Wednesday's Top Upgrades (and Downgrades)

Wednesday'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 upgrades for CVS Caremark and B/E Aerospace . But it's not all good news. Before we get to those two, let's take a quick look at why one analyst is...

Logging out of LogMeIn
Remote computer access software maker LogMeIn isn't due to report quarterly earnings till February 13, but one analyst isn't waiting around to get hit with any bad news. With the shares up some 50% over the past 12 months alone, banker Cowen & Co. is taking the money and running -- and downgrading LogMeIn stock to market perform.

Why? Well, there are a couple of reasons why Cowen might be worried about LogMeIn's future. The stock's not currently profitable -- that's a big one. It's also in the middle of a pretty big change in business model. LogMeIn recently warned users that it is discontinuing the freemium model of offering its "Ignition" remote access software to users free of charge, in hopes they'll like it so much that they will upgrade to more robust paid versions of the software. Henceforth, the company is offering only week-long trials of the software, after which they must either pay up or log out.

This is a move calculated to convert more free moochers to paying users of the software -- but it also has the potential to slow adoption of LogMeIn's products, and perhaps pinch revenue growth as well.

Speaking of which, that's another reason to worry about the stock: growth. Unprofitable today, LogMeIn is generating positive free cash flow of about $13.2 million annually. If you think the stock looks expensive at 65 times free cash flow, and a 21% projected growth rate, you may not want to stick around and see what happens to the stock's price if LogMeIn's business model switcheroo has the effect of slowing that growth rate down even further.

Does CVS spell B-U-Y?
Turning now to happier news, shareholders of mega pharmacy chain CVS Caremark are enjoying a nice boost to stock price today in the wake of an upgrade to strong buy at ISI Group. Here, too, growth is the story, with ISI predicting it will be "strong" going forward -- perhaps even stronger than the 15% growth rate projected by the majority of analysts.

It had better be a lot stronger than 15%, however, to justify the price tag the market is hanging on CVS stock today, though. Priced north of 19 times earnings today, CVS shares may not look all that expensive for a growth rate around 15%. But looks can be deceiving.

The problem at CVS, in a nutshell, is that the company's not generating quite as much cash as its GAAP "earnings" number suggests. Free cash flow for the past 12 months amounted to only about $3.9 billion, or just 88% of reported earnings. Factor CVS's $8.6 billion net debt load into the picture, and this company is selling for an enterprise value of roughly 23.5 times free cash flow.

Even if you argue that a small premium is justified on the stock of an oligopolist like CVS, which controls about 23% of the U.S. prescription pharmacy market, it's hard to see how paying an even greater premium would be justified. ISI may be optimistic about the stock's chances. I am not.

Time for B/E to fly?
And finally in today's story of "growth" stocks, we come to airplane interiors-maker B/E Aerospace, recipient of an upgrade to buy from analysts at Topeka Capital this morning. As describes the ratings change, Topeka is upgrading B/E on the theory that "as a leading manufacturer of aircraft passenger cabin interior products and a global distributor of aerospace fasteners and consumables, the Company is well positioned to benefit from cyclical and secular drivers in the commercial aerospace market."

To that extent, we agree. A supplier to both of the world's major airplane builders, Boeing and Airbus, B/E has benefited from a surge in airplane buying of late. As Topeka rightly points out, compound annual revenue growth at B/E has averaged about 20% over the past seven years, with operating profits growing even faster at 30%. And yet, at a P/E ratio flying north of 25, the company's success appears to be fully baked into B/E's stock price already.

Going forward, analysts are extrapolating B/E's past success far into the future, pegging the stock for 19% annualized earnings growth over the next five years. On its face, paying 25 times earnings for a dividend-less stock growing at 19% seems a bit optimistic (especially given that key customers like Boeing, on which B/E's growth depends, are only expected to grow at 11.5%). But the situation may be even worse than that. Over the past year, B/E generated only about $0.67 in real cash profits for every $1 it reported "earning" under GAAP. At today's prices, the shares now sell for 38 times annual free cash flow -- pricey even if we take 19% future growth as a given.

To me, this looks like a case of "great company, overpriced stock," plain and simple. Topeka may be right about the stock continuing to surge in 2014, as it did in 2013 -- but I wouldn't bet on it.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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