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 a downgrade for Research In Motion (RIMM) and a lower price target for Cabela's (CAB), but on the bright side, a new buy rating for online marketer ReachLocal (RLOC). Let's dive right in, beginning with the...
Good news first
Janney Montgomery Scott initiated coverage of ReachLocal with a buy rating and a $15 price target this morning. Shares are up more than 8% in response. But even so, Janney's new target price suggests there's still some room to run -- perhaps as much as 24% upside even after today's bump. But is the analyst right?
It just might be. Sure, on the surface, there seems to be little to like about ReachLocal. The stock's not technically profitable, and costs more than 100 times what it's expected to earn next year. On the other hand, though, ReachLocal is cash-rich, with more than $95 million in the bank. It's growing that treasure trove, too, with more than $17 million in annual free cash flow. And it's going to keep on growing it (according to analyst estimates) at about 20% per year going forward.
All of which adds up to a company that trades for an enterprise value about 13 times annual free cash flow, and growing those cash profits much faster than its multiple to enterprise value. If the lack of GAAP accounting profits doesn't worry you, ReachLocal just might be worth a look.
Research in unprofitability
Speaking of "unprofitable" companies that nonetheless bring in the cash -- Research In Motion. The stock got cut to "hold" at Hudson Securities today, and it's not hard to see why. RIM reported no GAAP earnings over the trailing-12-month period, and is not expected to earn a profit next year, either.
What RIM does have, though, is a lot of the same attributes that make ReachLocal look attractive. It's got $2 billion in the bank, for one thing; $2.4 billion in annual free cash flow for another. Growth is only expected to average 10% per year over the next half-decade, but even so, that works out to an absurdly low enterprise value-to-free cash flow ratio of just 0.2.
Long story short: Unless Hudson has some reason to expect RIM's free cash flows will evaporate, rather than grow steadily over time, there's simply no logic to downgrading the stock today. RIM's fallen on tough times lately, no doubt. But at today's deep discount, the risks seem more than incorporated into the stock price.
Shot in the foot
And finally, for a real change of pace, we turn from the tech world to the world of retail... and Cabela's.
Fallout from the shootings in Newtown, Conn., has done a number on the gun industry. Today, they took down Cabela's as well. Analysts at Monness, Crespi, Hardt cut $5 off their price target on the sporting goods retailer this morning. While still recommending that investors buy the shares, Monness now thinks they'll top out at perhaps $55 a share a year from now. Still, that works out to about a 31% potential gain on the shares. So should you still buy?
Actually, no, you shouldn't -- and I'll tell you why. First off, at 17 times earnings and a long-term projected growth rate of just under 17% as well, the stock looks only fairly priced to me today. It certainly doesn't look like something likely to gain 30%. The more so when you consider that, unlike the tech stocks we've discussed so far today, Cabela's has no net cash whatsoever on its balance sheet and, in fact, struggles under the weight of more than $2 billion net debt.
Factoring that debt into the calculation, the stock's selling for an enterprise value nearly 28 times its annual GAAP earnings, and is only a little less expensive when valued on free cash flow. It's unlikely to hit $55 a share anytime soon. In fact... I wouldn't be a bit surprised if Cabela's shares actually go down, rather than up, over the course of the coming year.