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Pandora Media Stock Upgraded After Earnings: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Three months ago, streaming music provider Pandora Media (NYSE: P) turned 1% sales growth and a reduced net loss into a 21% gain for its stock after Q1 earnings. Now, Pandora is doing it again.

Early morning trading saw Pandora jump more than 23% in response to the company's latest earnings report, which was released last night. Helping matters is the fact that Wall Street is starting to embrace the good news, with two big-name analysts upgrading Pandora shares today.

Here's what you need to know.

Dice with BUY and SELL stamped on them on top of a screen showing stock movements
Dice with BUY and SELL stamped on them on top of a screen showing stock movements

Image source: Getty Images.

Upgrading Pandora

According to early reports out on TheFly.com and StreetInsider.com (subscription required), analysts at both Barrington Research and RBC Capital Markets upgraded Pandora stock to outperform this morning.

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Barrington notes that 22 million listeners have "engaged" with Pandora's new strategy of selling "ad supported Premium Access" music subscriptions, one of Pandora's "two levels of pay products." Barrington calls Pandora's listener base "huge," and expects to see the company leverage that base using its purchase of advertising tech company AdsWizz (bought earlier this year for $145 million) to "attract advertisers to the digital audio ecosystem" and sell more ads (and make more money).

RBC adds that, in its opinion, Pandora should be able to continue growing revenue about 10% per year for at least the next three years. In Q2, it notes that Pandora already achieved a "double-digit" rate of organic sales growth while cutting its EBITDA losses.

Wait. Back up a sec. Pandora lost money?

Yes, that's the bad news. While Pandora beat on sales and earnings last night, and Wall Street is waxing euphoric over Pandora stock this morning, the fact remains that Pandora still failed to earn a profit.

Reviewing the results from last night, we find that Pandora grew its revenue at an accelerated 12% rate, year over year. It grew that much "excluding Australia [and] New Zealand," markets that it exited in 2017, and also revenue formerly attributed to Ticketfly, which it sold last year. If you include those businesses, though, GAAP sales were up only 2% year over year, or not much better than last quarter.

And Pandora lost money -- $0.38 per share, to be precise. Granted, that was much better than the $1.20 per share GAAP loss that the company reported in last year's Q2, but it was still a loss. Pandora also noted that even adjusting its results to account for the Australia/NZ exits and the Ticketfly sale, its pro forma profit was negative $0.15 for Q2 2018, a little better than the $0.21-per-share non-GAAP loss it said it would have made without those divisions in last year's Q2.

The company's listener hours (the amount of time subscribers spent on its service) also declined -- down about 2.5% year over year.

The upshot for investors

In short, Pandora beat expectations last quarter, cut the rate at which it lost money, and grew the businesses it decided to keep. (In fact, subscription revenue from the company's newish paid services was "up 67% and ad hour trends improve[ed] for the third straight quarter," said CEO Roger Lynch.) But it wasn't all good news for Pandora.

So are the analysts who upgraded Pandora stock this morning right or wrong? After all, Barrington Research's price target of $11 implies there's a further 36% of gains to be had from this stock on top of the 20%-plus gains it's already recorded today, and RBC isn't far behind with its prediction that Pandora stock will grow to $10 a share.

If these analysts are right, there's a lot of money to be made from Pandora still. As for me, though, I remain to be convinced. For one thing, while subscription revenue did surge in Q2, subscriptions are still less than half the size of Pandora's much bigger advertising business -- and revenue there declined year over year (down 2.6%). That doesn't bode so well for Barrington's hope that the AdsWizz purchase will pay off.

Cash reserves are still shrinking, down more than $200 million over the last 12 months. And while cash burn declined -- down by roughly half in comparison to last year's Q2 -- free cash flow in Q2 2018 was still negative $56.1 million, so the cash is still leaking out of Pandora's box.

I see a future for Pandora if the company continues growing subscription revenue faster than it loses advertising revenue, and if those subscriptions are profitable and begin generating cash for the company. Until I see that happening however, I will not be investing in Pandora stock.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Pandora Media. The Motley Fool has a disclosure policy.