U.S. Markets closed

Yandex Stock Upgraded: 3 Things You Need to Know

Rich Smith, The Motley Fool

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Yerterday, analysts at Russian investment bank VTB Capital (the new name for VneshTorgBank, or "foreign commerce bank") announced their second ratings move on Yandex (NASDAQ: YNDX) in as many weeks. On Nov. 2, after a good Q3 earnings report sent the Russian internet giant's stock rocketing 7% higher, VTB pulled the plug on its recommendation of Yandex, warning that its good news was "priced into the equity."

Now, VTB is having a bit of a rethink.

Putin's image on a banknote

Would you invest your money in a country run by this man? Image source: Getty Images.

TheFly.com reports that VTB is raising its rating on Yandex stock right back up again. Saying investors are in fact not giving Yandex full credit for its progress in three key business areas, VTB now recommends that investors buy the stock, and predicts Yandex stock will go to $40 -- a 29% gain from today's prices.

Here are three things you need to know about that.

1. Three keys to Yandex, starting with Yandex.Taxi

The first thing VTB says investors are getting wrong about Yandex is its Yandex.Taxi business. We learned this past summer that Yandex has struck a deal to absorb Uber's Russian operation into Yandex.Taxi, eliminating price competition and giving Yandex.Taxi a better shot at earning a profit. But even without Uber, VTB thinks Yandex is doing pretty well. Is it right about that?

Last quarter, Yandex.Taxi receipts more than doubled year over year to $20 million, and these sales were up 54% sequentially from Q2. Doing more business, however, cost Yandex investors a whole lot more money. EBITDA losses for the unit swelled from $10 million a year ago to $55.1 million in Q3 2017.

2. Online advertising and e-commerce

Online advertising is the second big growth driver that VTB cites in support of Yandex. Yandex's classifieds division grew its sales 73% year over year to $9.7 million. Moreover, in contrast to the unprofitable growth at Yandex.Taxi, classifieds EBITDA more than doubled to $0.9 million.

Finally, VTB cites e-commerce as Yandex's third big opportunity -- but here the story isn't so happy. Yandex's e-commerce sales declined 3% year over year, and were down 7% sequentially. EBITDA for the division declined 36% year over year to just $3.9 million.

3. The big one: Search

Of course, much like Google in the U.S., Yandex's real business is selling ads on search. Fortunately, this business is still chugging along just fine. Third-quarter search and portal revenue at Yandex grew 32% year over year to $367 million. Profits for the division were up a nearly as strong 30%, with EBITDA coming in at $155.1 million. Additionally, as my fellow Fool Steve Symington pointed out last month, Yandex turned around its market share erosion last quarter, expanding its market share to 54.9% in Q3.

What's more, Yandex management predicts that 2017 sales will grow 22% to 23% by year end. In a market where internet search queries are growing at only about 7% annually, this implies continued market share gains for Yandex.

What it means to investors

But now comes the big question: Is a 22% to 23% growth rate fast enough to justify Yandex's stock price, which has already risen more than 77% over the past year? The answer -- and I know not everyone is going to agree with me here, including the Motley Fool Rule Breakers team -- is absolutely not.

With a market capitalization of $10.3 billion, and more than $700 million in net cash on its balance sheet, Yandex stock sports an enterprise value of $9.6 billion. The company's free cash flow stands at $155 million for the past 12 months (according to data from S&P Global Market Intelligence). That works out to an enterprise value-to-free-cash-flow ratio of nearly 62 on Yandex stock -- which seems very aggressive for even a 23% grower.

What's more, this is the conservative valuation on Yandex. Valued on the more traditional price-to-earnings ratio, Yandex stock costs a clearly excessive 90 times trailing earnings -- and that's before we factor in any "Putin risk" from investing in Russia's somewhat less-than-market-friendly economy.

Conclusion: VTB got it right the first time when it downgraded Yandex two weeks ago and pointed out that every "critical [near-term] positive" imaginable had already been priced into Yandex stock. VTB analysts should have stuck with their initial instinct, and refrained from rating Yandex a buy.

More From The Motley Fool

Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Yandex. The Motley Fool has a disclosure policy.