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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.

So perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.

Aerospace stocks: Now boarding for take-off
Do you love aerospace stocks? If your name is Sterne Agee, you do -- and it shows. Yesterday, this well-respected analyst, ranked near the top 10% of investors we track on CAPS, initiated coverage on a squadron of aerospace companies, giving the vast majority of them its coveted "buy" rating:

• Boeing (NYSE: BA): Buy, and an $82 price target.
• Honeywell (NYSE: HON): Buy, and a $69 target.
• United Technologies (NYSE: UTX)? You guessed it: Buy, and ride to $87.
• And Spirit AeroSystems (NYSE: SPR), Precision Castparts (NYSE: PCP), Triumph Group (NYSE: TGI), and BE Aerospace (Nasdaq: BEAV) as well -- buy, buy, and buy some more.

Indeed, out of the eight aerospace companies it initiated yesterday, Sterne expressed reservations about only one: neutral-rated Rockwell Collins. I only wish I could tell you I'm as optimistic myself ... but I can't. If you ask me, anyone who climbs aboard, and tries to fly Sterne's friendly skies is cruising for a bruising.

Valuation matters
Why not? Well, I'll tell you in a minute. But first, let's let Sterne have its say. That's only fair. These are, after all, Sterne's recommendations we're discussing.

According to Sterne, there's a big ramp-up in airplane manufacturing in the works, due to begin kicking in sometime next year, as airlines around the world begin retiring antiquated aircraft and upgrading their gas-guzzling fleets with scores of shiny, newfangled fuel-sippers. Sterne sees plane production at Boeing and Airbus growing 19% in 2012 and then continuing to gain altitude until, by 2014, the two plane makers are churning out a combined 39% more aircraft than what we saw in 2011.

I don't necessarily disagree with those numbers. To the contrary, I'd say they match pretty closely what Boeing has told us about its plans for accelerating 737 plane production and what Airbus has stated concerning the A320 production ramp. What worries me, though, isn't how many planes the planemakers are building, but rather how much profit the planemakers, and their suppliers, will earn on them, and the price investors must pay to grab a piece of that profit. Let's take a look at those projections.

Sources: Yahoo! Finance, S&P Capital IQ. NM = not meaningful because of negative free cash flow.

When Sterne Agee looks at these numbers, it apparently spies bargains as far as the eye can see. Me, however, I'm struggling to see anything at all worth buying.

I mean, just look at these valuations: 13 times earnings for Boeing, and 13% growth in profits from building its planes. A 14 P/E for Triumph, and a 14% growth rate for its business of building wings, engine nacelles, and similar parts for Boeing's planes. Fifteen times earnings for Honeywell, and 15% growth in profits from outfitting Boeing jets with avionics and power systems.

Where's the cash?
See the pattern? Everywhere you look, you see perfect 1.0 PEG ratios for these stocks. (At best. Shares of titanium widget maker Precision Castparts will set you back a 1.4 PEG ratio, while airplane-seating specialist BE Aerospace costs closer to a 1.6 PEG.) And it gets worse.

Even where the P/Es look attractive, most of these companies aren't generating free cash flow at anywhere near the rate they claim to be earning profits on their income statements. Triumph, for example, generates only 1% as much free cash as it claims for earned income. And the company that boasts the lowest PEG ratio on the list -- Spirit AeroSystems -- generates negative free cash flow.

Abandon hope?
So is there any hope at all that an investor can make a profitable investment in aerospace today? Or is Sterne totally off base on its recommendations? Well, I do see potential in one of its recommendations: United Technologies.

Selling for a 14 P/E on 11% growth prospects, the stock's not an obvious bargain. But it has two things going for it that most of these companies lack: First, UTC sports a decent-sized dividend, 2.6%, which helps offset the high stock price. And second, it boasts free cash flow superior to reported income. Put them together, and UTC looks to me like an attractive prospect at less than 13 times free cash flow. It's not the cheapest stock in the world, necessarily, but it's the best of the bunch today.

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