Monday'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 a downgrade for Kroger , balanced out by upgrades for both of Masco and Olin Corp . Let's dive right in.
First up, analysts at investment banker Hilliard Lyons (now owned by PNC Financial ) warned that they're cooling their enthusiasm for supermarketeer Kroger Monday. Formerly a "buy" recommendation of the banker, Kroger's now considered only a "long-term buy" -- meaning it's probably worth owning... but just not at this price.
That's a surprising conclusion, considering that last week, Kroger "beat earnings" pretty soundly, reporting $0.77 per share in profits on $24.2 billion in Q4 revenue. Guidance-wise, management also stuck by its long-term goal of promising 8% to 11% earnings growth in 2013 -- $2.71 to $2.79 per share. Nor do the shares look particularly expensive. Even after gaining 6% in the wake of last week's results, Kroger only costs a little more than 11 times earnings. It's growing at nearly 10% per year, and pays a 1.9% dividend.
All that being said, I think Hilliard's right to be cautious, and for two reasons. First, Kroger's free cash flow -- never particularly strong -- currently stands at just $771 million for the past 12 months. That's barely half the company's $1.5 billion in reported net income. Kroger also carries a sizable debt load -- $8.6 billion -- which isn't factored into its market cap. Between the cash deficit on the balance sheet, and the little cash coming in on the cash flow statement, Kroger is a more expensive stock than meets the eye. Honestly, I'm not sure it deserves even the title of "long-term buy."
Next up, chemicals company Olin Corp. The stock won an upgrade to "buy" from brokerage house Monness, Crespi, Hardt this morning, but I'm hard pressed to say why. Sure, as the manufacturer of "Winchester" brand ammunition, Olin's enjoying boom times from rising fears over gun and ammo regulation these days. On the other hand, though, Olin's recent good fortune seems fully priced into its stock.
Priced at 13 times earnings, Olin pays a generous 3.3% dividend yield. But it's growing earnings at only about 7% per year. Worse, free cash flow at the company is positively anemic. As Olin reported earning $150 million in "GAAP" profit last year, the company was only able to back that number up with about $25 million in real cash profit. Factor debt into the picture, and the case can be made for Olin not costing "13 times earnings" but rather selling for an enterprise value-to-free cash flow ratio of 100, which is far too much to pay for 7% growth.
Long story short: Monness may have just discovered the attractions of this munitions maker. I think they're arriving late to the party. Olin's run is done.
Mighty, mighty Masco?
Speaking of Johnny-come-lately stock picks, RBC Capital gave us an idea this morning that's easily as bad as Monness's Olin pick. Predicting that furniture maker Masco will "outperform" the stock market over the next 12 months, RBC argued the stock will rocket from $20 to $25 in short order. Personally, I think it's overpriced already, and I'll tell you why.
Free cash flow at the company topped $160 million last year, and while that's certainly a better number than Masco's negative GAAP "earnings" (the company reported losing $114 million last year), it still leaves Masco trading for 44 times free cash flow. Its enterprise value-to-FCF is even worse: 59.
Meanwhile, Masco's projected growth rate is a plodding 10%, and its dividend yield a modest 1.5%. Neither number seems to justify an investment in overpriced Masco. My advice here, if you don't yet own the stock, is to stay far, far away. If you own the stock already, on the other hand, and are sitting on a 65% profit from the housing rally? Count yourself lucky, and start counting your winnings, as you take them off the table.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of PNC Financial Services.
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