Tuesday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. And speaking of sense, today being Election Day, you'd think most analysts would have the good sense to sit on their hands and see how things play out in the electoral race before opining on which stocks will be winners and losers over the next four years. But they didn't!

Instead, today's news feeds are chock-full of new ratings. As is our practice, though, we'll limit ourselves to examining just three of them: a new buy rating for Kraft (Nasdaq: KRFT  ) , a sell for its Mondelez International (Nasdaq: MDLZ  ) spinoff, and a downgrade for TW Telecom (Nasdaq: TWTC  ) . Let's begin with the...

Good news first 
More than a month after Kraft Foods completed its split by spinning off the foreign-oriented Mondelez snack foods unit, Canaccord Genuity has completed its taste test and decided which flavor of Kraft it likes best: "original." This morning, the analyst initiated coverage of Kraft proper, assigning the stock a buy rating and a $50 price target.

It's a strange choice, though. At 14.1 times earnings, Kraft costs more than Mondelez, which carries a P/E ratio of only 13.1. Similarly, Kraft's 6.4% estimated long-term growth rate is barely half that of Mondelez. While Kraft boasts superior free cash flow -- both superior to its own reported "earnings" under GAAP, and superior to Mondelez in quality of earnings (Mondelez's free cash flow is roughly equal to reported net income) -- Kraft isn't generating nearly enough cash to make its valuation look attractive.

Long story short, I'd rather be short this one than long.

Curiouser and curiouser
Canaccord only adds to the mystery of its choosing Kraft over Mondelez in its next piece of advice: Sell Mondelez. For the life of me, I can't see the logic in this one.

The international unit's 13-ish P/E ratio doesn't look at all out of whack when compared to growth estimates of 12%-plus. Factor Mondelez's 4.4% dividend yield into the mix, and the stock looks downright attractive.

If there's any logic at all to Canaccord telling you to buy Kraft while selling Mondelez, it can only be found in the companies' relative debt loads. Mondelez, with $26 billion debt on a $46.8 billion market cap, is undeniably heavily leveraged, and more vulnerable than Kraft proper to a blowup in interest rates. Kraft, on the other hand, with $6 billion in debt on a $26.7 billion market cap, appears to possess the better-defended balance sheet. Still, on balance, while I'd be leery of investing in Mondelez knowing all the debt that comes with it, I'm downright scared of the valuation at Kraft.

Pull the plug on TW Telecom?
And speaking of scary stocks, this morning's ratings weren't all about junk food. We also saw a downgrade on TW Telecom, handed down by the analysts at FBR Capital. Yesterday, the telecom services provider reported in-line earnings of $0.14 per share, alongside revenues that came in just short of consensus estimates.

Hardly a worst-case scenario, therefore, but the numbers were sufficiently scary to convince FBR to pull its "market perform" rating on the stock, and downgrade to "underperform" -- with a $20 price target that suggests 20% downside to today's prices.

And that's the good news. The bad news is that TWT could actually fall quite a bit further than this -- must fall further, in fact, if the stock's to become cheap enough to consider buying.

Why? Sure, TWT is growing quickly. Analysts project 21% annualized profits growth over the next five years. But at its P/E ratio of 56, investors are being asked to pay through the nose for that growth. More precisely, they're being asked to overpay. Adding to the risk, this supposed cash cow of a cable business pays its shareholders no dividend, and carries more than $800 million net debt. All in all, it's simply not an attractive stock, and FBR is right to counsel selling it and seeking your bargains elsewhere.

Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above.


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  • Report this Comment On November 07, 2012, at 12:41 PM, tweenthelines wrote:

    Verify your 4.4% div on MDLZ. It may wrong. Before throwing out percentages only, give us the $$$.

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