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 an upgrade for Walgreen Company (NYSE:WAG) , a downgrade for Cubic Corporation (NYSE:CUB), and for Dawson Geophysical Company (NASDAQ:DWSN) , a big bump in target price. Let’s take ’em in order:
Walgreen can make you some green
First up is Walgreen, recipient today of an upgrade to “buy” from Mizuho Securities. Priced at $41 and change today, Mizuho is calling for a rise to $46 over the next 12 months, which makes for a 10% profit. Combined with Walgreen’s generous 2.7% dividend yield, that makes for a tidy 12.7% return — not bad for a year’s “work.” But how likely is it to happen?
Call me an optimist, but actually do think it might happen, and I’ll tell you why: At first glance, Walgreen shares look pretty pricey. They cost nearly 19 times earnings, which is about a 12% premium to the average big drugstore chain and an apparent premium to the company’s 13% growth rate as well.
But consider: Walgreen also generates a lot more free cash flow than it reports as net income — $2.75 billion in FCF versus GAAP “earnings” of just $2 billion. When valued on the cash profit it’s actually generating, therefore, rather than the earnings it is allowed to report, the company actually looks attractive at a price-to-free cash flow ratio of just 14.4. To my mind, 13% profit growth and the 2.7% dividend yield are more than enough to support Walgreen’s share price — and may even justify a small increase in that price.
Result: So long as Walgreen’s profits grows as they’re projected to, the stock price should follow.
Cubic gets cut
Worse news awaits Cubic Corp shareholders, however. Yesterday, the defense contractor reported a sizable “earnings miss,” admitting that Q4 profits came to only $0.47 per share, versus the $0.70 that Wall Street had been counting on. Needless to say, analysts were not pleased.
Already this morning, Benchmark Capital has downgraded the stock to “hold.” StreetInsider.com says the reason is Benchmark’s fear that “lower growth in Transportation and deceleration in Defense” will compress profit margins, and make this a “transitional year” for Cubic. Expectations need to be reset before Cubic can begin growing again.
And how! With a P/E ratio that’s risen to 14.2 after its deeply disappointing earnings quarter, Cubic looks significantly overpriced relative to single-digit earnings growth projections. The company’s measly 0.5% dividend yield does little to tip the scales in its favor. Topping off the bad news, Cubic’s now burning cash, with free cash flow for the past year running to negative $52.8 million.