This Just In: Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Freeport? Alpha Natural? There's gold in them thar stocks!
This just in from the mind of Citigroup: Everything you thought about mining and commodities is wrong. China's not overstocked with copper, natural gas won't take over the world, and in fact, now is starting to look like a fine time to own some coal stocks.

This, it would appear, is the upshot of a pair of new upgrades just out of Citi, which opened up the trading week Monday with a pair of upgrades to "buy" for Freeport-McMoRan (NYS: FCX) and Alpha Natural Resources (NYS: ANR) , purveyors of copper and coal, respectively.


With no major media outlets covering the upgrades so far, details remain hard to come by. What we do know, however, is that StreetInsider.com is quoting Citi analysts calling a bottom on thermal coal (also called "steam coal," because it's the kind that competes with natural gas for use in electric power plants). This suggests that good things (and perhaps more upgrades?) lie ahead for Alpha rivals CONSOL Energy (NYS: CNX) and Arch Coal (NYS: ACI) , both big producers of thermal coal. We also know that Citi's buy thesis will be put to the test almost immediately, because, as the analyst points out, Peabody Energy (NYS: BTU) -- yet another thermal coal producer -- kicks off earnings season for this industry on Thursday.

That will give us a chance to take the temperature (so to speak) of the thermal coal industry. But do we really have to wait for BTU to report? Perhaps taking a glance at a few of these companies today will be instructive.

Coal companies, by the numbers
Scanning the financials of the named coal companies, what we find is an industry in some disarray. With natural gas prices now at decade-long lows, coal company share prices are selling for lower-than-market multiples across the board: Arch Coal costs just 13.3 times earnings; CONSOL, 12.2 times; and Peabody, a mere 7.9 times! Even better, all three companies back up their attractive P/E ratios with positive free cash flow.

Where does Alpha Natural break from the pack? Again, Citi isn't saying, but as I scan the numbers, two jump out: First, of the four companies named, Alpha Natural may be the only one not currently profitable, but this fact also helps to make it the cheapest company of the bunch on a price-to-book-value basis. If you're investing on book value, therefore, Alpha Natural's 0.46 P/B would appear to offer the best upside potential in the industry.

At the same time, Alpha Natural's debt-to-equity ratio of 40.1, while sizable, is literally multiples smaller than the D/E ratios of its rivals: 88.6 times at CONSOL, 112 at Arch Coal, and 120 at Peabody! What this suggests is that if you're gambling on coal making a comeback against $2-a-million-cubic-foot natural gas -- an admittedly risky bet -- Alpha Natural's superior balance-sheet strength may offer you the greatest insurance against betting wrong and the least downside in case the gamble goes against you.

Great upside and least downside? Sounds like almost as good a combination as chocolate and peanut butter to me.

But you can still do better
All that said, and despite Citi's strong case in favor of its coal pick, I still prefer the analyst's recommendation of copper-and-gold miner Freeport-McMoRan. Perhaps the fact that I own the stock myself is making me biased here. Still, when I look at the $4.1 billion in free cash flow -- a number five-and-a-half times better than the best number the coal industry can produce (that being Peabody's $750 million in trailing FCF) -- I can't help but think Freeport's a bargain.

The stock's 7.5 times earnings valuation and its 8.5 times free cash flow multiple both tell me this stock is a good bet to outperform. That's why I own it, why I have publicly endorsed it on Motley Fool CAPS, and why I agree with Citigroup today: Freeport-McMoRan is still the best bargain in mining stocks.

Or is it? Over at Fool Central, our analysts think they've found an even better bet in the high-stakes world of gold mining. Read all about it in our new, free report: "The Tiny Gold Stock Digging Up Massive Profits."

At the time this article was published The Motley Fool owns shares of Freeport-McMoRan Copper & Gold, and so does Fool contributorRich Smith.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 350 out of more than 180,000 members. The Motley Foolhas adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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