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 upgrades for a couple of the globe's biggest aluminum producers -- Century Aluminum (CENX +8.42%) and Alcoa (AA +0.00%). On the downside, though, UnitedHealth Group (UNH +1.03%) just got hit by a downgrade. In fact, let's jump right in and start with that one.
No good deed...Insurer UnitedHealth Group gave analysts what they were looking for last week, reporting "in-line" fourth-quarter earnings of $1.41 per share on $31.1 billion in revenue (slightly ahead of estimates). Management furthermore confirmed that it still expects to earn between $5.40 and $5.60 per share this year. But this news was not what analysts had hoped to hear.
At least not one analyst. Responding to UnitedHealth's warning that Medicare reductions required by the Affordable Care Act will keep a lid on growth in the current year, analysts at Monness, Crespi, Hardt today downgraded their rating on the nation's biggest provider of Medicare plans to sell. That hardly seems fair, given that this is a problem not of the company's making. But it might be the right decision nonetheless.
Priced north of 13 times earnings today, UnitedHealth already sells for a small premium to the 8% growth that analysts expect it to produce over the next five years. But with the company promising essentially no earnings growth at all in the current year, even that 8% growth projection may come into question.
Long story short, even with a modest dividend yield and decent free cash flow, I don't see a strong case for buying into UnitedHealth with its significant debt load and iffy growth prospects. To me, an insurer such as WellPoint (WLP +2.52%), with a better balance sheet, better dividend yield, and lower P/E, makes more sense as an investment.
Will the 21st be Aluminum's Century?
Moving on to happier news, analysts at JPMorgan Chase are becoming markedly more bullish about the prospects for Century Aluminum. Citing "tightening aluminum markets and rising Midwest premiums" today, JP said it sees "a significant amount of earnings support to the company's primary aluminum smelting operations."
The potential for earnings improvement is so great, in fact, that it convinced JPMorgan to swing 180 degrees from an underweight rating (i.e., sell) all the way over to overweight (buy) -- and to more than double its price target to $13 per share. But should you follow JP's lead?
I don't think so, and here's why.
First off -- that $13 price target. If you haven't noticed yet, JPMorgan's yawp of support for Century has already moved the stock's price to within pennies of the analyst's new price target for the year. This suggests there's very little prospect for profits left in the stock, even if JPMorgan turns out to be right. Yet it may not be right about Century.
After all, while greater demand for aluminum might help Century in the future, as of today this company remains deeply unprofitable and is working toward completing its fourth unprofitable year out of the past six. True, free cash flow is positive. But with less than $7 million in cash profits generated over the past year, it's hard to justify the stock's current $1.1 billion market capitalization -- much less the richer market cap that JP is promising -- on free cash flow alone.
Can't wait for Alcoa
Heedless of the illogic of recommending the unprofitable Century, however, JPMorgan rushed right out this morning and recommended a second aluminum maker to boot: Alcoa. Here, the analyst took a global view, citing "recent producer capacity curtailments and ... China's likely production profile." In a nutshell, JP noted that while it is true China produces more than enough excess aluminum (1.5 million tons annually) to supply the metal's deficit in the rest of the world (1.1 million tons), little of this extra supply is likely to leak onto world markets due to China imposing a 15% export tax on aluminum shipments abroad.
As a result, JPMorgan noted that pricing premiums on aluminum have been rising in certain U.S. markets. If this continues, it has the potential to expand Alcoa's profit margin, as well as Century's.
Be that as it may, Alcoa is going to have to get a whole lot more profitable if it's to deserve even its current valuation, much less a higher one. Priced at 44 times earnings, and 58 times earnings if you factor the company's net debt into the valuation, Alcoa shares are being valued as if the 32% annualized earnings growth that analysts like JPMorgan expect had already happened -- and was certain to continue happening.
On the one hand, this suggests there's little potential for the shares to rise in value if JP's proven right about the aluminum market -- because the good news is already baked into the stock price. On the other hand, there's every chance that Alcoa will fall if JPMorgan is proven wrong.
