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 downgrades for both Duke Energy (DUK) and lululemon athletica (LULU). But it's not all bad news...
Back in the hunt for Huntsman
Notably, this morning featured good news for shareholders of chemical concern Huntsman (HUN), which scored an upgrade to "buy" from analysts at Monness, Crespi, & Hardt. With Huntsman priced at just $18 and change today, Monness sees it heading for $25 a share within a year -- but is it right?
After all, at today's prices, Huntsman shares are valued at just 12.1 times earnings. That doesn't sound expensive. And it wouldn't be expensive, either, except for one important fact: Huntsman isn't growing its earnings very fast at all.
Most analysts agree that Huntsman has pretty much peaked, earnings-wise, and is likely to notch underwhelming growth levels from here on out -- maybe 7% per year over the next five years. Combined with a generous 2.7% dividend yield, that may be fast enough to sustain a low-double-digit P/E at Huntsman. It may be enough to make investors stick around for the dividend. But it's not a growth rate fast enough, or a valuation cheap enough, to support Monness' argument that Huntsman shares will gain 37% in price over the next 12 months. It's just not happening.
Duke is a pauper
The situation's even worse at Duke Energy, which got downgraded by Argus Research today even as Huntsman was getting upgraded at Monness. Why?
Basically, Duke's got one thing over Huntsman: a bigger dividend. It pays 4.2% to its shareholders, versus 2.7% at Huntsman. Past that, though, Duke shares suffer in comparison. They cost more (23 times earnings). They're growing slower (only 4% growth projected over the next five years). And they're carrying a heaping helping more debt -- about $39 billion net of cash.
Perhaps worst of all, while Huntsman has begun generating decent free cash flow again, Duke is still burning cash like crazy -- as it's done in every fiscal year since way back in 2007. Last year, Duke Energy reported "earning" $1.8 billion under GAAP accounting standards -- but its cash flow statement clearly showed that the firm's capital spending program ate up $257 million more than it brought in as operating cash flow. Result: Duke's debt load, already too big to countenance, is only getting bigger -- and its prospects for outperformance are getting smaller.
Last and most intriguingly, lululemon athletica has received a lot of bad press lately over its need to recall one of its most popular products -- "black luon pants and crops" -- for poor quality control. Today, the fallout continued as investment banker RBC Capital pulled its "outperform" rating and cut its price target on the stock by $10, to $70 a share.
Headline risk aside, this downgrade stands on its own merits, for as we've pointed out many times in the past, Lululemon is one pricey stock. Even today, with its stock down 9% from mid-March, the shares look overpriced at 35 times earnings, and an even more expensive-sounding 50 times free cash flow. With a growth rate now pegged at 24%, this suggests the stock could, conceivably, lose another 50% more of its market cap before finally beginning to approach value territory.
In short, a downgrade to only "sector perform" from RBC? That should be the least of Lululemon shareholders' worries.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends lululemon athletica.