Thursday'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 a couple of (completely different) "tech" companies -- Alliant Techsystems and Akamai Technologies . Meanwhile, despite buyout talk, Men's Wearhouse gets downgraded. Let's start with that one.
No cheap suit
Tackling the tough news first: Men's Wearhouse got hit with its second downgrade in less than a week when Stifel Nicolaus cut its rating to hold this morning. The stock's holding up pretty well, with a share price that's so far treading water and avoiding the worst of today's sell-off. Still, there's good reason for Stifel to be skeptical of the potential for MW shares to go higher.
As you probably recall, rival suit seller Jos. A. Bank bid $48 a share -- $2.3 billion total -- to acquire Men's Wearhouse last week. MW management promptly dismissed the bid as "highly opportunistic" and a "significant" undervaluation of the retailer's stock. Ordinarily, this would suggest that the target company intends to hold out for a higher price, that the buyer will have to pay it, and that therefore Men's Wearhouse shares are likely to go up.
In this case, however, Jos. A. Bank's bid already richly values a company whose slow growth and low profit margins make it a less-than-ideal acquisition candidate. At nearly 20 times earnings, MW may not look much more expensive than Bank (whose own shares sell for 21 times earnings). But given that Men's Wearhouse earns an operating profit margin of only 7.9 percentage points (22.5% lower than what Bank earns) and is only expected to grow its profits 8% annually over the next five years (31% slower than Bank), the buyer's bid looks pretty generous to me already.
Might Bank be so desperate to own Men's Wearhouse that it ups its bid and drives the share price higher? Sure. But Stifel doesn't seem to think this will happen (it's telling investors to only hold the shares, not to buy in anticipation of a better bid), and neither do I.
Bargains in "tech"?
Now let's switch gears and take a look at our two "tech" stocks. We'll start with Akamai, a company built to facilitate the efficient delivery of digital content over the Internet.
Investment banker D.A. Davidson just upgraded Akamai to buy, and set a $62 price target on this $52 stock. According to the analyst, Akamai is "leveraged" to growing demand for content as more and more people pile online, and as they consume more and more content through their electronic devices. As a macro theme, this is sound reasoning. But is the price right?
Unfortunately, no. At the most basic level, Akamai looks dreadfully overvalued with a P/E ratio of 38 but a growth rate of only 14%. Dig a little deeper, and the valuation proposition improves... somewhat. Akamai's robust free cash flow (31% better than reported GAAP earnings) and hefty cash reserves mean that when viewed in the most favorable light, the stock's enterprise value-to-free cash flow ratio is "only" 26.6.
If you ask me, though, that's still about twice the price I'd want to pay for a 14% grower (the rate analysts agree on over its next five years). In short, Akamai needs to grow about twice as fast as analysts think it can to be worth the price its shares cost today. And the $62 that Davidson thinks these shares will fetch a year from now?
Not going to happen.
Turning finally to our other "tech" stock, Alliant Techsystems, here we're dealing with an entirely different kind of tech from that which Akamai hawks.
Selling rockets, bombs, ammunition, and the high-tech trappings of modern military equipment, Alliant's tech tends more toward the hardware side of things, and to government contracting. As such, its prospects have definitely improved now that the government shutdown is out of the way. But I'm not sure they've improved enough to justify RBC Capital's assigning the stock an outperform rating and a $122 price target.
Sure, on the one hand, I admit that the stock looks initially attractive. Alliant sells for only 12.2 times earnings. Like Akamai, Alliant also boasts superb free cash flow -- $331 million over the past 12 months, well ahead of its $273 million in reported GAAP earnings. Unlike Akamai, it pays its shareholders a modest 1% dividend yield.
Alliant's growth rate, however, is a mere 6.4% (projected by analysts). RBC may believe that this rate will increase as the company makes inroads into the consumer guns business, buying first long-guns manufacturer Savage Sports and more recently Bushnell. However, such expansion comes at a cost. Alliant already carries a sizable slug of debt -- about $1.2 billion net of cash. That debt load's likely to increase as the acquisitions roll in.
Meanwhile, if you ask me, Alliant's making its hunting and target-shooting purchases near the top of the market for such companies: immediately following an Obama administration-inspired rush to buy guns 'n' ammo, approaching the end of that rush, and with little certainty as to whether the next president will inspire similar fears (and full shopping carts) among firearms aficionados.
Result: When I look at Alliant Techsystems today, I see a cheap but slow-growth company with high and rising debt, overpaying for acquisitions in an industry likely to decline. And I see little reason to buy the stock.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Thursday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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