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 optimistic notes urging investors to buy shares of Exact Sciences (NASDAQ:EXAS) and Under Armour (NYSE:UAA). Before we get to those two, however, a few words are in order on why...
AMC Networks just got downgraded
Shares of trendy cable TV producer AMC Networks (NASDAQ:AMCX) are sliding in mid-day trading, down about half a percentage point in response to a downbeat assessment out of NYC-based equities research firm MoffettNathanson.
As quoted on StreetInsider.com this morning, Moffett is taking AMC to task for a "$43 million increase in National Network programming expenses" that the analyst says AMC has done a poor job of explaining, and that "remains inexplicable" today.
Worries Moffett: "Given the looming ramp in original scripted hours, and the company's unwillingness to provide greater cost detail" it's likely that "the continued shift of AMC Networks' schedules from licensed to owned originals will pressure cash flow conversion." Worse, as "hits becomes increasingly harder to come by," AMC may have trouble recouping these investments. (Ahem. Low Winter Sun," cough-cough), pressuring profit margins and hurting earnings.
Now, some might argue that at a share price of less than 15 times earnings, this risk is already baked into AMC stock -- but I don't think so. The reason: Real cash profits at AMC are far lower than the company's better-publicized $300 million in trailing generally accepted accounting principles "earnings" may lead investors to believe. In fact, according to S&P Capital IQ data, AMC generated only $40 million in real free cash flow over the past year -- mere pennies on the dollar when compared to the GAAP profits the company claims to have earned.
At a valuation of well over 100 times free cash flow today, these shares are a whole lot more expensive than they look on the surface -- and MoffettNathanson is right to downgrade them.
Overoptimistic about Under Armour?
Moving on from AMC, another popular brand name is getting a big boost in investor interest today, as Jefferies urges investors to pile into Under Armour. Calling UA the "it" brand of the decade, Jefferies opines: "we don't believe the market is factoring in the magnitude of UA's LT revenue growth potential. We think sales can exceed $15 billion over the next 10 years," and that the company could easily be earning $6 a share by 2024.
Notes the analyst: UA is "the top athletic choice for many men," has "resonance" with women, and a recent poll that the banker conducted found that 87% of the shoppers are "likely to purchase UA products in the next 12 months."
That's quite an endorsement for the sportswear stock. And yet, even Jefferies admits that the stock price remains "rich." Free cash flow-negative over the past 12 months, priced at 69 times trailing profits and 45 times what it might earn next year, UA shares carry a premium valuation for a dividend-less growth stock -- even one expected by many analysts to maintain a 24% annualized growth rate over the next five years.
From a valuation perspective, it's hard to justify making an investment in Under Armour shares at today's prices -- even with the shares down 15% from their highs of three months ago. While the company's growth potential is undeniable, I find myself unconvinced by Jefferies' argument that paying nearly 10x earnings that a company might (or might not) earn 10 years from now is a good way to make money.
Is Goldman Sachs exactly right or exactly wrong?
And speaking of cash-burners, we wrap up today's column with a recommendation from Goldman Sachs, which thinks it's time to buy small-cap bioresearcher Exact Sciences Corporation.
Praising the prospects of Exact's new "Cologuard" diagnostic test for detecting colorectal cancer, or CRC, Goldman argues that this stock has several near-term catalysts in the form of (1) an imminent approval of the screener by the FDA, (2) a compelling business model, and (3) an "undemanding valuation." Problem is, while it's hard to predict whether the FDA will approve Cologuard, it's even harder to say for certain that Exact Science has a good business model ... until it gets more of a business behind it.
Over the past 12 months, Exact Sciences has reported only a bare $3.4 million in revenues, and it's lost $51.8 million in the process of collecting them. Valuation-wise, the stock sells for infinity times the-earnings-it-hasn't-got, and for 347 times revenues.
Certainly, these numbers will change when and if Cologuard goes to market. And with the FDA Advisory Committee having already recommended approval, chances are good that it will go to market eventually. But for now, the sales that will result from this, and the profits Exact Sciences might earn on those sales, are entirely unknown, making an argument for buying the stock based on its valuation an exercise in wishful thinking. While this stock might make for an interesting speculation for venture capitalists, it's far too speculative for individual investors to consider buying.
Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case(s) in point: The Motley Fool recommends both AMC Networks and Under Armour, and The Motley Fool owns shares of Under Armour.