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 downgrades for both airline Delta (DAL +0.03%) and electric car company Tesla (TSLA 2.16%). But on the bright side ...
Someone loves Seagate
Our big upgrade of the day is for hard disk drive manufacturer Seagate Technology (STX +0.00%), and you can thank the friendly analysts at Pacific Crest for it.
According to StreetInsider.com, Pacific Crest upgraded Seagate to "outperform" this morning, based on its belief that there's a big opportunity in cloud computing for "HDD" makers like Seagate, as they sell hard drives to provide the memory for all the server farms that create the cloud. At the same time, Pacific Crest thinks investors have focused too much on the risks posed to Seagate's business by declining personal computer sales.
As the analyst explains, the "top 9" cloud computing companies make up 35% of Seagate's revenues from business customers, and the money they spend generates profit margins 70% to 80% above what Seagate gets when selling hard drives to PC manufacturers. Thus, even if Seagate loses revenue from PCs, if it gains share in the cloud computing market it will be trading hi-margin revenues for low.
All of which sounds good -- but what about the price?
Well, Seagate shares currently sell for about 8.7 times trailing profits -- profits that may well understate the company's true profitability, given Seagate's established ability to generate free cash flow. These profits are expected to grow at roughly 7% annually over the next five years, according to S&P Capital IQ. With the stock yielding a nice, fat, 3.4% annual dividend, this suggests the shares are indeed underpriced -- and could indeed rise the 17% necessary to reach Pacific Crest's $53 price target.
Long story short: This looks like a good stock to go long on.
Mayday! Mayday! Delta going down!
And what about Delta Air Lines, which this morning found its rating cut from "buy" to "hold" by analyst Standpoint Research? Standpoint says it's taking profits on a trade that is up 100% so far this year. But could Standpoint be cutting bait too early?
Perhaps. After all, the numbers indicate that Delta might actually be on the ascent. This stock sells for less than 12 times earnings today, even as analysts polled by S&P Capital IQ continue to predict long-term earnings growth in excess of 28% per annum .
True, free cash flow at Delta is nothing to brag about. The $1.3 billion in cash profits the company brought in over the past year amount to only 73% of claimed "GAAP" income. But even so, the price-to-free cash flow ratio on this stock is still less than 16, which seems entirely reasonable in light of its projected growth rate.
In short, even if the stock has gained 100% this year, there could be even more gains in store.
Tesla running out of gas
If only we could say the same thing about Tesla Motors, whose run to $190 and change had it up more than four times the $35 and change its shares sold for back in January.
According to analysts at R.W. Baird, the stock's terrific run this year leaves Tesla now priced for "flawless execution." Granted, to date, Tesla has done everything right, successfully introducing its Model S sedan to the market (and to rave reviews), developing what Baird calls a "breakthrough battery technology, and establishment of a cutting-edge brand."
All that being said, the analyst notes that there are still several things that could trip Tesla up over the next 18 months: ramping production of the Model S, building and selling the Model X SUV, and of course, living up to investor expectations -- which, for a stock that has neither profits nor free cash flow to its name yet carries a $23 billion market cap, must be very high indeed.
Given that Tesla has been valued less like a business this year, and more like a concept -- electric cars are the wave of the future, and therefore you need to invest in the leading electric car company regardless of its price -- it's hard to say whether Baird is right or wrong about Tesla shares having no more room to run. All I can say for certain is that unless and until Tesla proves it can earn a consistent profit from its business, it's not a business that I would want to own.
