This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today, we'll be looking into why one analyst, UBS, has initiated coverage on two brand-name consumer goods stocks -- Clorox (CLX 0.28%) and Energizer Holdings (ENR 2.30%) -- with sell ratings. Then, on a "lighter" note, we'll examine SunEdison (SUNEQ), a solar power stock that's been receiving a whole lot of upgrades on Wall Street lately.
But first, the bad news.
Clorox can't get the red out
Markets are soaring Tuesday in a sharp rebound from Monday's sell-off. One stock that's more or less sitting out the rally, though, is Clorox. Up just a fraction of 1%, the stock appears to be held back by a new announcement out of Swiss banker UBS that it's initiating coverage of Clorox shares with a sell recommendation. Why?
According to UBS, Clorox has limited prospects for organic growth that will keep its revenues in check. Meanwhile, higher prices for the inputs for its products could squeeze profit margins, potentially shrinking its bottom line. This all adds up, in UBS' mind, to little reason to buy the stock and plenty of reason to sell.
Priced in excess of 20 times trailing earnings, and with weak free cash flow that backs up only about 89% of reported earnings, Clorox is pegged for only about 7.5% annualized earnings growth over the next five years. That's not enough to support the stock's 20-times earnings multiple -- and certainly not its 22 times multiple to free cash flow. While the stock's 3.3% dividend yield offers some downside protection (the dividend yield will swell as the stock price declines), Clorox is pretty clearly overpriced already. Chances for further growth in the share price look poor.
Will Energizer run out of juice?
UBS has similar concerns about Energizer Holdings, and thanks partly to the banker's decision to rate the stock a sell, Energizer shares are declining as the rest of the market rises. But in this case, I think UBS' worries are misplaced.
Priced at just 15.5 times earnings, Energizer shares are significantly cheaper than Clorox's. Meanwhile, the stock's projected growth rate of 6.3% annualized is not that much worse than Clorox's. The key here is that with strong free cash flow of $634 million, Energizer is about 65% more profitable than its $385 million "GAAP income" number makes it appear.
At a price-to-free cash flow ratio of just 9.4, growing at 6.3% and paying its shareholders a 2.1% dividend yield, I don't consider Energizer any great "bargain" of a stock. But it's not as clearly overpriced as Clorox is.
My one real concern about Energizer is that with $1.5 billion in net debt, the company's a bit more heavily leveraged than I'd like to see. Given that its chief rival is Duracell, owned by the much better capitalized giant Procter & Gamble, Energizer really needs to be running a leaner ship if it hopes to compete effectively. The good news is that with so much free cash flow at its disposal, the decision to pay down debt and "get lean" is one Energizer can probably make at will.
Will SunEdison also rise?
And finally, we turn to the stock that Wall Street likes today -- and likes a lot. Over the past two weeks, solar power company SunEdison has reported a strong earnings beat and been rewarded with upgrades by price target hikes at Needham & Co and Goldman Sachs, plus upgrades at FBR Capital, and now, this morning, at Morgan Stanley as well.
Once primarily a maker of silicon wafers for other solar power firms farther downstream, SunEdison has reinvented itself as a builder and manager of solar power plant projects -- a business that now provides more than half of its revenues. Morgan Stanley believes that this "commercial-scale market" for solar power is growing and offers an opportunity for SunEdison shareholders to grow with it. Accordingly, the analyst rates SunEdison stock overweight.
This analysis accords with recent comments from Goldman that revenue growth is "accelerating" at SunEdison, and with Needham's prediction that "SUNE is able to scale its business and monetize projects developed through multiple means, including direct sale, yieldco, securitization, and other forms of financing."
But I disagree.
Notably, while both Needham and Goldman were singing the praises of SunEdison's long-term prospects, they lowered their near-term estimates for SunEdison's profits. Personally, though, I tend to put more weight on actual results than on promises to achieve actual results in the future -- and at SunEdison, actual profits have been hard to come by. The company hasn't booked a GAAP profit since 2010, and has been burning increasing amounts of cash as it tries to build a utility-scale business. Last year, operating cash flow ran negative to the tune of more than $720 million. Combined with the company's near-$600 million in cash outlays for capital improvements, free cash flow exceeded $1.3 billion. Meanwhile, SunEdison itself already owes its creditors about $3 billion more net of cash on hand.
Granted, these kinds of numbers are typical all across the cash-burning solar power industry. But that still doesn't make these numbers "good." And it's still not a good reason to buy SunEdison.
Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Procter & Gamble.