This Just In: More 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. But 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, Wall Street is knocking the shares of data storage maker OCZ Technology (Nasdaq: OCZ  ) and iron ore miner Cliffs Natural Resources (NYSE: CLF  ) . Curiously, though, it's also talking up shares of a company that buys ore from Cliffs: AK Steel (NYSE: AKS  ) . So how does that work? We'll find out in a moment. But first…

RIP, OCZ?
The big news in semiconductors today is that solid-state drive memory maker OCZ Technology just warned of significant revenue shortfall in fiscal Q2. This has already sparked at least two downgrades that we know of -- to "hold" at Needham and to "underperform" at FBN Securities.

According to OCZ, a shortage of NAND flash memory in the market is hurting its ability to produce the drives. This is good news for companies like Micron (NYSE: MU  ) and SanDisk (Nasdaq: SNDK  ) , which manufacture flash -- and whose shares are spiking today. Those two can likely command much higher prices on their memory chips as drive makers scramble to get a piece of the available inventory. For OCZ, however, the dearth of supply means about 8% less revenue than previously planned -- and a 21% slide in market cap.

Considering that OCZ wasn't profitable even before the warning, investors are probably right to worry.

Falling off a cliff?
Another company in Wall Street's crosshairs this morning is Cliffs Natural Resources, the target of simultaneous downgrades from both Longbow and UBS. Priced at less than four times earnings and paying a 7.4% dividend, Cliffs has been a favorite "bounceback" play for value investors and dividend seekers alike. But according to UBS, a steep decline in the price of iron ore is hurting the company's ability to earn profits -- and may imperil Cliffs' dividend as well.

UBS believes ore prices will "re-rate higher in 4Q" and is unwilling to downgrade Cliffs all the way to "sell" with this prospect so close. "However," warns the analyst, "CLF will likely be range bound until then."

And if prices don't "re-rate" higher? Well, in that case, the situation looks bleak for Cliffs. The company's already lugging around $4.1 billion in net debt. The $378 million in free cash flow that Cliffs is bringing in annually wouldn't be enough to pay that off, even if management spends every penny it makes on debt repayment for the next decade. The longer ore prices remain low, the more likely it is Cliffs will have to cut its divvy in order to make a dent in its debt.

That's A-OK with AK
One company shedding no tears over the steep decline in ore prices is AK Steel, which buys iron ore from miners such as Cliffs. And, not coincidentally, one of the analysts that downgraded Cliffs today decided to upgrade the steelmaker for the same reason. According to Longbow, lower prices on metallurgical coal and iron ore both portend lower input costs for AK -- and higher profits. If Longbow is right, then it's entirely possible AK Steel is a bargain today.

Then again, perhaps investors should consider why exactly ore and met coal prices are plunging? Chances are, it's not due to a surge in demand by steelmakers like AK Steel. Rather, the opposite seems more likely. (And indeed, sales at AK Steel last quarter were down a steep 14%, with profits nonexistent.)

In short, while lower input costs are undoubtedly a good thing for AK Steel in the short term, what steel bulls should really be looking for is the time when ore prices turn back up. That, after all, will be the signal that cyclical steel demand is returning to a long-term upswing. In the meantime, natural-resources investors are best advised to stick with companies like the one recently profiled in our report: "The Tiny Gold Stock Digging Up Massive Profits." Because the best way to be sure your company can survive the ups and downs of a commodity cycle is to be sure it's not in hock going into the downturn.

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

Fool contributor Rich Smith has no position, short or long, in any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 256 out of more than 180,000 members. The 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.


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  • Report this Comment On September 07, 2012, at 11:33 AM, garifolle wrote:

    Good news for MU, but the shares are not spiking today.

    Yesterday! Tommorrow?

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