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 a pair of new ratings from Chinese brokerage house CLSA, which has upgraded marquee tech names BlackBerry (BBRY 3.10%) and NVIDIA (NVDA 2.94%). Before we get to those two, however, let's take a quick look at a "tech" stock of a different type entirely -- defense contractor United Technologies (UTX +2.89%).
Goldman guns for United Tech
United Technologies shares are enjoying a nice boost this morning in reaction to a bullish note from investment banker Goldman Sachs. Cited on StreetInsider.com this morning, Goldman is quoted praising UTC as "a market leader in its non-residential construction market" and "well positioned in a strengthening Commercial Aerospace aftermarket" as well. The analyst thinks that difficulties with pension costs and unfavorable foreign exchange rates are both behind the company now, while weak construction markets in Europe may also be turning around -- helping to boost demand for the company's products.
What it all adds up to, in Goldman's view, is the potential for UTC to earn $6.89 per share this year, then grow that net 14% in 2015 and a further 10% in 2016. If Goldman's right about that, then it would appear analysts predicting an average rate of 11% profits growth for the company over the next five years may be underestimating the stock's earnings potential -- and acting on that belief, Goldman is rating the stock a buy.
But is it right to do so?
I don't think so, and I'll tell you why. Valued on GAAP earnings, UTC shares sell for nearly a 19 times multiple today. That's expensive whether you believe the consensus estimate of 11% long-term growth, or (what is effectively) Goldman's estimate of 12%. Worse, free cash flow ($5.2 billion) at UTC currently lags reported GAAP income ($5.7 billion) by about 9%. So the company's arguably even more expensive than it looks on the surface.
Long story short, while I agree with Goldman Sachs that United Technologies is a good business and that its business prospects are looking up -- the stock's still too expensive to own.
Time to pick up BlackBerry?
Turning now to the real tech stories of the day, this morning, CLSA announced a rather strange "upgrade" for shares of smartphone maker BlackBerry. According to the analyst, "the company has a decent shot at BES10/12 adoption with a richer Android/iOS offering and losses are likely to improve." The stock, says CLSA, is accordingly worth closer to $9.50 per share than the $6 CLSA was previously valuing it at.
That said, CLSA warns that "the mobile device management (MDM) industry is too small, fragmented, and commoditized to justify a bullish stance." Accordingly, the most CLSA is prepared to do for BlackBerry is upgrade the shares from an out and out "sell" rating, to a still underwhelming "underperform."
That's hardly surprising. Unprofitable currently and not expected to earn a profit anytime in the foreseeable future, BlackBerry remains a stock in shambles. The company has large cash reserves and continues to generate some small amount of free cash flow, however -- $286 million over the past year -- and, as long as that remains true, hope for its survival isn't entirely misplaced. But free cash flow has been headed downhill for quite a long time already, and could easily turn negative if this trend persists. With no hope of GAAP profits and a real risk of cash burn, it's hard to see much reason to want to own this one, either.
Don't envy NVIDIA
Last but not least, we come to NVIDIA, a real tech stock star, whose shares have gained 47% over the past year -- more than twice the average on the S&P 500. This morning, CLSA called a halt to NVIDIA's advance, however, initiating coverage with a $19 price target and the same "underperform" rating it now assigns to BlackBerry. But is NVIDIA really in as bad a shape as BlackBerry?
I don't think so, no. While at 25 times earnings, NVIDIA shares are arguably no longer cheap, the stock has a whole lot more going for it than BlackBerry does. Free cash flow is $610 million, or 39% better-than-reported net income. The company has $3.3 billion in net cash and an enterprise value-to-free cash flow ratio of only 11.5. Between the stock's 1.9% dividend yield and its 8.8% projected growth rate, this means the stock arguably sells for a slight discount to its intrinsic value -- and undeserving of a sell rating.
All that being said, NVIDIA stock has made a lot of gains in the past year, even as its free cash flow number has posted two straight years of declines. Personally, I own the stock myself, but with NVIDIA's FCF on a downtrend and the growth rate looking modest at best, I believe the days of this stock offering a compelling bargain are at an end.
