Wednesday's Top Upgrades (and Downgrades)

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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 include upgrades for both Denny's and Green Dot . But stocks can reach buy ratings in ways other than actual upgrades. So before we get to those two, let's first take a quick look at why ...

Hudson Square just rang up T-Mobile
Deutsche Telekom announced today that the merger of its T-Mobile USA subsidiary with MetroPCS Communications is complete -- and the newly merged company will now begin trading on the NYSE as T-Mobile US . No sooner had it done so than out came Goldman Sachs with a buy recommendation.

According to Goldman, the new T-Mobile "is likely to attract ... interest" from potential entrants into the U.S. communications market looking to buy a company. What's more, StreetInsider.com explains that Goldman is also looking at T-Mobile as "a business emerging from its trough on a number of metrics, with several positive inflections ahead," and therefore buying in its own right, and not just as a potential buyout target. But is Goldman right?


Well, let's see here. According to S&P Capital IQ, the new T-Mobile is a company with $19.7 billion in annual revenue, and $4.9 billion in earnings before interest, taxes, depreciation, and amortization, or EBITDA. That's about a 24.9% "EBITDA margin," which sits right in between the 22.7% EBITDA margin at AT&T and the 26.9% EBITDA margin at Verizon. So quality-wise, T-Mobile looks all right.

That being said, I wouldn't go out and buy the stock on Goldman's say-so alone. Nobody seems to have a firm handle on T-Mobile's valuation just yet. Yahoo! Finance hasn't yet been able to figure out the new company's market cap. Nor has S&P Capital IQ. Until we know the cost of the company, it's too soon to say whether its only average profitability offers superior value for the stock's investors. For the time being, let's just keep an eye on T-Mobile, but not buy just yet.

Order up at Denny's
I'm more confident, though, in the upgrade to "buy" we saw at Denny's today, from the analysts at Feltl & Co.

Denny's just got finished reporting an earnings beat, which is certainly a good start. And if the stock appears a bit pricey at 25 times earnings, I think Denny's superior free cash flow (which at last report was running about twice as high as reported "net income") and strong 19% predicted profits growth rate suffice to make the stock look attractive.

Up-to-date free cash flow numbers aren't out at Denny's just yet, but based on the $45 million in annual FCF it was generating as of last quarter's report, I'd say the stock looks cheap at a price-to-free cash flow ratio of less than 12, and even at an enterprise value-to-free cash flow ratio of close to 16. Nineteen percent growth is fast enough to erase a multitude of overvaluation sins -- and so long as Denny's can maintain a growth rate such as it's projected to produce, I'd say Feltl is right: The stock looks buyable.

Green Dot upgrade is on the mark
Wrapping up with probably the trendiest, "sexiest" name on today's Wall Street buy list, we find prepaid card pioneer Green Dot shares skyrocketing on an earnings beat, raised guidance, and today, an upgrade to "buy" from Compass Point.

Compass loves the fact that Green Dot's "Wal-Mart linked revenue increased 11% from the prior year quarter following 14% growth reported in 4Q'12 -- despite facing competition from American Express in each quarter."

Sure, at 16 times earnings, the stock looks a wee bit overpriced relative to 14% growth assumptions. But as Compass points out (and I agree), "the shares still screen cheap at 8.6x our estimate of this year's EPS excluding unencumbered cash and at 9.4x our estimate of this year's free cash flow adjusted for unencumbered cash." Green Dot, by the way, produced free cash flow of $48 million over the past 12 months, comfortably ahead of its $46 million in reported net income. According to the company, its "unrestricted cash" -- what Compass calls its "unencumbered cash" -- came to $370 million.

Back that cash out of the firm's market cap, and you'll quickly see: Green Dot is fully as cheap as Compass says it is.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends American Express.

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The article Wednesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.

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