This Just In: More Upgrades and Downgrades

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

Given this, 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.

Today, we're going to take a look at three high-profile ratings moves on Wall Street: New buy ratings have just been issued for biotechs Ariad Pharmaceuticals (Nasdaq: ARIA  ) and Human Genome Sciences (Nasdaq: HGSI  ) . On the other hand, ArcelorMittal (NYSE: MT  ) just lost its buy rating.

ArcelorMittal's new rating: neutral
Let's get the bad news out of the way first. Yesterday, we looked at how a previously spooked Wall Street may be moving back into steel stocks, with Wells Fargo leading the way with an upgrade for AK Steel. Today, though, another analyst is stomping on the brakes, and warning, "Not so fast." This morning, the analyst in question, HSBC Securities, downgraded shares of the world's biggest steelmaker, ArcelorMittal.

According to HSBC, there's a limit to how much profit Arcelor can earn before attracting cut-price competition from Chinese steelmakers. Analysts looking for $0.12 per share out of Arcelor in its next quarterly report, and an even more robust $0.50 profit in Q1 of 2012, are going to get their hopes dashed. Accordingly, HSBC says you should sit on the sidelines till the damage has been done.

I agree. Arcelor's profit margins are already pretty high. At 7.7% operating margin, the company outshines U.S. Steel by a factor of... 7.7. So there's little room for improvement on the margins front. Meanwhile, Arcelor continues to struggle under the weight of a $25 billion net-debt load -- and yes, it's still free-cash-flow negative.

Ariad Pharma's new rating: buy
Turning now to the biotech industry: Ariad Pharma is no stranger to cash-burn either. But according to a new report out of Maxim Group, the cancer researcher's ponatinib and AP26113 compounds are "superior" to other drugs on the market, and make this company an attractive acquisition target. Over at The Motley Fool Blog Network, prolific commentator Robert Fisher also likes Ariad's ridaforolimus treatment for "metastatic soft-tissue or bone sarcomas." Ariad is partnering with Merck (NYSE: MRK  ) on that one, which means it's got to share the profits, which limits the upside for Ariad stock.

Will Merck (or someone else?) buy Ariad's cow instead of just milking the company for cheap access to new drugs? It's possible. The company had more than $73 million in net cash at last report, which means that for the time being, Ariad can negotiate a sale from a position of strength -- but this window is closing fast. With a cash-burn rate exceeding $44 million annually, Ariad has less than two years to either raise new capital through debt or dilutive stock issuances, or seal a deal with an acquirer.

Human Genome's new rating: buy
Last but not least, Maxim also likes the prospects for Human Genome. Yesterday, my fellow Fool Sean Williams highlighted the possibility that GlaxoSmithKline (NYSE: GSK  ) might buy the company for its Benlysta lupus drug. (You guessed it -- Glaxo is Human Genome's marketing partner on Benlysta.)

Human G's in a trickier position than Ariad, however. While flush with cash on the surface ($540 million cash and equivalents), the company has $525 million in debt, which basically cancels that out. Making matters worse, it's burning cash much faster than Ariad is, with annual cash burn approaching $410 million. If a buyout's going to happen here, it had better happen fast, or else Human Genome will be forced to avail itself of the dilution solution.

Foolish final thought
Personally, I would not buy any of these stocks. As I've said many times already, I'm no huge fan of negative free cash flow. ArcelorMittal seems unattractive to me on this score, especially when there are better options available. And as for the biotechs, Ariad and Human Genome, is there potential for a cash payday when a buyout materializes? Sure there is -- but I don't like to rely on the kindness of strangers to bail me out of bad investment decisions. I might not be brave enough to bet against these biotechs (because sometimes, strangers do strange things), but I wouldn't risk my money on 'em, either.

Whose advice should you take -- mine, or that of "professional" analysts like Maxim? Check out my track record on Motley Fool CAPS, and compare it to Maxim's. Decide for yourself whom to believe.

The Motley Fool owns shares of ArcelorMittal, and Motley Fool newsletter services have recommended buying shares of GlaxoSmithKline, but Fool contributor Rich Smith does not own shares of, nor is he short, any company mentioned above. (He does, however, have public recommendations available on 56 separate companies. Check them out on Motley Fool CAPS page, where he goes by the handle TMFDitty -- and is currently ranked No. 349 out of more than 180,000 CAPS members.)

The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Read/Post Comments (4) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 19, 2012, at 2:02 PM, TechnoPharm wrote:

    ARIA's cash balance for the quarter ending Sept. 30, 2011 was more than $85 million. Add to that $243 million in net proceeds from a public offering that completed on Dec. 20, 2011.

    They are likely sitting on $310 million today. If they are burning $45 million a year then they have seven years of cash float now even without a milestone payment from Merck. Companies just don't raise cash for that long into the future.

    So either they are expecting to increase their burn rate (which is what ARIA implied in their Press Release for the Proposed Offering on Dec. 14) or they are setting themselves up to be acquired.

    But the burn rate increase would have to be substantial to justify this much capital. Doubling the current burn rate still gives them 3.5 years and by then ARIA should have received another milestone payment or two from Merck and be receiving decent revenue from ponatinib.

    It is interesting to note that only ten months ago CEO Harvey Berger swore up and down that the company is not for sale. Now, despite widespread rumors and comments from analysts, not a peep.

  • Report this Comment On January 19, 2012, at 7:04 PM, Zankudo wrote:

    Ah well, lessee, MT's debt to assets is 0.22, PB-0.53, price to sales 0.34. Management is Lakshmi Mittal, 30 years in the business. Its operating margin is 7.7% you say. It is located in Luxembourg, a country with a AAA rating if you believe the pay for hire rating agencies, and most importantly the final resting place of one George Patton. And finally today HSBC cut it from buy to neutral which caused an immediate drop in price yes? Nooooo, went up over 3%. I think I will trust my analysis. HSBC can go fish.

  • Report this Comment On January 19, 2012, at 7:58 PM, TMFDitty wrote:

    Zankudo: Generally speaking, I agree with you on telling analysts to "go fish." But in this particular case, I think HSBC has finally gotten one right.


  • Report this Comment On January 22, 2012, at 4:37 AM, WEBbuff wrote:

    "and yes, it's still free-cash-flow negative."

    Does it affect your analysis that the average price-to-free-cash-flow ratio (TTM) in the industry is minus 15.30, whereas MT's is minus 9.30?

    Also--and I need to research this further--a negative P/FCF can simply mean that a company is making large investments that will beget potentially high returns in the future, though ArcelorMittal seems to be permanently and temporarily closing blasting furnaces rather than investing in them.

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