This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, international banker Barclays takes a dim view of China's mobile telephony sector, downgrading both China Unicom (CHU +0.00%) and China Mobile (CHL +0.00%). Meanwhile, on the bright side of things...
3D Systems gets a new fan
Yesterday we told you about how investment banker Pacific Crest was warming up to three-dimensional printing pioneer 3D Systems (DDD +1.59%). Today, the company won a second fan: megabanker Deutsche Bank threw its support behind the stock as well.
Initiating coverage with a "buy" rating, Deutsche posited a $95 price target for 3D Systems' stock. According to StreetInsider.com, Deutsche is arguing that a company's "sales ratios coupled with DCF [is] the best way to value 3D printing stocks. [With] the shares trading at 14x our EV to FY-14E sales, which is in line with other high-growth software and Internet companies," Deutsche views the stock as a buy at anything under $95.
I disagree.
As I said yesterday, 3D is clearly a better operation than rivals Stratasys and ExOne, neither of which currently generates a red cent's worth of positive free cash flow. But even 3D is no great shakes when it comes to generating cash profits -- or at least, it's not generating enough cash to justify even its current share price of $80 and change, much less the $95 valuation that Deutsche ascribes to it. Priced today at nearly 180 times free cash flow, the stock's quite simply overpriced for a long-term growth rate now estimated at 20%.
Long story short, just because 3D is less of a "sell" than Stratasys or ExOne, that doesn't make it a "buy."
And speaking of selling ...
For the past several days, all the talk in the tech markets has been about how China's biggest telecom company, China Mobile, may soon start taking orders for the iPhone from its customers. And yet, while this sounds like good news, somebody is not impressed with the "Chinese growth" story at all.
This morning, Barclays Capital announced that it's decided to go negative on both world's-biggest telecom China Mobile, and smaller rival China Unicom as well. Both stocks got downgraded, with Barclays assigning an "equalweight" rating to China Unicom, and an even more pessimistic "underweight" rating to China Mobile. The ratings are having the exact effect you'd expect them to have, with both stocks taking a dive this morning.
But is this deserved? Let's find out.
China Mobile
After all, at a price-to-earnings ratio of just 10.5, China Mobile hardly looks overpriced today. Sure, analysts have the company pegged for 2.5% annual declines in earnings over the next five years. But even so, the company's massive cash stash (Yahoo! Finance has the company loaded up with $72 billion in cash, against only $4.6 billion in debt) would suggest the firm could at the very least "buy growth" sufficient to offset these declines with share buybacks, should it be so inclined.
Meanwhile, China Unicom at 23 times earnings is sporting a 41% projected earnings growth rate. That suggests the smaller player, too, may have considerable room to grow. So isn't Barclays being too harsh here?
Perhaps not. Take China Mobile, for example. China's biggest mobile phone provider reported earning $21.2 billion in profits over the past year. But its actual free cash flow for the period was only $7.6 billion -- so the company's actually only taking in about $0.36 in real cash profit for every $1 it claims to be "earning." Valued on these real profits, therefore, the stock's actually selling for closer to a 28x multiple than to the 10.5 "P/E" that meets the eye. Fact is, even if we give China Mobile credit for its sizable cash stash, the company's enterprise value-to-free-cash-flow ratio is an unappetizing 19.8.
Barclay's probably right, therefore, that at this high price, the stock will underperform the market going forward.
China Unicom
In contrast to its negative view of China Mobile, Barclays seems sanguine about the prospects of China Unicom, downgrading that one only to the equivalent of a "hold" rating. But contrary to what you might expect, the numbers at Unicom actually look worse than what we find at Mobile.
To cite just two examples, while Mobile is sitting on a cash hoard, Unicom's net debt levels stretch to $18.4 billion. And while Mobile is generating less free cash flow than its GAAP profits numbers suggest, Unicom is actually burning cash -- negative free cash flow of $1.4 billion over the past year. Negative free cash flow... in each of the past five years!
When you consider, finally, what China Mobile's entry into the iPhone market might do to hobble China Unicom's supposed "40%" growth rate, I think the picture gets even bleaker for Unicom. That's why, although I agree with Barclay's decision to remove its "overweight" rating the stock, I'd personally be more inclined to sell than to merely "hold" it.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends 3D Systems, ExOne, and Stratasys. The Motley Fool owns shares of 3D Systems, China Mobile, ExOne, and Stratasys and has the following options: short January 2014 $20 puts on 3D Systems.
