This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we’ll be looking at a pair of downgrades for both Lear Corporation (NYSE:LEA) and Whole Foods Market, Inc. (NASDAQ:WFM), followed by an improved price target at 3M Co (NYSE:MMM) . Let’s start with that one.
3M gets an A
3M Co (NYSE:MMM) gave Wall Street a mildly pleasant surprise last week, reporting $1.71 per share in earnings, a 3% improvement over last year and either matching or a penny ahead of analyst estimates — depending on whose estimates you’re referring to. This news has Swiss banker UBS upping its price target on the stock Monday morning, with UBS now saying the shares could hit $128 within a year, and recommending a buy rating on the stock.
Is that prudent? I don’t think so, and I’ll tell you why. Right off the bat, you can see that 3M Co (NYSE:MMM) is a pretty pricey stock at its 18-times-earnings valuation. Earnings growth over the next five years is estimated at less than 10%, and the company’s 2.2% dividend yield, while nice, isn’t quite big enough to make up the difference.
Adding to the case against 3M Co (NYSE:MMM), its P/E ratio is about 50% higher than the average among industrial conglomerates (which as a whole sport a 12.1 P/E ratio according to data from Yahoo! Finance). Also, 3M Co (NYSE:MMM)’s profits are of somewhat lower quality than we’d like to see. Although the company reported nearly $4.5 billion in GAAP “earnings” over the past 12 months, actual free cash flow generated by the business fell short of $4.2 billion. That discrepancy pushes the stock’s price-to-free cash flow ratio up to nearly 19, while the addition of debt to the calculation gives the stock an enterprise value-to-free cash flow ratio of more than 19.
Long story short, the stock looks overpriced to me. I wouldn’t recommend buying it at today’s price, much less hoping to see 3M Co (NYSE:MMM) run up to $128.
Moving on now to the downgrades, we find UBS in the mix again, this time cutting its rating on auto parts maker Lear to “neutral.” That’s a bit counterintuitive, given that Lear, like 3M, beat earnings last week — and by a much more decisive margin, reporting pro forma profits of $1.62 per share versus analyst expectations of $1.37. Lear also beat estimates on revenues, and increased its forecast to a prediction of $15.8 billion in revenues, and operating profits of between $750 million and $800 million.
And yet… with its shares up 90% already over the past year, there’s an argument to be made that Lear shares already have all of this good news “priced in.” With the stock now approaching UBS’ $70 price target, the analyst is downshifting a bit — leaving its price target intact, but curbing its enthusiasm about actually buying the stock. Is that the right call?