This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we begin with a quick look at why lululemon athletica (NASDAQ:LULU) just got its target price cut. Then we'll move on to examine a little-known relationship between Mobile Mini (NASDAQ:MINI) and Waste Management (NYSE:WM). Let's dive right in, beginning with...
Is this stock a lemon?
Yoga-wear brand lululemon athletica is due to report Q1 earnings on Thursday, and analysts seem confused about what to expect.
Canaccord Genuity doubled down on its buy rating on the stock this morning, encouraging investors to buy now and ride the stock to $69 over the course of the next year. Canaccord notes that lulu is unlikely to report any gains in same-store sales for the quarter, and sees little chance of an improvement in guidance for the rest of the year, either. But the analyst argues that "an inline Q1 coupled with... unchanged full year guidance should be viewed positively." And if that's how things work out, the 28% of the stock's float that is sold short could result in a short squeeze that will propel the stock upwards.
Meanwhile, analysts at DA Davidson are more cautious. Like Canaccord, Davidson is reiterating a buy rating on lulu stock today. Unlike Canaccord, Davidson is cutting its price target on lulu to $56 a share -- hedging its bets against the risk of worse news that Canaccord expects we will see.
Davidson is right to worry.
On the one hand, you can't discount the possibility that a short squeeze will result from lulu's news. That 28% short interest represents millions of shares' worth of positions that could be closed at any moment. On the other hand, though, I suspect that lululemon's business may be worse than anyone realizes -- and that the shorts are right.
Priced at about 23.6 times earnings today, lulu shares already carry a premium valuation relative to the 16.6% long-term earnings growth that analysts expect them to produce. (Yes, I said it. Even after losing nearly half their value over the past year, the stock is still overpriced). But the situation is even worse than that. Lululemon's cash flow statement confirms that the company generated only $172 million in free cash flow from its business over the past year, which is more than $100 million less than the company reported for "net income" under GAAP. In other words, the company is really only about 61% as profitable as meets the eye.
Long story short, I'd probably rather be short this stock than long.
Waste not, but should you want it?
Our next stock is neither an upgrade nor a downgrade per se. Think of Deutsche Bank's new "neutral" rating on Waste Management as a vote of no confidence in the stock being a buy. According to the analyst, this is because Waste Management stock will probably be "range bound for the foreseeable future."
Why? America's biggest trash hauler by revenues, Waste Management is a behemoth of industry. But with $14 billion in annual sales, it's got precious little room left to grow. Most analysts who follow Waste Management (Deutsche included) doubt the company will manage much more than 6% annual earnings growth over the next five years. Even combined with the stock's generous 3.4% dividend yield, that only adds up to an argument for paying perhaps 10 times earnings for the stock -- yet Waste Management sells for 130 times earnings.
Now, things aren't quite as bad as this makes them sound. Waste Management throws off a tremendous amount of cash from its business -- $1.2 billion over the past year. But even so, this works out to a 17-times multiple to free cash flow, and an even higher multiple to FCF if you could the company's $9.9 billion debt load against it.
Long story short, I don't see much value in a Waste Management investment today. But this still doesn't explain why I'm mentioning the stock in the context of...
If you've moved house any time in the last 10 years, chances are you're familiar with the new set of "portable on-demand storage" companies that have been disrupting the traditional U-haul model of moving. When preparing to move, you call up 1-800-Packrat or PODS, and have them drop a big storage container in your driveway. You then load it up at your leisure, have it taken away to a storage depot -- then delivered to the driveway of your new home just as soon as you've bought one.
Packrat and PODS are probably the two most recognizable brand names for residential "storage" of this type. And as it turns out, S&P Capital IQ tells us that Packrat is actually a subsidiary of Waste Management! (A small subsidiary within a large conglomerate). But there's a third firm in this market, which while serving residential customers, tends to focus more on upscale "boxes" for use in the construction industry. Its name is Mobile Mini, and it's the subject of a new buy rating from Deutsche Bank.
Quoted on StreetInsider.com this morning, Deutsche says it sees "30% upside" in the stock, which currently costs $47, but which Deutsche thinks can hit $57 within a year. Deutsche loves the "new, highly capable management team" which it says is turning Mini into the "best-in-class" mobile storage company, and predicts the company will grow its earnings at about 27% annually over the next five years.
For the record, that's nearly twice the rate of growth that most analysts project for Mini over the next five years. If Deutsche is right about the growth rate, though, then it's almost certainly also right about the stock being a buy.
Mobile Mini generates considerable free cash flow for such a small company -- $107 million over the past year. At $2.2 billion in market cap, this works out to about a 20-times multiple to cash profits for the company, and a bargain price for 27% growth. Meanwhile, the stock is currently unprofitable from a GAAP standpoint, so it's unlikely many investors were considering the stock prior to this upgrade. Kudos to Deutsch Bank for point out the potential.
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 Lululemon Athletica, Mobile Mini, and Waste Management. The Motley Fool owns shares of Waste Management.