Friday's Top Upgrades (and Downgrades)


This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines include an upgrade for Mississippian banker Renasant , a downgrade for Nuance Communications , and for Limited Brands , a higher price target.

A bigger banker down South
We begin the day on a bright note, as Mississippi banker Renasant scored double upgrades from Stephens and Wunderlich this morning. Both bankers say Renasant's a buy now, and it's easy to see why.

Yesterday, Renasant announced it's merging with First M&F Corporation, parent company of Merchants & Farmers Bank. The news sent M&F shares flying -- up 39% on the day -- but Renasant shares headed in the opposite direction. The weird thing, though, is that even the steep premium (to then-current prices) Renasant paid for M&F let it acquire shares for just 1.2 times tangible book value, while Renasant's own shares were selling for 1.6 times tangible book. This suggests the banker got itself a nice bargain, and helps to explain Wall Street's optimism about an acquisition that most investors decided to shun.

And yet... could the reason behind this apparent bargain price be not so much that M&F was underpriced, as that Renasant was overpriced -- and still is?

Priced at 18 times earnings today, Renasant shares don't look particularly attractive in light of a long-term earnings growth rate that's predicted to average just 7% annually. Even with a 3.5% dividend yield, it's hard to argue the shares are undervalued today.

Nuance gets overlooked
Dragon NaturallySpeaking software maker Nuance beat revenue expectations, but "missed earnings" by a penny yesterday, reporting $0.35 per share GAAP, versus the $0.36 Wall Street was expecting. The news prompted triple downgrades on Wall Street this morning, as each of Craig-Hallum, Needham & Co., and Stifel Nicolaus pulled their buy ratings on the stock, and downgraded to hold.

Needham's note held the most detail, pointing out that the real pessimism over Nuance concerns not the penny missing from fourth-quarter 2012 earnings, but the warning that gross margin in 2013 could be down as much as 250 basis points (2.5 percentage points), while revenues will be weak until toward the end of the year.

Now here's the problem. Investors might have been more inclined to trust Nuance, and wait out a decline in revs if the stock was cheap -- but it's not. Indeed, based on trailing-12-month earnings of $176 million, Nuance shares now cost more than 35 times earnings. And that's before you factor in the company's $1 billion in net debt, or ding the company for the cash-cost of its serial acquisitions, by virtue of which it's possible to criticize the company for running free cash flow-negative for more than two straight years.

Long story short, I see every reason to remain short this stock -- and little excuse for going long.

Un-Limited potential
Last but not least, we come to Victoria's Secret owner Limited Brands, which belied its own company name yesterday with a report of 9% comparable-store sales growth in January. points out that the company has shown 5% comps growth over the past three months, which demonstrates that not only are sales growing, but they're accelerating. Given this bright news, it's no wonder analyst MKM Partners decided to up its price target on the stock today (to $45). The real question is whether MKM should also have raised its rating on Limited to "buy." (MKM currently has Limited rated only "neutral.")

Well? Should it have upgraded?

Maybe, but probably not. Here's why: Priced just under 20 times earnings, Limited is actually a bit more expensive than it looks. Free cash flow over the past year came to only $668 million, or about 5% below reported GAAP net income. When you compare these numbers to the growth estimates, and dividend promises we have for the stock -- 12.5% and 2.1%, respectively -- it's hard to call the shares "cheap." In fact, I'd even question MKM's assertion that they're priced conservatively enough to be worth holding on to at today's prices.

Far from holding on to the $45 share price level they currently enjoy, and that MKM projects them to retain by year end, I think Limited shares are priced to fall.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Nuance Communications. The Motley Fool owns shares of Nuance Communications.


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