote
Intrepid Potash, Inc.
IPI
$45.50 (2.50%) $1.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
400%
 
S&P 500 Returns
128%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/15/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.