Tuesday's Top Upgrades (and Downgrades)

Tuesday'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, with earnings season in full swing, we're seeing mainly analyst reactions to earnings news. Specifically, today we'll be looking at a pair of price target hikes for coffee makers Starbucks and Dunkin' Brands . But the news isn't all good, so before we get to those stories, let's find out why...

Coach is falling out of fashion
Shares of Coach are cratering this morning on news that the company's fourth-quarter earnings tumbled more than 9% (to $0.78 per diluted share), despite a 6% rise in revenues. The bad news here seems to center on a 1.7% decline in comparable store sales at Coach's North American unit -- only the second time Coach has seen declines here in about the past four years. Worries over this drop are being compounded by the fact that, according to Coach, the market for handbags actually grew about 15% in the quarter. That means the company is losing share in a growing market.

This news led analysts at Canaccord Genuity to cut their target price on Coach shares to $65. However, the news isn't all bad. For one thing, Canaccord still thinks Coach shares are a buy. For another, after today's drop, Coach shares only cost about $53 and change, so Canaccord still sees more than 22% upside to the shares.

Are they right? Well, let's see here. Based on the $1 billion Coach says it's earned over the past year, its shares now cost about 14.5 times trailing earnings -- or even a bit less, once you back out the firm's net cash position. For a reputed 12% grower paying a better-than-2% dividend yield, this suggests the shares are fairly valued after this morning's sell-off.

Coach hasn't released cash flow information for its fourth quarter yet, but over the past four quarters for which we do have FCF data, the company appears to be holding its own -- generating cash profits at or above the rate at which it records net income. This suggests that, unless things went horribly wrong in the fourth quarter, Coach's quality of earnings is strong -- and the stock, if not a screaming bargain, is at least unlikely to sink much further. On balance, I think Canaccord is right to recommend buying it.

Coffee's on
Moving now to bona fide "good" news, two separate analysts have upped their price targets on two separate coffee houses, as Argus Research backs Starbucks with a buy rating and an $84 price target, and Williams Capital ups its estimate of "outperform"-rated Dunkin' Brands to $51.

Both companies reported earnings last week, with Starbucks recording 28% earnings growth to $0.55 per share, and Dunkin' recording a similar 24% increase in "diluted adjusted earnings per share" to $0.41. (And if all that sounds suspiciously full of qualifications, don't fret. Dunkin' was actually playing down the significance of its net earnings results, which showed a 153% increase in net earnings per share).

But which of these two buy-rated stocks is now the better buy?

Again, we turn to valuation. On the surface, both stocks actually sport pretty similar P/E ratios: Starbucks is a bit cheaper at 34.6, Dunkin' a bit more expensive at 36.7. Dunkin' makes up for its higher price tag (in part) by paying a more generous dividend payout of 1.7% (versus 1.1% at Starbucks).

However, in at least three respects I see Starbucks as retaining the advantage here. For one thing, it has a better record of producing free cash flow than does Dunkin'. For another, Starbucks is growing faster -- by more than 3 full percentage points, if analyst estimates are to be believed. For a third, Starbucks carries much less debt on its balance sheet than does Dunkin' Brands, and so looks more financially sound to me.

Mind you -- both of these stocks remain too expensive for my tastes. I don't plan on buying either one at present-day prices. However, if you feel you absolutely have to own a coffee stock in your portfolio, Starbucks' better balance sheet, better quality of earnings, faster growth, and superior valuation make it the less egregiously overvalued of the two stocks. Gun to my head, that's the one I'd buy.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Coach and Starbucks. The Motley Fool owns shares of Coach and Starbucks.

The article Tuesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.

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