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 new buy ratings for Diamond Foods (DMND) and Blue Nile (NILE) -- but...
Not for Intrepid Potash
Might as well get the bad news out of the way first, and with its shares down 1.5% in midday trading, today does look likely to be a bad day for shareholders of Intrepid Potash (IPI) . StreetInsider.com is reporting today that BMO Capital just downgraded the stock to "underperform," even as it left its price target unchanged at $11 a share.
Why downgrade now, after the stock's already lost 25% of its value over the past year? Simply put: There's no time like the present.
You see, Intrepid Potash shares have experienced a recent surge from prices that began, in early August, very near to BMO's target price. Trading just shy of $16 today, the shares cost more than 16 times trailing earnings -- which may not sound expensive, but is, and for two reasons:
First, those earnings are expected to decline at Intrepid Potash. Most analysts agree the company is likely to experience about a 5% annual rate of profits shrinkage over the next five years. Second, even the profits Intrepid Potash currently reports as "earnings" may not be worth as much as you think. Despite reporting GAAP profits of $74 million over the past 12 months, Intrepid Potash actually experienced negative free cash flow of about $147 million. FCF was negative last year as well, and in truth, it's been about five years since the last time Intrepid Potash produced real free cash flow of close to the $74 million in GAAP profits it's claiming today.
Long story short, the stock's not as cheap as it looks. BMO is right to recommend selling it. So let's turn now to a couple of stocks that Wall Street believes are worth more than they now cost. We'll begin with:
...which just caught an initiation of coverage from B. Riley & Co. Riley thinks the stock, currently at $41 and change, will soon be worth $49 a share, and recommends buying it. I think they may be right.
Priced at 54.5 times earnings today, Blue Nile doesn't look cheap on the surface -- not even with a growth rate projected at "only" 21%. What's key here is that Blue Nile is one of those diamonds in the rough that generate more cash profit than they're allowed to report as "net income" under GAAP. To be precise, Blue Nile generated $22.9 million in positive free cash flow over the past 12 months, even as it reported "earning" only $9.7 million.
That works out to a price-to-free cash flow ratio of only 22.7, or an even more attractive enterprise value-to-free cash flow ratio of 19.7. ( Enterprise value gives a company credit for any extra cash it has on hand, by deducting the value of that cash, minus any debt, from the market cap.)
Assuming Blue Nile achieves the 21% growth rate that Wall Street is giving it credit for, I think the stock's cheap enough to buy, and I think B. Riley is right to recommend it.
Diamond Foods -- less than sparkly
In contrast, I'm less enthralled with Diamond Foods, which despite being upgraded to "buy" at BB&T Capital Markets this morning, looks somewhat less than gem-quality to me.
Diamond's not currently profitable under GAAP accounting standards, although it does produce positive free cash flow -- about $10 million over the past year. If you ask me, though, that's still far too little cash to justify the stock's heady $553 million market cap -- or the $1.07 billion the enterprise is valued at, with debt included.
Adding to the reasons for caution, most analysts seem to have this food products stock pegged for just 7% annual growth over the next five years. (S&P Capital IQ is a bit more optimistic, quoting its analysts as projecting 12% growth, versus the 7% figure shown on Yahoo! Finance.) Whichever number you believe, though, it's not nearly fast-enough growth to support a 55 times price-to-free cash flow ratio, or the more than 100 times multiple you get when calculating Diamond's enterprise value.
My take: Diamond Foods may be valued like a Tiffany -- but the stock's 100% pure cubic zirconium.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Blue Nile.