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 a pair of price target hikes for plastic purveyors Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA). But the news isn’t all good, so before we address those two, let’s take a look at why one analyst thinks that…
Ulta Salon is falling out of fashion
Tuesday began on a down note for shareholders of Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA). Megabanker Goldman Sachs cut its rating on the stock from “buy” to “neutral,” and knocked $5 off its price target to boot.
Why? Well, according to Goldman (and as related by StreetInsider.com), the sale of cosmetics over the Internet “has much potential given favorable characteristics for logistics and
replenishment, and given its dominance by brands.” Goldman sees this as a mark in Ulta’s favor. However, the banker also worries that Ulta will need to spend more on improving its e-commerce abilities if it’s to take full advantage of its opportunities — and that costs money.
Problem is, Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA) is already spending a lot of money. Capital spending ate up nearly $189 million of the $239 million in cash flow that Ulta brought in last year, leaving the company with free cash flow of only $50 million or so. That’s far less than the $172 million the company claimed as GAAP net income for the year. And that means that the stock’s already high P/E ratio of 33 should more realistically be looked at as a price-to-free cash flow ratio north of 110.
Even growing at 21.5%, as it’s projected to do, that’s a hard price to swallow. If you ask me, Goldman is right to downgrade — and the only question is why the analyst didn’t go even further and mark Ulta down to “sell.”
Credit card companies: Don’t leave home without them?
But I still don’t.
Don’t get me wrong — as businesses go, it’s hard to think of better companies than Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA). They basically own the credit card space, and act as “tollbooths” to more and more consumer purchases with each passing day. Analysts have Visa pegged to grow its earnings north of 18% per year over the next five years, and expectations for MasterCard are nearly as strong. The problem, however, is valuation.
Priced at 50 times earnings, and paying a dividend yield less than 1%, Visa Inc (NYSE:V) looks vastly overpriced even for its robust prospects of profits growth. Mastercard Inc (NYSE:MA), growing slightly slower, costs much less — but even at 25 times earnings, is no great bargain.
