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." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the worst ...
And now, in what appears to be the latest installment from "News of the Weird," we bring you the latest bad news on natural gas extractor Chesapeake Energy (NYSE: CHK): Yesterday, boutique investment banker Howard Weil downgraded the stock to "market perform." Coming on top of the news that CEO Aubrey McClendon has just finished dumping his entire stake in the company -- a forced liquidation necessitated by margin calls -- you wouldn't expect investors to be pleased with the news of an analyst piling on. But they were.

So how pleased were they?
22% pleased. (The amount the stock went up yesterday.) And another 10% today.

Wow. That's pretty pleased.
Indeed it is. Though I'll admit that all that movement probably wasn't due just to Howard Weil's call. However, considering the record of the analyst in question, I think part of that reaction is understandable. We've been tracking Howard Weil's performance for about three months now on CAPS. Through Friday, it was remarkable for the singular fact that Howard Weil hadn't gotten a single one of those picks right in three months of trying.

Not one. Each of its picks -- Pride International (NYSE: PDE), Helmerich & Payne (NYSE: HP), Range Resources (NYSE: RRC), Hercules Offshore (Nasdaq: HERO), Massey Energy (NYSE: MEE), and Callon Petroleum (NYSE: CPE) -- was lagging the market.

And while it's true that yesterday's rally lifted Howard Weil into the green on Pride and Helmerich, its other picks all remained deeply in the red, lagging the S&P 500 by anywhere from 9 to 45 points.

Whither points this contrarian indicator?
Suffice it to say that a record like this one doesn't inspire a lot of confidence in the downgrade (it may even have encouraged investors to bet against Howard Weil, and in favor of Chesapeake). But just as important as the banker's lack of a successful record is the fact that no one seems to know why it decided to downgrade Chesapeake. None of the major news outlets reported the basis for the downgrade, saying only that it happened, not why.

Playing Devil's advocate
So allow me to suggest a reason for Howard Weil's pessimism. According to The Wall Street Journal, the CEO isn't the only one having money troubles at Chesapeake these days. The company itself is experiencing something of a credit crunch, selling off assets and cutting back on capital spending to conserve cash after going on a land-leasing spree that it can now ill afford.

The Journal quoted Chesapeake board member Charles Maxwell commenting on an "excess of enthusiasm" that, as of the end of the second quarter, contributed to Chesapeake sitting on zero cash -- but $13.7 billion in debt. Not an enviable position to be in, in a market where the price of natural gas has fallen by half. And the company's plans (since scaled back) to spend three times its operating cash flow on capex this year gave analysts further reason for worry.

Foolish takeaway
As a fan of Chesapeake for some time, I have to admit -- the lack of free cash flow at the company has been the key factor keeping me from buying shares as well. And ultimately, that proved the prudent course, as management's irrational exuberance (both corporate and in the person of the CEO) laid the groundwork for a 50% decline in share price.

Sure, the stock looks cheap after this decline, and even after two days of frenetic buying on Wall Street. Yes, the forward P/E of 6 looks tempting. And well, yes, the downgrade from a less-than-distinguished analyst also has me intrigued.

Still and all, it's been nearly two years since Chesapeake last generated free cash flow in any single reported quarter. Unless and until it proves itself capable of generating actual cash profits, I plan to sit this rally out.

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