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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And so it ends
Investors in Ohio steelmaker AK Steel (NYSE: AKS  ) had high hopes for a rebound last year. In June, international megabanker Deutsche Bank had declared the slump in steel prices at an end, predicting a floor in pricing was just around the corner. Deutsche urged its clients to pile into shares of U.S. Steel (NYSE: X  ) quickly, "in anticipation of steel price and demand inflection." But even more, Deutsche argued the merits of AK Steel as a "particularly attractive stock." So how'd that work out?

I'll tell you how it worked out: Over the past six months, AK shares have shed 43% of their value, falling from a closing price of $15.76 per share on June 30 (when I wrote up the Deutsche write-up), to a current valuation of $9.04 per share. Adding insult to injury, the Dow Jones Industrial Average as a whole had the temerity to eke out a 1% gain. Not that you'd know it from reading Deutsche's latest report on the stock.

Noting that AK had experienced "recent outperformance," Deutsche removed its buy rating on the stock yesterday, and cut its price target to $10 per share. Said the analyst: "We are lowering AKS to Hold on recent outperformance ... lower expectations for its carbon and electrical steel businesses, scale of estimate cuts, perceived earnings risk, continued concerns over its financial profile & pension obligations and valuation."

Why so shy, Deutsche?
Notable in Deutsche's write-up is that you'll find not one word mentioning how, just a bit over a half-year ago, Deutsche was calling for a rocketship ride to $17.50 per share. (But that's OK, Deutsche. That's why we built Motley Fool CAPS in the first place -- to help analysts remember what they said in months past.)

Another thing that might be worth remembering: I told you so. Ever since Deutsche, and the rest of the Wall Street, began singing the praises of the steel sector, I've warned investors against following these pied pipers to their doom. In fact, as recently as December I criticized Deutsche peer Wells Fargo for urging investors to double down on their AK bets. At just under 10 times earnings, the stock may look cheap -- cheaper than U.S. Steel at any rate. But just like U.S. Steel, and just like industry behemoth ArcelorMittal (NYSE: MT  ) , AK still fails the most crucial test for any profit-making venture: It's not generating free cash flow. Instead, it's burning cash. Until AK fixes that problem, I don't see any urgent need to rush back into the stock.

A better idea
Now I don't want to end this column on a down note, and in fact, there is good news to report, as well. While I've little confidence in AK, U.S. Steel, or Arcelor outperforming the market, Deutsche's other steel idea this week has more merit. At the same time it was downgrading AK yesterday, Deutsche also offered investors a new buy idea in the form of minimill operator Steel Dynamics (Nasdaq: STLD  ) . As StreetInsider.com relayed the news: Deutsche likes Steel-D for "its favorable & improving cost structure, upstream integration & expansion, attractive product exposures, less perceived downside to estimates, solid financial profile, strong FCF ... and valuation."

I agree with it on at least one of these points.

With more than $150 million in annual free cash flow, Steel Dynamics looks to me like it's on firmer footing than any of the bigger name steel stocks discussed so far. The stock sells for 22 times free cash flow today, which is a price that might prove nice if the company achieves consensus growth forecasts of 21.6% annually. It's not my favorite stock in the sector, however.

Foolish final thought
If you ask me, the best bet for steel investors today is the same stock I said was the best bet seven months ago: Nucor (NYSE: NUE  ) . At a share price just 15 times the amount of free cash it generates in a year, Nucor costs less than Steel Dynamics. It boasts an equivalent growth rate of near 22%. And to top it all off, Nucor pays a superior dividend yield: 3.5%. If you ask me, there's just one stock worth owning in the steel sector today, and Nucor is it.

That's why, today, I'm going to put my reputation where my mouth is. I'm heading over to Motley Fool CAPS right now to publicly rate Nucor an "outperform." Feel free to follow along, and jeer loudly if I'm wrong.

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Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 336 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of ArcelorMittal. Motley Fool newsletter services have recommended buying shares of Nucor. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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