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.

Who's hot, who's not -- in transportation stocks
The Dow Jones Industrial Average, at 13,850, is pushing once again toward its all-time high today, but can it keep the momentum up? According to stock market lore, key to future strength in the stock market at large, is the performance of some of its strongest constituents -- the transports. So how are those guys doing?

As luck would have it, three separate analysts chimed in with three separate ratings changes on three of the biggest names in transport this week. Here's what they said:

UPS -- still going up
Shares of UPS hit a new 52-week high yesterday -- and earnings aren't even out yet. (In fact, they're due out Thursday). But one analyst, at least, has decided to beat the rush, and beat feet to get into UPS stock early. Yesterday, Bank of America announced it was upgrading UPS ahead of earnings. Problem is... B of A may be coming late to this party.

UPS shares, you see, have rallied strongly off their November lows near $70 -- up 17.5% in a matter of just a couple months. As a result, the stock now costs a heady 24.4 times earnings, which seems quite a lot considering that most analysts believe UPS will have difficulty growing earnings in the future at much more than a 10% annual rate.

In UPS's defense, the shares aren't quite as overvalued as they look. UPS boasts strong free cash flow of $4.8 billion annually, or roughly 45% more than the $3.3 billion in net earnings it reports for the past year. Even so, at a price-to-free cash flow ratio of 16, the stock looks fully valued to me -- and maybe even too fully valued to justify B of A's buy rating.

FedEx -- flying into turbulence?
Another transport stock setting new records this week was none other than UPS archrival FedEx. What's curious here, though, is that while UPS probably got a little help with hitting its high from the B of A upgrade, FedEx was actually bucking the headwinds of a negative ratings move from Standpoint Research, which downgraded the stock to hold Wednesday.

The stock's up again today, so investors appear to be ignoring the analyst's warning. But even so, I have to say that Standpoint has the better of this argument, long term.

Oh, I know -- at first glance, FedEx shares look like a much better value than do UPS's. The stock sells for only a 16.4 P/E ratio, after all, fully a third less than the ratio UPS sports. But here's the thing: Where UPS's GAAP earnings understate the company's real cash profitability, FedEx's earnings actually overstate the case. Fact is, over the past 12 months, FedEx has only generated about $707 million in free cash flow from its business -- that's about $0.36 for every $1 it claimed to be "earning."

Thus, if you value the company on its cash profits, rather than its accounting profits, FedEx actually sells for a price-to-free cash flow ratio nearly three times as large as the one UPS sports. It costs 45.3 times the amount of cash it generates in a year. And speaking of cash, FedEx's dividend yield is positively miserly -- a mere 0.6%, versus the generous 2.8% that UPS shares yield.

Turns out, far from being too harsh with FedEx, Standpoint may have been too generous. This stock's just way, way, too pricey to buy today.

CSX -- time to pull the brakes?
Last but not least, we come to railroad operator CSX, which caught an upgrade to outperform from RBC Capital Markets Thursday, two days after it joined rival railroads Kansas City Southern and Norfolk Southern in trouncing analyst estimates in the fiscal fourth quarter. According to the RBC, demand for metallurgical coal has finally bottomed out. As volumes slowly begin to improve, and CSX is called upon to move more coal to market, the company will surely benefit from the increase in demand.

Let's hope so -- because based on the numbers I'm looking at today, it seems more likely investors should be reaching for the emergency brake.

Sure, on the one hand, CSX sells for the lowest P/E ratio of the three transports discussed here today -- just 12.4 times earnings. True, it pays a dividend nearly as good as UPS's (2.6%), and also true, it's growing earnings nearly as fast as FedEx (12.2% projected, over the next five years).

The problem is that, just like FedEx up above, CSX has little or no fuel in its cash flow tank, to keep its earnings engine churning. Free cash flow over the past 12 months was an anemic $605 million, or only $0.33 per $1 reported as GAAP earnings -- a proportion even weaker than FedEx's. Plus, with so little cash being generated from its business, CSX has been hard pressed to keep its debt under control. Long-term debt at the railroad has increased every year for the past five, most recently topping out north of $9 billion.

Foolish takeaway
Although CSX has lots of cash on hand, and is at no risk of missing an interest payment, the fact remains: When you factor in the debt load, this stock is a whole lot more expensive than it looks. And you know what? It wasn't looking all that cheap to begin with.

With 21,000 miles of track serving two-thirds of the U.S. population, CSX maintains a valuable proprietary asset. Still, this railroad will face difficult obstacles in the years ahead due to a domestic surplus of natural gas and coal's declining popularity. To help investors better understand how CSX can deal with these challenges, The Motley Fool has released a brand-new premium research report authored by Isaac Pino, Industrials Bureau Chief and transportation expert. Isaac provides an in-depth look at CSX's competitive advantages, risk areas, and prospects for the future; as an added bonus, he'll keep you informed with key updates and guidance as news develops over the course of a year. Simply click here now to access your copy of this invaluable investor's resource.

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Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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