This Just In: More Upgrades and Downgrades

Before you go, we thought you'd like these...
Before you go close icon

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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given this, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.

Today, analysts digging through the mining sector, trying to separate the gold (Yamana Gold (NYS: AUY) , to be precise) from the dross (that would be Arch Coal (NYS: ACI) and Cliffs Natural Resources (NYS: CLF) ). Are they right to like the one, and hate the others? Let's find out, as we begin with a bona fide...


Gold rush!
Considering the mixed messages that AngloGold Ashanti (NYS: AU) and Goldcorp (NYS: GG) have delivered this week, you might think Wall Street would be tempering its enthusiasm for peer gold producer Yamana Gold -- but the opposite is more accurate.

On Monday, AngloGold announced a 9% year-over-year increase in gold production, and an 18% sequential improvement. Even better, AngloGold confirmed that its cash costs for production were a mere $805 an ounce, or about 5% lower than previously feared. While official earnings haven't yet been released, the news bodes well, and AngloGold is telling investors to expect "adjusted" earnings of as much as $255 million for the quarter. In contrast, Goldcorp came out this morning with its official numbers, which showed lower production -- but also lower cost per ounce -- the net effect of which was an "earnings miss" for the company.

Wall Street, ever the critic, responded by lowering price targets for both companies this morning. But rather than ratchet back expectations for Yamana as well (Yamana reports early next month), analysts at HSBC are taking the opposite tack, and upgrading the shares to "overweight" (read: "buy"), and setting an $18 price target on this $15 stock -- suggesting 20% upside lies ahead.

Bad call. Listen, Fools: Yamana may give us good news next month (as AngloGold did), or it may give us bad news (like Goldcorp). One thing's for certain, though: Based on today's numbers, Yamana's nothing close to a "buy" ... and HSBC is wrong to counsel "overweighting" it in your portfolio. At nearly 20 times earnings, and with weak cash-production characteristics that give it an even higher price-to-free cash flow ratio, the company's too expensive for its 10.6% long-term growth prospects. Unless Yamana tells us something dramatically different next month, something that changes these numbers in a big way, Yamana is not "overweight." It's just overpriced.

(But hey, that's OK. If it's value-priced gold stocks you're looking for, we just happen to have one handy. Read all about it in our new -- and free! -- report: The Tiny Gold Stock Digging Up Massive Profits.)

ArchCoal collapses
Similar story for Arch Coal, but more so. This company doesn't report its earnings till tomorrow, but you don't have to wait for the numbers to know this is a stock to avoid. Priced at 12 times earnings, but with only 5% long-term growth in its future (according to consensus estimates), the company's dreadfully overpriced on its face.

Sure, Arch pays a modest 2.2% dividend, which offers an alternative reason to own it. But already, it's maxed out at a payout ratio of 98% (meaning almost every penny of profit it produces goes to dividends, leaving little or nothing for reinvestment). Any shortfall in earnings going forward, and that dividend could go away. Plus, Arch is carrying nearly $4 billion in net debt, while generating so little free cash flow (just $16 million over the past year, or about $1 million a month) that paying down the debt becomes a real issue for Arch.

Based on numbers like these, analysts at Stifel Nicolaus decided to downgrade Arch this morning ... but only to "hold." Me, I think that that's too generous by half. Unless something radical changes in the economics of coal -- and soon -- we could easily see Arch follow rival Patriot Coal down the bankruptcy rabbit hole.

Down the hole ... and over the Cliffs
And in other downgrade news, FBR Capital took an axe to Cliffs Natural Resources today, pulling its "outperform" rating and downgrading to "market perform."

Why? Check out the earnings report that Cliffs just released yesterday -- the one that has the stock trading down 11% today. Cliffs managed to hang on by its fingertips, and beat earnings estimates, but that was a bit of a Pyrrhic victory for the iron and coal miner. Compared to last year, revenues were down 10%, and GAAP profits dropped precipitously thanks to "lower year-over-year pricing for the commodity products the Company markets." Meanwhile, the company suffered from " increased cost of goods sold driven by higher labor, mining, and maintenance expenses."

Now, it's not all bad news for Cliffs. The company remains firmly free cash flow-positive, generating $378 million in free cash. Problem is, that's barely a quarter of the $1.4 billion the company claims to be earning under GAAP. It means that you can't just look at the stock's Yahoo! Finance page and say, "it only costs 3.3 times earnings, so it must be cheap." You have to dig deeper, value the company on its free cash , and note that 14 times free cash is a pretty steep price to be paying for a company that's only expected to grow at 7% per year over the next five years.

When you consider further that figuring Cliffs' debt load into the equation gives this stock an enterprise value-to-free cash flow ratio of nearly 26 -- more than three times the growth rate -- the case for selling Cliffs only gets stronger.

Whose advice should you take -- mine, or that of "professional" analysts like HSBC, Stifel, and FBR?Check out my track record on Motley Fool CAPS, andcompare it to theirs. Decide for yourself whom to believe.

The article This Just In: More Upgrades and Downgrades originally appeared on Fool.com.

Fool contributorRich Smithdoes not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 330 out of more than 180,000 members. The Fool has adisclosure policyWe 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.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners