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 downgrades for both Alcoa Inc (NYSE:AA) and Overstock.com, Inc. (NASDAQ:OSTK). But the news isn’t all bad, so before we get to those two, let’s first check out why one analyst is…
Putting Chipotle on the menu
Markets are off a couple tenths of a percent in early Wednesday trading, but shareholders of at least one stock are still grinning: Chipotle Mexican Grill, Inc. (NYSE:CMG). The upscale burrito-meister is up 2.3% itself today on the back of an upgrade to “buy” from analysts at Argus Research. Citing expected same-store sales gains of 2.5% in 2013, Argus is taking its target price on Chipotle Mexican Grill, Inc. (NYSE:CMG) shares to $430. But is it right?
Unfortunately, probably not.
Priced in excess of 41 times earnings today, Chipotle is not quite as expensive as it looks. Free cash flow at the fast-casual restaurant chain is a beefy $324 million for the past 12 months, or 11% ahead of reported net income. Yet even so, this leaves the shares trading for 36 times free cash flow, or significantly more than you’d ordinarily want to pay for a company like Chipotle, which is expected to grow its profits at about 20% per year over the next five years.
In other words, with fast growth and good free cash flow, Chipotle is a terrific business, and one you should want to own at the right price. Unfortunately, today’s price is not right.
Alcoa: No longer shiny
Switching gears now from aluminum-foil-wrapped food to aluminum foil manufacturing, we turn to Alcoa Inc (NYSE:AA) and its downgrade. Citing a predicted 5% cut in aluminum pricing for 2013, and an even steeper, 12% drop in 2014, JPMorgan removed its buy rating from Alcoa Inc (NYSE:AA) this morning, and downgraded to “neutral.” JP notes that demand for aluminum remains “firm”; however, supply is even stronger, which makes it hard for companies like Alcoa Inc (NYSE:AA) to charge more for their metal.
Result: The banker is cutting its predicted earnings for Alcoa Inc (NYSE:AA) to $0.29 this year, and $0.55 next year — reductions of 49% and 47%, respectively — and cutting its price target to just $9 a share. Personally, I think the analyst is still being too generous.