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 downgrades for Tyson Foods (TSN 0.07%) and Coca-Cola Enterprises (NYSE: CCE). Before we get to those two, though, a bit of happy news for investors in new IPO GrubHub (GRUB +0.00%).
Wall Street chows down on GrubHub...
As quiet periods expire for recent online food-ordering service IPO GrubHub, Wall Street began publishing comments on the stock this morning -- with near-unanimous approval. At last count, 4 out of 5 analysts surveyed -- Raymond James, Canaccord Genuity, BMO Capital, and Citigroup -- all rate the stock as the equivalent of a buy. (And the fifth, Morgan Stanley, thinks the shares are at least fairly priced.)
Price targets currently range from $36 to $40 among the stock's fans, suggesting potential profits of as much as 22.5% for buyers today. But will those profits materialize?
Honestly, it's hard to be optimistic. Based on the $6.7 million in GAAP profits that GrubHub reported last year, the stock trades for a nosebleed valuation of 382 times earnings. Free cash flow is stronger than GrubHub's income statements suggest, granted -- but only strong enough to push the price-to-free cash flow ratio on this one down to about 70. Long story short, GrubHub's going to have to show blockbuster growth in order to justify the prices investors are already paying for it today, much less achieve the 22.5% share price growth that Wall Street is predicting for it. Given that similar-in-business-idea online restaurants reservation service OpenTable is only pegged for 14% long-term profits growth, I'd say the chances of GrubHub growing at 70% are basically slim to none.
...but turns chicken on Tyson
Turning away from that "good" news to the "bad" news of the day, ratings-wise, we begin with Tyson Foods. Tyson's the subject of a downgrade to "market perform" at BMO Capital this morning (yes, the same BMO that's singing GrubHub's praises). The good news here, though, is the reason for the downgrade.
BMO, you see, has a $43 price target hanging on Tyson stock. With Tyson shares up 73% over the past year, however, the stock has already achieved most of what BMO had expected from it. Hence, today's downgrade is more of the "mission accomplished" variety than a "Houston, we have a problem" situation. Put plainly, since the stock has hit its target price, BMO thinks you should wait for a pullback to cheaper prices before buying any more.
I agree. Priced at 18 times earnings, but projected to grow at only 7% over the next five years, Tyson shares look more than fully valued to me. The company's a strong cash producer, granted. Free cash flow last year hit $944 million, exceeding reported net income by about 10%. But that's still not enough excess cash to bridge the gap between the stock's double-digit P/E ratio and its single-digit growth rate.
Fact is, with Tyson paying shareholders only 0.7% in dividends to stick around in hopes of better share prices, I'd even go a step further than what BMO is advising. At today's prices, I'd be much more inclined to cash out my shares and take some profits, rather than merely hold an overpriced stock in order to collect the dividend.
Coca-Cola Enterprises losing its fizz?
Finally, we end with a few words on Coca-Cola Enterprises, bottler to the gigantic Coca-Cola Company (KO +4.32%) proper. Priced at less than 19 times earnings, Coca-Cola Enterprises looks a bit cheaper than its more famous partner (whose P/E is closer to 22). But according to analysts at Nomura Securities, Coca-Cola Enterprises carries some pretty sizable risks -- more than the cheaper valuation justifies taking.
Specifically, "recent cost increases for Coca-Cola Hellenic signal a more aggressive stance by the brand owner," Coca-Cola Company. And if the latter raises prices on soda pop concentrate for Coca-Cola Enterprises, as Nomura fears it will, this will squeeze profit margins for the bottler. Citing concerns about Coca-Cola Enterprises' "ability to achieve both volume and price growth" so as to pass on and dilute the effect of price increases on concentrate, Nomura is cutting its rating on the bottler's stock to "reduce."
As sell ratings go, that's not a huge vote of no confidence in Coca-Cola Enterprises -- but it does appear to be the right decision. Costing more than 18 times earnings, Coca-Cola Enterprises is expected to grow earnings at less than 11% annually over the next five years. That's a steep valuation for unexceptional growth already. And if Nomura is right -- if margins are due to be squeezed, while sales growth struggles -- then it could well be that Coca-Cola Enterprises will fall short of even 11% growth. That suggests that the shares, already seemingly pricey, could actually be more expensive than they look.
Considering Coca-Cola's heavy debt load ($3.5 billion, net of cash) and weak record of cash production (about $0.80 in cash profit generated for every $1 in net income reported last year), I just don't see enough margin of safety in this stock to justify taking the risk of buying it.
Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and OpenTable. The Motley Fool owns shares of Coca-Cola and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola.
