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 Bed Bath & Beyond , but downgrades for both OfficeMax and Tiffany . Let's dive right in, beginning on a bright note as...
Bed, Bath wakes up on the right side
Thursday dawned bright and sunny for Bed Bath & Beyond shareholders. For, rolling out of bed and online, what did they find but an analyst at Oppenheimer, upgrading their shares to "outperform."
According to Oppy, shares of Bed, Bath that currently cost just $59 and change could rise to $71 within a year. If the analyst is right, that would make for a clean 20% profit. But is Oppy right?
Actually, maybe, yes. Here's why: At first glance, Bed, Bath shares don't look particularly cheap or expensive, either one. Priced at 13.6 times earnings, the stock costs a bit more than the average home furnishings chain. Most companies in this industry actually cost a bit closer to 13.1 times earnings. On the other hand, though, Bed, Bath isn't your typical home furnishings store. To the contrary, it's probably one of the best in the business, boasting above-average growth rates (12.3%), strong free cash flow that backs up nearly 93% of reported net income, and a robust balance sheet boasting $785 million in cash, and no debt worth mentioning.
Plugging these numbers into my calculator, I come up with an enterprise value-to-free cash flow ratio of 12.5 for Bed, Bath, which is right in line with the firm's projected rate of growth. In other words, what we have here is a great company selling for a good price -- and a price that should rise over time as the company continues to execute. Cautious investors may still want to wait for an out-and-out discount on the stock. But for an operation as good as Bed, Bath is, there's no guarantee a better price will ever emerge.
Speaking of great retail operations... OfficeMax isn't one. The office supplies superstore earns just 1.7% operating margins on its sales, a number almost literally 10 times smaller than the 15.5% that Bed, Bath books.
According to investment banker KeyBanc, this number simply isn't good enough to justify buying more of OfficeMax , which needs to show "improvement in the core office supply business" to become buyable -- that, or merge itself into a better operator. KeyBanc cut its rating on OfficeMax to "hold" this morning, arguing that "major balance sheet catalysts have played out."
Personally, I'd go even further than that, though, and argue that OfficeMax is a sell. Why? Because while the stock certainly looks cheap enough at just two times earnings, looks can be deceiving. Fact is, while GAAP accounting permits OfficeMax to claim $453 million in "net income" for the past year, its actual free cash flow for the period was a lowly $56.5 million -- yielding a price-to-free cash flow ratio of 17.
That's not an expensive number on its face. But given that OfficeMax is expected to grow its profits at only 11% or so a year over the next five years, given that it pays a dividend of only 0.7%, and given that it's up to its gills in debt ($465 million net of cash on hand), I'd say it's still too high a price to pay.
My advice: Look at Staples instead. It's got better free cash flow, a lighter debt load relative to its market cap, and pays a much more generous 3.3% dividend yield. At eight times free cash, I think it's a better bet than OfficeMax, despite its slower projected growth rate.
Can Tiffany shine again?
Finally, wrapping up our retailer roundup, we come to Tiffany, recipient of a similar downgrade to "hold" (but from Canaccord Genuity this time) this morning. Tiffany is actually similar to OfficeMax in other respects, too. For example, its dividend is a bit light at 2%. Its growth rate is almost identical to OfficeMax's at 10.8% projected, for the next five years. Finally, and contrary to what you might expect from such a high-class retailer, Tiffany is actually an abysmal cash producer.
Over the past year, Tiffany generated only $74 million in positive free cash flow -- a far cry from the $415 million in "earnings" that GAAP gives it credit for. Result: If you thought the stock looked expensive at 19 times earnings, what would you say if I told you that the company actually sells for something like 107 times its annual cash profit?
I'll tell you what I said when I came across the number: "Wow. And I thought their diamonds were expensive!"
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond. The Motley Fool owns shares of Staples and Tiffany & Co.
The article Thursday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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