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 new buy ratings for tech stars SanDisk (UNKNOWN:SNDK.DL) and Netflix (NASDAQ:NFLX). But elsewhere the news isn't as happy. Before getting to the good news, let's take a quick look at why one analyst is...
Shifting Ryder into neutral
Shares of Ryder System (NYSE:R), owner of the famous Ryder Truck moving vehicle rental chain, are leading the market down this morning in response to a negative note out of Stifel Nicolaus. Downgrading Ryder from buy to hold, Stifel criticizes the stock's valuation after a year that has seen Ryder rocket 44% in market cap -- twice the gains of the broader S&P 500. This run-up leaves Ryder shares sells for a pricey 17.7 times earnings, which may not sound expensive, but really is, especially after you delve into the details.
About 17.7 times earnings means Ryder shares are about 25% more expensive than the P/E at rival rental truck provider AMERCO (NASDAQ: UHAL), owner of the U-Haul brand. That's especially worrisome given that Ryder carries a heavier debt load than AMERCO does (about $4.1 billion net of cash), and is currently generating no positive free cash flow whatsoever to service the debt. Free cash flow at Ryder for the past 12 months was, in fact, negative to the tune of about $478 million.
With a red-hot growth rate, maybe these valuations would cut the muster at Ryder. But with the stock projected to grow earnings at only 8% annually over the next five years, Ryder stock looks overpriced -- and Stifel is right to downgrade it.
Not much better at Netflix
Turning now to the day's "good" news, we begin with an upgrade for Netflix, courtesy of the friendly analysts at Pacific Crest. PC targets a $500 stock price on Netflix shares, arguing that international expansion will accelerate at the company over the next 18 months, leading to increased revenues at the video streaming company.
This isn't exactly an unpopular view. On average, analysts who follow Netflix project an astounding 50% annual profits growth rate at the company over the next five years. Problem is, this growth rate is pretty much assumed and taken for granted in the stock's price already -- leaving Netflix vastly overvalued if the growth fails to appear and pretty pricey even if it does.
Priced at a P/E of 182 today, Netflix shares sell for an even more premium multiple to their anemic free-cash-flow (positive $43 million if you don't count DVD library costs against the stock, or negative $23 million if you do). If paying triple-digit multiples for double-digit profits growth appeals to you, then Pacific Crest's recommendation to buy this stock may hold water. Personally, though, I think the stock's weak record on cash production, and the argument that the stock is actually burning cash, rather than simply generating too little of it, make for strong arguments against avoiding an investment in Netflix.
But a bona fide buy at SanDisk
Last and far from least, though, we come to a buy rating I think I can get behind: SanDisk.
SanDisk reported Q1 2014 earnings yesterday, with $1.44 in per-share profit exceeding analyst estimates by a good $0.19. Revenue likewise topped expectations, and SanDisk CEO Sanjay Mehrotra boasted of the company's "momentum" and "growth initiatives" going forward, which promise more of the same in quarters to come. This suggests that, in management's view at least, the analyst consensus of 12.5% long-term earnings growth potential for SanDisk (several points shy of the average in semiconductors) may be conservative.
This good news elicited an initiation of coverage at overweight from investment banker Piper Jaffray this morning. As reported on StreetInsider.com, Piper likes SanDisk's "favorable mix of higher-margin SSD revenue, which grew to 28% of revenue and was up 17% q/q," and particularly emphasized SanDisk's expectation for "25-35% y/y" growth in 2014 predicting profits this year will hit $5.73 per share -- and grow to $6.53 per share in 2015.
Naturally, all this good news is having an effect on SanDisk's stock price, which rocketed more than 10% today, giving the stock a 16.5 P/E today. Value the stock on free cash flow, though (which at $1.55 billion are even more impressive than SanDisk's GAAP earnings), and give the company credit for its large cash stash (at least $1.6 billion net of cash), and the stock sells for an enterprise value-to-free cash flow of not much over 11 -- cheap for analysts' consensus projected growth rate and incredibly cheap if growth comes in closer to Piper's estimate.
Long story short, even after today's post-earnings run-up, SanDisk stock looks like a bargain.
Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool recommends and owns shares of Netflix.