This Just In: Upgrades and Downgrades

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.

And speaking of the worst ...
Steel investors are finding friends hard to come by this week. So far, we've seen Imperial Capital recommend that investors take a position in U.S. Steel (NYS: X) , but that was way back on Monday, and ever since, the news has been nothing but bleak.

On Tuesday, USX rival AK Steel (NYS: AKS) disappointed investors when despite "beating earnings" and coming close to meeting expectations on revenues, the company decided to suspend its dividend. This decision compounded the damage done to the stock when UBS downgraded it (ahead of earnings, by the way).

Looking farther afield, FBR took a pickaxe to iron ore-and-coal miner Cliffs Natural Resources (NYS: CLF) yesterday, downgrading to "market perform." Simultaneously, Bank of America took a generally pessimistic view of General Moly (NYS: GMO) , downgrading to "underperform" and tacitly acknowledging molybdenum's role in the manufacture of some forms of hardened steel.

And of course, yesterday was also the day that ING Group revoked its "buy" rating on the world's largest steelmaker, ArcelorMittal (NYS: MT) . Let's focus on that one before addressing the question of whether there's any hope at all for this sector in the near term.

What's the deal with steel?
Arcelor announced earnings one day before the downgrade (which is a phenomenon we refer to as cause and effect). Sales at the European steel giant dropped 10% year over year, while operating profits plunged by more than 51%. On the bottom line, Arcelor net income dropped 38%, to $959 million.

Now, given all the pessimism we've seen in this industry this week, you might want to look at that drop as "bad news." It isn't -- not necessarily.

For one thing, $959 million is a whole lot more than the $11 million Arcelor earned in Q1 of this year. For another, if you look at the company's cash-flow statement, you'll see that this improvement in profitability has done great things for Arcelor's ability to create cash.

You see, even if "net profits" are down, free cash flow is up -- way up. Operating cash flow at the company came to $2.3 billion, versus just $0.5 billion generated last quarter. Capital spending, conversely, is down from $1.2 billion to $1.1 billion. Result: positive free cash flow of $1.2 billion. This helped lift Arcelor's trailing FCF figure into positive territory, with more than $1.3 billion generated over the past 12 months -- more than twice what the company's reporting as net profits.

Foolish final thought
The good news here, therefore, is that this quarter is a whole lot better than last quarter -- and may even be the beginning of a trend of better results.

Now for the bad news: We're not there yet. Even its new-and-improved figure still leaves Arcelor trading for a price-to-free cash flow ratio of 18.5. And when you add debt to the picture, enterprise value-to-FCF is pushing 35.0. Even with analysts predicting 25% long-term profits growth at the company, this is still too high a price to pay for Arcelor shares, and so ING is right to downgrade it.

Your choice as an investor: Sit patiently, cash the generous 5.1% dividend checks, and wait for the rest of the turnaround to materialize, or ... not. If patience isn't your thing, and you're ready to ditch smokestack industry stocks and move on to the next revolution in manufacturing, read the Fool's new report "3 Stocks to Own for the New Industrial Revolution," a.k.a. "The Future Is Made in America."

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The Motley Fool owns shares of ArcelorMittal, but Fool contributorRich Smithowns no shares of, nor is he short, 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. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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