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 top headlines run the gamut -- from U.S. drugstore chain Rite-Aid (NYSE:RAD) to Russian steel concern Mechel (NYSE:MTL)and back home again to utility company Consolidated Edison (NYSE:ED). Let's tackle this hodgepodge of companies in order, beginning with...
Rite stock, wrong time?
Our first stop on today's stock shopping spree is Rite-Aid, which just received a new outperform rating from analysts at Imperial Capital. As reported on StreetInsider.com today, Imperial is picking Rite-Aid on the theory that the company is smack dab in the middle of "a successful multi-year turnaround strategy with opportunity for further gains in the years ahead." Cash flow and profits are on the upswing and, according to Imperial, are likely to improve further "as older stores are remodeled, loyalty programs expand, and operational efficiencies take hold."
And I agree -- sort of.
On the one hand, there's clearly improvement afoot at Rite-Aid. Gone are the days of GAAP losses and negative earnings. Rite-Aid today generates positive free cash flow at the rate of $414 million a year -- $100 million more than even its GAAP earnings suggest. But, honestly, my main objection to the stock isn't its performance but the price being charged to own a piece of the new-and-improved Rite-Aid.
Rite-Aid shares, you see, cost 16.5 times earnings today. That's easily twice what you'd ordinarily want to pay for a projected 8% grower like Rite-Aid. Worse, its P/E doesn't take into account the company's still-large debt load -- nearly $6 billion net of cash. Factor that into the picture, and Rite-Aid is selling for an "enterprise value" closer to 36 times earnings, or 27 times free cash flow.
Whichever way you look at the valuation, this is a high price to pay for 8% growth. It's too high to justify a buy rating, I fear.
Mighty, mighty Mechel
Russian steel-and-coal mining magnate Mechel engenders similarly mixed feelings. In a startling 180-degree reversal, the stock just caught an upgrade to buy from Citigroup, which had previously rated the stock a sell. But if you ask me, Citi should have stuck to its guns.
Sure, Mechel achieved positive free cash flow last year after three straight years of burning cash. But Mechel remains in the red from a GAAP perspective -- as it has been for three of the past five years. Free cash flow remains tenuous (Mechel burned cash in Q1 of this year, for example). Most disturbing of all is the debt.
Valued at a market cap of less than $1 billion, Mechel carries more than $9.5 billion in net debt. The company's paying out nearly $670 million a year in interest payments alone, which is not a good situation to be in when you're already generating operating losses in excess of $1.1 billion. It's even less desirable when you've got barely $170 million in the bank with which to try and keep up with the interest obligations.
Personally, I wouldn't go long this stock. Not even if Mechel succeeds in getting creditors to defer interest payments for a year, as Reuters says may happen. And not even with a recommendation from Citi.
Consolidated Edison: Coming unraveled?
Last and -- with the possible exception of Mechel -- least, we come to utility company Consolidated Edison.
Citing fears that ConEd will be unable to reach a settlement in its ongoing electric, gas, and steam rate case, investment banker Jefferies announced that it's giving up hope and cutting the stock from hold to underperform today. Jefferies thinks ConEd will be seeking better rates from the state next year, but for now, it will probably have to content itself with a court decision guaranteeing it a 9% return on equity for the next year.
On the one hand, that's not horrible news. ConEd currently boasts a ROE of only 8.6%, according to Yahoo! Finance, so a move to 9% would be a small improvement. The question is whether it will be enough of an improvement to move the needle on analysts' expected five-year, long-term earnings growth rate of just 1.7% -- and I fear it will not be.
While it's true that ConEd holds some attraction for dividend investors -- the company pays a 4.2% divvy -- the stock's 16.1 P/E ratio still looks too rich for the stock's anticipated growth rate. Rival AEP (NYSE:AEP), for example, costs more at 20 times earnings, but is growing twice as fast as ConEd and pays a dividend (4.1%) nearly as rich. Plus, AEP is generating at least some positive free cash flow ($523 million) versus the negative FCF currently reflected on ConEd's books.
Long story short, I don't think ConEd looks particularly attractive relative to its rival -- or all by its lonesome, either. I think Jefferies is right to downgrade the stock.