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 improved price targets for two consumer favorites: Nike and Darden Restaurants . But the news isn't all good. Before we get to those two, let's take a quick look at why one analyst is no longer ...
Stuck on Gluu
After watching shares of mobile games maker Glu Mobile rocket 72% over the past year, analyst B. Riley is declaring victory and calling it quits this morning.
According to StreetInsider.com, Riley cut its rating to neutral today -- and it's not hard to see why. Just two months ago, Riley predicted that Gluu shares would hit $3.75 per share within a year and recommended buying them. Two months later, the shares had climbed past $4 a share, achieving all the analyst had hoped they would achieve -- and more -- 10 months ahead of schedule.
But should investors stick around in hopes of more gains to come?
Riley seems to be voting "no," and I agree. With no GAAP profits to its name -- no profits earned ever, at any time in the past decade -- Glu may have turned in great returns as a stock, but as a business it's anything but great. The company's burning through its cash reserves at the rate of nearly $15 million a year, and unless something changes it will be out of cash within just two years. Personally, I'd bail before that happens.
Next up, Nike
Nike reported $0.59 per share in profits for fiscal Q2 earlier this month, a penny better than expected, and largely thanks to an improvement in gross profit margins. Sales, however, fell short of estimates, rising only 8% year over year, as inventories climbed 11%.
Weighing the results, analysts at Argus Research appear to be more impressed with the earnings "beat" than with the sales miss, and today announced they're hiking their price target on the already buy-rate stock by four dollars, to $88 a share. I think that's a mistake.
Priced at close to 25 times earnings today, Nike shares look overvalued relative to 12% anticipated annualized earnings growth. Plus, the $2.3 billion in net income the company has reported earning over the past three reported quarters overstates true free cash flow at the company by 30% -- so the profits that Nike is earning don't appear to be of particularly high quality. Meanwhile, the stock -- like Glu's -- has beaten the S&P 500 soundly over the past year, racking up 50% gains to the market's 29% return.
I don't think Nike necessarily deserves all those gains, given its only modest prospects for earnings growth over the next five years and the low quality of the profits it is currently earning. While a move to $88 certainly isn't impossible, I don't think it would be justified given the numbers we see today. At today's valuation, I think the stock's more likely to go down than up.
Red Lobster no more
Finally, we turn to Darden. Last week, the owner of Olive Garden, LongHorn Steakhouse, and Red Lobster announced it's spinning off one of these three marquee brands, and reining in capital spending by reducing unit growth at Olive Garden and LongHorn.
Management predicts these moves will result in "increased cash flow from reductions in capital spending." Management further promises to use the cash it saves "to support dividends, share repurchase and strengthening of the Company's credit profile." Analysts seem to like the idea, with Wunderlich in particular upping its price target on the hold-rated stock to $54 a share -- and I agree.
Darden's 17-times-earnings valuation is anything but attractive in light of the stock's projected 3% long-term earnings growth rate. But if Darden starts redeploying its cash to earnings-concentrating stock buybacks, boosting the already rich 4.4% dividend yield further, and paying down the company's substantial $2.7 billion debt load ... well, who could argue with that?
The prospect of cutting capex -- so that Darden's free cash flow number (currently a measly $65 million) begins to better resemble reported GAAP earnings ($197 million over the past 12 months) -- will also be a positive for the stock.
Mind you, I still see Darden as too expensive given the growth rate. I still think Wunderlich is right to be cautious about its optimism -- raising the price target ever so slightly, but maintaining its hold recommendation on the stock. But prospects are improving. Let's give this one a second look after the spinoff and see how much good unloading Red Lobster does for the valuation of the pieces that remain.
The article Tuesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Nike. The Motley Fool owns shares of Darden Restaurants and Nike.
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