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 downgrades of industrials companies B/E Aerospace (NASDAQ:BEAV) and 3D Systems (NYSE:DDD). But the news isn't all bad. In fact, let's start off the day on a bright note.
A new upgrade for Angie's List
On a down day for markets generally, shares of the contractor recommendation site Angie's List (NASDAQ:ANGI) are going on a tear. Wunderlich Securities upgraded Angie to buy this morning, setting a $15 price target on the $12 stock, and predicting that "improving sales productivity, traction with the e-commerce marketplace, and the rollout of tiered pricing to all markets" will boost profits.
In its most recent quarterly report, Angie's List CFO Tom Fox touted "member and revenue growth, as well as our generation of cash from operations." With nearly $15 million in operating cash flow, Q1 was Angie's most cash-profitable quarter ever. Even after subtracting capital expenditures, S&P Capital IQ data show the company generated $12.6 million in positive free cash flow -- a much better result than the $3.8 million "GAAP" loss would suggest.
That being said, trailing free cash flow still has Angie pegged at just $5.2 million in cash profits for the past year. The stock therefore trades for a sky-high valuation of more than 130 times FCF -- a most optimistic valuation, even with analysts projecting a 31%-plus long-term growth rate for the company.
So is Wunderlich wrong to recommend it? It all depends on how easily Angie can replicate its Q1 success. Were the company to put together a string of four "Q1-like" quarters in a row, Angie would be churning out close to $60 million in annual cash profits, and selling for about 12 times FCF -- an incredible bargain. On the other hand, if future results resemble trailing results, the stock still would look expensive.
My advice: Look very closely at Q2 results when they come out next month. A return to negative free cash flow will probably warn us if Q1 was a fluke. Continued cash profitability, on the other hand, may confirm for us that Wunderlich is on to something.
B/E gets a "C"
Turning now, reluctantly, to the day's bad news, we begin with B/E Aerospace. You've probably heard by now that the company is giving up on its plan to sell itself whole to an acquirer -- pretty much every would-be acquirer on the planet having already gone on record saying they're not interested. And well... it seems Wall Street is starting to lose interest as well.
This morning, not one, but two separate analysts -- Jefferies & Co. and Canaccord Genuity -- pulled their buy recommendations from B/E stock. Jefferies couched its downgrade in "valuation" terms. Quoted on StreetInsider.com today, Jefferies said it sees a "sum-of-the-parts" value of just $97 in the shares. Canaccord put the likely price tag on B/E, one year from now, at $98. Notably, both of these estimates are slightly above today's share price of $93 and change. But the average difference -- the potential gain from buying the stock at today's levels -- is a mere 4%.
For investors who can buy an S&P index fund and expect to earn long-term average returns of 10% or thereabouts, the prospect of a 4% gain from a risky, undiversified investment in a single stock, probably isn't worth the effort -- the more so given that B/E doesn't even pay its shareholders a dividend.
Long story short, the analysts see no reason to buy B/E shares today, and neither do I.
And so does 3D
A second stock losing its Street-approved buy rating this morning is three-dimensional printer manufacturer 3D Systems. Yesterday, 3D Systems updated its fiscal 2014 outlook, predicting that revenues for the year will come in somewhere between $695 million and $735 million, while pro forma earnings per share could range from $0.73 to $0.80. Both number ranges appeared to be above Wall Street estimates -- but there's always some uncertainty about "pro forma" numbers, and in today's market, investors seem reluctant to give 3D Systems the benefit of the doubt.
Consequently, 3D Systems shares dipped about 1.8% in response to the news yesterday. Taking its cue from what everyone else was doing, analysts at Gabelli cut their rating on the stock one notch, to hold. Meanwhile, analysts at RBC Capital cut their price target on the stock by $14, to $64 a share (but with the stock trading at $49 and change today, RBC maintained an outperform rating on the company).
So it seems we're getting some mixed messages from Wall Street on 3D Systems today. On the one hand, both analysts seem unenthused by the company. On the other hand, 3D Systems appears to be upping its estimates for this year's sales and earnings -- and even RBC says it expects to see more money on the "bottom line."
Even so, I think caution remains to be the watchword of the day. Even if things are looking up at 3D Systems, the stock remains shockingly overpriced for any but the most speculative investors. Its $43 million in GAAP profits give the stock a P/E ratio of close to 120. Its weak free cash flow -- barely a quarter of reported GAAP profits, according to data from S&P Capital IQ -- gives 3D Systems a price to free cash flow ratio of well over 400. Even if analysts are right about the company's projected growth rate, which is still expected to average north of 20% annually over the next five years, that valuation is far too high to give investors any reasonable expectation of earning a profit on a long-term investment.
Gabelli is right to downgrade 3D Systems. RBC is right to be cutting its price target -- and just to be safe, should probably cut it even further.
Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool both recommends and owns shares of 3D Systems.