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 ratings at the intersection of tech and housing, as vacation rental facilitator HomeAway (NASDAQ: AWAY) scores an upgrade and Zillow (NASDAQ:ZG) goes down. But first, a few words about why...
FTD may be a buy
Mother's Day is just a couple weeks away, and in honor of the spring season, Monness, Crespi, Hardt announced today that it was initiating coverage on flowers-by-phone provider FTD (NASDAQ:FTD). With the company priced at just $31 and change today, Monness sees FTD shares climbing to $39 over the course of the coming year -- a roughly 24% profit for investors who buy in now. But is this rating all it's cracked up to be?
At first glance, the answer would appear to be "not by a long shot." FTD's high P/E ratio (47 times earnings) doesn't look particularly attractive. But looks can be deceiving.
One thing FTD has going for it, which doesn't show up in the P/E, is a rapid earnings growth rate of about 30% annually over the next two years, according to Capital IQ estimates. Also arguing in the stock's favor is the fact that FTD generates far more cash profit than it reports as generally accepted accounting principles earnings -- about $23.4 million in positive free cash flow, versus net income of only $12.5 million.
What this works out to, in a nutshell, is a company selling for about 25 times earnings, but growing at 30%; that's a pretty nice value. What's more, FTD's trailing free cash flow actually looks depressed below historical norms. Cash production levels in 2010, 2011, and 2012, for example, were all far superior to the 2013 number. It wouldn't take much more than a return to prior-year profits to prove analyst suggestions of FTD's growth prospects correct -- and to make FTD the buy than Monness says it is.
Speaking of buys...
A second tech-ish company winning plaudits on Wall Street this morning is HomeAway, which war upgraded to outperform by FBR. As relayed by StreetInsider.com, FBR sees "continued, healthy, near-term listings growth" at HomeAway contrasting with a 27% dive in share price from the "late-February peak. It thinks the stock's a buy, and potentially worth as much as $45 a share.
But is FBR right?
Hard as it may be to believe, HomeAway shares cost so much that they almost make FTD's 47 P/E look cheap. Valued on ($18 million in) trailing profits, HomeAway sells for a P/E ratio of 194. But here again, looks may be somewhat deceiving. Free cash flow at HomeAway is a robust $85 million -- nearly five times reported GAAP income. Value the stock on free cash flow, and credit the company for its ample cash reserves of $391 million, and I get an enterprise value-to-free cash flow ratio of just 35 on HomeAway shares.
That's a whole lot cheaper than HomeAway's triple-digit P/E ratio makes the stock look. Personally, I'm not quite convinced that it's cheap enough to justify a buy, given that long-term profit growth at the company is expected to average only 25% annually. But should the shares continue to sag despite FBR's endorsement, the stock may be worth a closer look, and sooner than we may think.
Last and, in the opinion of one analyst, least, we come to online real estate listings service and valuation calculator Zillow. CRT Capital downgraded Zillow to fairly valued this morning, and I think that's the right move -- albeit still a bit optimistic.
Over the past year, Zillow shares have gained 74% in price, despite the fact that the company is showing no GAAP profit whatsoever and generating only $9 million in trailing free cash flow (for a price-to-free cash flow ratio of 443). Zillow stock has zoomed well beyond CRT's price target of $96 already, and since there seems to be no good argument for raising that target, CRT is making the logical observation that at today's share price of $105 and change, the stock no longer offers investors much reason to buy.
I agree -- but I'd go a bit farther. Analyst estimates for future growth at Zillow currently circle near 50% annualized. That's a high bar to clear. It may be doable in the short term, when Zillow is growing earnings off of a small base. Longer term, however, the company's ability to keep growing earnings as such a fast clip will be called into greater question. Even if the company succeeds, paying a triple-digit multiple to free cash flow, for even a fast double-digit growth rate, doesn't seem prudent.
Consequently, CRT Capital is right to downgrade the stock.