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." 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.

In today's column, we're looking at new upgrades for Arch Coal (NYSE: ACI  ) and Chimera Investment (NYSE: CIM  ) -- but a downgrade for Heckmann (NYSE: HEK  ) . Do these moves make sense? Let's find out, beginning with...

Arch reaches for the skies
The news just gets better and better for Arch Coal investors. Two weeks ago, the coal miner wowed the Street with a report of higher revenues and lower losses, sparking a one-day, 24% jump in share price, which quickly swelled to 45%. Today, Arch is tacking on another 6% in response to an upgrade (to "buy") from Argus Research. Is all the excitement justified?

Motley Fool Blog Network contributor Peter Epstein recently pointed to Arch's "strong cost control and [positive talk about] coal inventories, natural gas prices and hot summer temperatures" as all backing up the bull thesis at Arch. Regardless, investors should bear in mind that even this hasn't sufficed to turn a profit for Arch. With roughly $4 billion in net debt hanging 'round its neck, the company remains deeply unprofitable and is burning cash to boot.

That may sound like a buy thesis to Argus, but I'm still seeing a sign hung over Arch: "Abandon all hope, ye who enter here." And I'm matching actions to words, going head-to-head with Argus and its buy rating, and publicly rating Arch's stock an "underperform" on Motley Fool CAPS. Tune in here, and see how the pick works out.

Chimera can't be killed
Next up on the "good news" front, Chimera Investment was down 30% over the past year, but this morning it took a step toward repairing the damage, confirming that it will pay a $0.09 quarterly dividend in each of the third and fourth quarters of this year. The news prompted an immediate upgrade to "hold" from analysts at Wunderlich -- but did the analyst jump the gun?

Sure, on the surface, this commercial and residential real estate investment trust looks attractive: The new dividend suggests an ongoing dividend yield of 15% per share, and Chimera stock only costs 4.3 times earnings based on trailing-12-month results. That's a whole lot cheaper, and more generous, than the P/E and dividend yield you'll find at Chimera's recently downgraded rival Annaly Capital (NYSE: NLY  ) . But here's the thing: Simultaneously with the dividend announcement, Chimera informed investors that it will be restating financials for the past three years, and delaying filing of last year's 10-K, and the first 10-Q for this year as well.

Management says: "The restatement is not expected to affect the Company's previously reported GAAP or economic book values, actual cash flows, dividends and taxable income for any previous period," and Wunderlich seems to be taking that at face value. Smaller investors, however, might want to wait a bit to see how the numbers actually work out before jumping into today's rally.

What the Heck?
And finally, a story from the good news, bad news files: Yesterday, Heckmann announced Q2 earnings of $0.07 per share, or three and a half times better than what Wall Street was expecting. It did this despite collecting revenues that fell far short of consensus estimates, which means profit margins expanded significantly. In response, analysts at Craig-Hallum... downgraded the stock. Does this make sense?

In a "the market abhors uncertainty" sense, it actually does. You see, investors aren't necessarily objecting to what Heckmann said yesterday, but rather to what it refused to say, and specifically, to its declining to give guidance for full-year earnings, citing a "very difficult" environment for the drillers it services. This is the main reason shares sold off by 20% in response to the earnings beat. It's also probably why analysts are pulling in their horns, and rolling back their price targets. (Craig-Hallum, for example, just lopped off $2 and set a new target of $4 a share).

Foolish takeaway
With Heckmann still unprofitable despite the earnings beat, the bull thesis now depends on the company regaining profitability on time, achieving the 15 times earnings forward P/E that analysts project for it, and growing these profits at the 25% annual rate Wall Street has been expecting. But with management kicking out the third leg of the stool their buy thesis was sitting on, investors are rightly upset -- and right to be cautious.

So basically, none of the stocks mentioned above -- not the ones getting the upgrades, and not the ones getting the downgrades either -- looks particularly attractive today. What then is an investor to buy? For a few ideas, read our new, free report: Find out which stocks only the smartest investors are buying.

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

Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 308 out of more than 180,000 members. The Fool has a disclosure policy.

The Motley Fool owns shares of Annaly Capital Management and Heckmann. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management.

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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  • Report this Comment On August 07, 2012, at 2:49 PM, Teacherman1 wrote:

    Good informative article Rich, but I disagree with you on HEK.

    I think in the not too distant future, we will look back at this price and ask, "Why didn't I buy then?"

    They spent a lot of money to expand their operations, and it will take time to make it back, but they are in the right "businesses", at the right time, and in the right place.

    It is just a matter of time before their new relationships will pay off.

    JMO and worth exactly what I am charging for it.

    I am long on HEK, and plan to stay that way.

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