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 blue-chip stocks ExxonMobil (NYSE:XOM) and The New York Times (NYSE:NYT). We'll get to both of those in a moment, but, first, a few words about...
Over the past week, we've seen shares of former Canadian tech star BlackBerry twice endorsed by Wall Street as first CLSA, and then Cormark upgraded the stock. Today, we get the counterpart to that sentiment, as French investment banker slaps a sell on the stock.
According to StreetInsider.com, which reported on the ratings move this morning, SocGen is warning investors that "[s]ervices revenues will also be down almost 13% sequentially as subscriber accounts continue to fall" in BlackBerry's next earnings report. The analyst sees no chance of a turnaround in the immediate future, and thinks that the entire company is worth perhaps $6 a share -- cash, patents, and services business included.
That's significantly less than BlackBerry shares sell for today (close to $9). But the really bad news is that the longer you wait, the less these shares may be worth.
Currently unprofitable from a GAAP perspective, the company is still generating free cash flow at the rate of $286 million a year. On a market cap of $4.6 billion, that works out to a seemingly not expensive 16 times price-to-FCF ratio. But cash production at BlackBerry has been in decline for some years now, and few analysts see any hope of this trend reversing. The longer the company remains in business, the less cash it's likely to retain -- and the lower its sum-of-the-parts valuation will fall. Given this risk, SocGen's advice to sell the stock and look for a better business to invest in seems to me the right advice.
Is Exxon a better business?
Speaking of cash, free cash flow plays the largest role in my decision not to follow Merrill Lynch's advice to buy ExxonMobil today. This morning, Merrill announced an upgrade on Exxon's stock, arguing that its current $95 and change valuation is too low, and that the stock could hit $110 within a year.
That's certainly possible, but I wouldn't bet on it, and here's why: Exxon shares currently sell for about 13 times earnings. Long-term earnings growth, however, is expected to average just 3% per year over the next five years. So even with a 2.7% dividend yield, 13 times earnings looks expensive.
Now consider further that while Exxon reported earnings of $32.6 billion last year, its actual free cash flow was only $11.2 billion. It's apparent, therefore, that the quality of the earnings Exxon is reporting is exceedingly low. For every $1 in profits the company reports, it collects only about $0.34 in actual cash profit -- and that makes the its price-to-free cash flow ratio a very pricey 37 times. That's significantly more than a 3% growth rate can justify, and it's why Merrill is wrong to rate the stock a buy.
None of the news that's fit to invest in
Last and least, we come to Evercore's endorsement of The New York Times Company -- and if you can believe it, this one's an even worse investment idea than Merrill's Exxon pick. This morning, Evercore Partners argued that at $16.65 per share today, the stock's a good bet to hit $18.50 within a year.
But take a look at the numbers here. With $65 million in trailing earnings, "The Grey Lady" is selling for 40 times earnings today, a high price to pay for a growing company with high-quality profits. And yet, The New York Times is neither of those things.
It's not growing. Analysts expect GAAP profits to decline by about 6% annually over the next five years.
And its earnings are not of high quality. Rather, free cash flow at The New York Times totaled a bare $18 million over the past 12 months, or about $0.18 for every $1 of reported earnings.
Result: Valued on earnings and especially valued on real cash profits, the company's simply not worth owning at all. Evercore's recommendation to overweight the shares is dead wrong.