Tuesday's Top Upgrades (and Downgrades)


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 price target hikes for plastic purveyors Visa and MasterCard . But the news isn't all good, so before we address those two, let's take a look at why one analyst thinks that...

Ulta Salon is falling out of fashion
Tuesday began on a down note for shareholders of Ulta Salon . Megabanker Goldman Sachs cut its rating on the stock from "buy" to "neutral," and knocked $5 off its price target to boot.

Why? Well, according to Goldman (and as related by StreetInsider.com), the sale of cosmetics over the Internet "has much potential given favorable characteristics for logistics and
replenishment, and given its dominance by brands." Goldman sees this as a mark in Ulta's favor. However, the banker also worries that Ulta will need to spend more on improving its e-commerce abilities if it's to take full advantage of its opportunities -- and that costs money.

Problem is, Ulta is already spending a lot of money. Capital spending ate up nearly $189 million of the $239 million in cash flow that Ulta brought in last year, leaving the company with free cash flow of only $50 million or so. That's far less than the $172 million the company claimed as GAAP net income for the year. And that means that the stock's already high P/E ratio of 33 should more realistically be looked at as a price-to-free cash flow ratio north of 110.

Even growing at 21.5%, as it's projected to do, that's a hard price to swallow. If you ask me, Goldman is right to downgrade -- and the only question is why the analyst didn't go even further and mark Ulta down to "sell."

Credit card companies: Don't leave home without them?
In happier news, two credit card companies received hikes in price target from analysts at Oppenheimer this morning. Both Visa (now projected to hit $200 a share within a year) and MasterCard ($625), are already buy-rated by Oppenheimer. The only thing that's changing, therefore, is that the analyst likes them both even more today than it did before.

But I still don't.

Don't get me wrong -- as businesses go, it's hard to think of better companies than Visa and MasterCard. They basically own the credit card space, and act as "tollbooths" to more and more consumer purchases with each passing day. Analysts have Visa pegged to grow its earnings north of 18% per year over the next five years, and expectations for MasterCard are nearly as strong. The problem, however, is valuation.

Priced at 50 times earnings, and paying a dividend yield less than 1%, Visa looks vastly overpriced even for its robust prospects of profits growth. MasterCard, growing slightly slower, costs much less -- but even at 25 times earnings, is no great bargain.

Adding to the riskiness of investing in these stocks, Visa generated less than half as much real free cash flow as it reported in net income last year -- meaning its P/FCF ratio is well over 100. MasterCard, on the other hand, generated more free cash flow ($3.3 billion) than reported profit ($2.8 billion) -- but that still gets the P/FCF ratio on that one down only to 21.

On balance, I have to say that I like the valuation at MasterCard much more than the valuation at Visa -- or perhaps I should say, I hate the valuation at MasterCard much less. That said, neither stock offers much potential for appreciation at today's prices -- and certainly not enough to justify the price target hikes that Oppenheimer is bandying about today.

Maybe that's the reason both stocks are actually declining in midday Tuesday trading. Maybe investors can just spot bargains -- or the lack thereof -- better than the "professional" analysts can.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends MasterCard, Ulta Salon, Cosmetics & Fragrance, and Visa. The Motley Fool owns shares of MasterCard and Ulta Salon, Cosmetics & Fragrance.


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