Wednesday'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, we're talking all fertilizer, all the time, as ace analyst RBC Capital Markets (ranked in the top 10% of investors on CAPS) initiates coverage on a raft of fertilizer stocks. Let's begin with ...
An outperform rating for Mosaic ...
One of RBC's two favorite recommendations in the fertilizer sector is Mosaic , a specialist in phosphate and potash crop nutrients. Mosaic won one of just two positive rating that RBC assigned this morning, an "outperform" recommendation with a $57 price target. Why?
Well, on the surface at least, the answer appears to be that Mosaic looks cheap. The stock trades for less than 11 times trailing net income, and analysts think Mosaic is capable of growing its earnings at about 8% annually over the next five years. The stock pays a modest 2.1% dividend yield, and Mosaic also sports a strong balance sheet featuring $2.3 billion more cash than debt.
So far, so good. But here's where things get tricky. According to its cash flow statement, only about $300 million of Mosaic's GAAP "earnings" are actually backed up by free cash flow. Put another way, the company generated only about $0.16 in real cash profits for every $1 it claims to have "earned" over the past year.
The way I look at these things, this means the stock is actually a whole lot more expensive than it looks. Too expensive to be worth buying? Probably, yes.
... and another outperform for Agrium ...
So what about RBC's other recommendation of the morning, wholesale and retail nitrogen, phosphate, and potash distributor Agrium ? Does this stock offer any more promise than Mosaic?
Unfortunately, no. To the contrary, Agrium actually looks like a worse bet than Mosaic.
For one thing, analyst expectations for Agrium's earnings growth over the next five years fall far short of what we're told to expect from Mosaic. According to the experts, Agrium will grow its earnings at only about 2% per year over this period. The stock's also deeply in hock, relative to Mosaic, with net debt of $3.6 billion. And to top it all off, while Mosaic's free cash flow is meager, Agrium's is downright nonexistent. The company generated no free cash flow whatsoever over the past year. Instead, it burned through $124 million.
Long story short, while Agrium's smaller P/E ratio (of 10.4) and higher dividend yield (3.4%) may incline you to believe the stock is a better bargain than Mosaic -- it's not. It's actually a worse deal, and a stock you should probably shy even farther away from.
... but no recommendation for Potash? Why not?
Perhaps the strangest bit of advice coming out of RBC today, though, isn't its suggestion that these two overpriced stocks will somehow outperform the market. It's RBC's inexplicable failure to recommend a higher-quality player in the sector: PotashCorp , for example. Whereas RBC picked Mosaic and Agrium to "outperform" today, it initiated coverage of Potash with only a "sector perform" rating.
Yet while seeming more expensive than its rivals at a P/E of 14.2, Potash is growing faster than Agrium and pays a better dividend yield than Mosaic (and better than Agrium too, for that matter). Potash's 4.5% dividend yield trumps just about all comers in this industry. Best of all, the company's churning out a respectable amount of cash from its business. Free cash flow for the past 12 months approached $1.6 billion. That's still only 80% of reported GAAP income -- but it's still better than the numbers we see at the stocks RBC recommended.
Make no mistake: I think that all of these stocks are overpriced and would not buy a one of them -- not even Potash. But if RBC truly believes that Mosaic and Agrium are buy-able, and you agree with the banker, then there's simply no reason not to conclude that Potash is an even better buy.
The article Wednesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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