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 bad news for DuPont shareholders, as the price target gets cut. On the plus side, used-car salesmen Penske and Group 1 are both catching upgrades. We'll find out why in a moment, but first...
The bad news
The markets are up this morning, but shares of DuPont are sliding in the wake of a fourth-quarter earnings report featuring weak results in performance chemicals and solar panels, flat revenues overall, and a 70% decline in fourth-quarter profit (to $0.12 per share) from last year's levels. DuPont may have beaten analysts' consensus earnings number, but that's not keeping UBS from cutting its price target on the stock (already rated an unenthusiastic "hold") to $51.
Was the cut deserved? Sadly, yes.
While DuPont has many things to recommend it -- strong free cash flow of $3.06 billion and a generous dividend yield of 3.7% -- the negatives unfortunately outweigh the positives in this stock. DuPont, you see, already costs more than 14 times earnings, which is quite a steep price for a company only expected to grow earnings in the mid-single digits over the next five years. Even viewed in the most positive light, and valued on free cash flow instead of "GAAP earnings," its price-to-FCF ratio exceeds 14, and is probably too high to justify based on the growth rate. Add in a sizable debt load -- about $11.5 billion net of cash on hand -- and the only real reason to want to own this one is the dividend. And even then, only if you're willing to accept the risk that the stock itself will decline in value.
And now for some good news
Gladder tidings greeted shareholders of Group 1 Automotive and Penske Automotive this morning, as analysts at KeyBanc Capital Markets announced upgrades for both stocks ahead of their earnings reports next month. Let's take them one at a time.
Regarding Group 1, KeyBanc is rating the stock a buy and predicting a move to $77 per share within a year. If the analyst is right, that would be about a 13.5% improvement in stock price, on top of Group 1's modest 0.9% dividend yield. And KeyBanc may be right. After all, at just 15.4 times earnings, Group 1 looks pretty darn cheap relative to consensus earnings growth projections of 20.5% annually over the next five years.
But that's just the thing: Group 1's GAAP "earnings"may look good, but under the hood, this company is leaking cash badly. Free cash flow at the firm over the past year was a depressingly negative $164.5 million -- a far cry from the positive $104million the company claimed to be earning.
Result: KeyBanc may think Group 1 is a screaming buy. As for me, I can't recommend the stock until it's passed a full financial inspection and gotten its cash engine tuned up.
Can Penske win the race?
Moving along down car dealer alley, we come next to KeyBanc's other automotive retailing idea -- and while this one's not as big a lemon as Group 1, I'm afraid I can't endorse Penske Automotive for you either.
Penske costs a bit more than Group 1 -- 15.8 times earnings. But again, it's not GAAP earnings that are the issue here. It's cash flow. With $30 million of positive free cash flow generated over the past year, Penske's running smoother than Group 1. But that number still isn't big enough to back up the $185 million in GAAP profit that Penske claims to have amassed over the past 12 months.
As a result, once again the company's supposed growth rate of 17.8% fails to impress. Likewise, its 1.7% dividend yield, while attractive, simply doesn't justify the risk of investing in a company that's generating so little real cash profit from its business. KeyBanc says this one could go to $36, but given the weak cash production, even the prospect of getting a 12% gain on your investment (if KeyBanc is right, and I'm wrong) probably isn't worth the risk.
Fool contributor Rich Smith has no position in any stocks mentioned.
The article Wednesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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