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.

Guided by a Navistar
Shares of truckmaker Navistar (NYSE: NAV  ) -- the company behind the International brand of long-haul trucks -- set out on a bit of a long haul itself last week. After reporting earnings (and a management change) that exceeded expectations Thursday, Navistar shares spiked 28% in a single day. Then, on Friday, the shares gained another 11% as Wall Street analysts began to rethink their opinions of where Navistar is headed.

On Friday, JPMorgan Chase upgraded Navistar shares to "overweight" and assigned them a $45 target price on "moderate cash burn" and reduced "liquidity risks." Acknowledging that the shares had gained sharply in Thursday trading, JP argued they were nonetheless still cheap and bound to go higher.

Jefferies' opinion was similar. Reiterating its buy rating and confirming JP's $45 target price, Jefferies said it sees Navistar continuing to cut costs, improving "sequentially," and "ramping into a profitable 2014." According to Jefferies, Navistar is quite literally "the cheapest EV/sales name" that Jefferies is covering today.

Which got me to thinking: Fine about today, but what about tomorrow? Can the amazing turnaround in Navistar's fortunes perhaps point us to other stocks that other analysts will be upgrading in the future?

Three to keep an eye on
Taking a close look at Navistar, and then plugging the company's vital statistics into a screening engine on finviz.com, I began hunting about for a few such companies. I screened for companies showing modest but not exceptional growth prospects of 5% or above (Navistar is at 7%), a fairly high debt load (half of equity or more), and also positive trailing free cash flow (Navistar generated $211 in FCF last year). The results included some interesting names:

Oshkosh (NYSE: OSK  )
In many ways, Oshkosh looks a lot like Navistar. It's a large vehicle manufacturer, for one thing -- fire trucks, armored cars, and construction equipment, as opposed to tractor-trailers. It has a sizable debt load to it, if not as much as it once did, and if not as much as Navistar still has. And of course, like Navistar today, Oshkosh was once the object of Carl Icahn's desire. Only last year, he tried to buy the company.

And no wonder. Oshkosh also generates about as much free cash flow in a year as Navistar does ($195 million), despite sporting an enterprise value less than two-thirds of Navistar's. With a lighter debt load, a price-to-free cash flow ratio of only 18, and a 17% long-term projected growth rate, Oshkosh looks like a winner. Although Oshkosh's enterprise value-to-sales ratio -- the metric Jefferies refers to -- is identical to Navistar's at 0.48, I think Oshkosh offers a better bargain.

U.S. Steel (NYSE: X  )
In a column last week, I laid out the reasons I don't think U.S. Steel stock is "cheap enough to deserve your hard-earned investing dollars." Yet if you recall, USX fared pretty well in comparison with the other steel stocks that got upgraded last week. Coincidentally, it also compares pretty favorably with Navistar.

USX, after all, sports a similar market cap ($3 billion) to Navistar. It also boasts faster growth (8%), free cash flow nearly twice as great ($412 million), and a 0.33 enterprise value-to-sales ratio. Although carrying a somewhat higher debt load, USX's ability to generate cash profit at nearly twice the rate Navistar does gives the stock a much better price-to-free cash flow ratio (7.3 versus 13.5). USX's faster growth rate and modest dividend yield of 1%, where Navistar pays nothing, add up to a pretty strong case in favor of the stock: Simply put, if Wall Street thinks Navistar deserves an upgrade, USX deserves it more.

Ford Motor (NYSE: F  )
Last but not least, we come to a bit of an odd man out: Ford Motor. At first, Ford appears to fail our screen for low enterprise value-to-sales ratios. At an even 1.0 EV/S, Ford appears to cost fully twice as much as Navistar -- but looks can be deceiving.

As Ford is quick to point out, the key reason its stock looks expensive when valued on "enterprise value" is that the company's hybrid nature -- half manufacturer, half bank -- means financial websites count debt held by the company's auto finance division as debt of the whole company. If you buy this argument, therefore, and agree not to hold Ford Credit's debt against it, then the company's EV/sales ratio rapidly drops below 0.6 -- not significantly greater than what Navistar costs.

For the record, I'm still not sure I do buy this argument. To my mind, debt is debt, and Ford Credit debt is, by definition, Ford debt. That said, when viewed in the light most favorable to it, I admit there's a case for arguing that Ford is attractive at 9.1 times earnings, an 11% growth rate, and a 3.2% dividend yield. So yes, I guess you can call Ford cheap, too ... so long as you don't mind an $80 billion debt load.

Foolish takeaway
Which company will be next to score an upgrade after Navistar? Will any of them? There's no way of knowing, because, to be perfectly blunt, Wall Street's not always consistent in how it hands out "buy" ratings. But one thing's for sure: These companies all seem to meet the test that Jefferies laid down for Navistar. Any one of them could be next to win the Wall Street lottery.

Ford has been performing incredibly well as a company over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. But Ford's stock seems stuck in neutral. Does this create an incredible buying opportunity, or are there hidden risks with the stock that investors need to know about? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report.


Read/Post Comments (5) | 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 March 10, 2013, at 11:37 AM, rschulthies wrote:

    Your skepticism on Ford debt is a rather large dismissal. One would then say there is no difference in the leverage ratio of an electrical utility, steel manufacturer, commercial bank etc. Clearly, there is a structural balance sheet difference between an auto finance entity and an auto manufacturer. If there is a question in the auto finance company financial structure i.e. over/under leverage, that would require further analysis of that company and its implication for Ford.

  • Report this Comment On March 10, 2013, at 1:24 PM, MARKETSURFER wrote:

    The finance arm of Ford which encompasses the $80 billion in debt brings in $1 to $2 billion in additional profits for Ford each. As long as the credit worthyness of the debt in it's entirety is reasonable, then more debt in the finance arm

    translates into more profits on the bottom line.

  • Report this Comment On March 11, 2013, at 1:27 AM, TMFDitty wrote:

    @MARKETSURFER: That's a totally fair point. All I'm saying is this --

    Say Ford makes $6B earnings on $50B in market cap and $80B debt (I'm rounding, obviously). Say $2B of those earnings come from Ford Credit. Is it fair to say Ford has a P/E of only 8.3, thereby crediting Ford for the earnings from its finance division, while ignoring the debt it carries?

    Seems to me you can argue that Ford has an EV/E of $130B/$6B = 22. Or you can argue Ford's manufacturing division, ex-Ford Credit, has an EV/E of $50B/$4B = 12.5.

    But it seems wrong to credit Ford for earnings from its Ford Credit debt, without dinging it for the amount of that debt when determining its market cap/enterprise value. Just one Fool's opinion, but that's how I'm looking at it.

    TMFDitty

  • Report this Comment On March 11, 2013, at 9:56 AM, TMFTwoCoins wrote:

    Precisely why using ratio's can be misleading. While you're right that it isn't fair to exclude the financial arm's debt if you include the financial arms' profit in the ratio.

    I think it's just more accurate for this purpose to use automotive debt rather than total debt. I feel that way because if $70 billion in debt is creating a profit, then it can be ignored in the ratio. The interest accrued from the debt is accounted for by posting the profit it makes from lending it out at higher interest.

    Just my two cents!

  • Report this Comment On March 11, 2013, at 1:39 PM, TMFDitty wrote:

    Another good point. But I'd even go a step further. Rather than "ignore" the Credit division's debt, I think you need to separate it out, break the company into two parts, and value the one part as a manufacturer, and the other part as a bank.

    For example, Ford Credit did close to $8B in revenue last year. That's about 13% of the revenue booked by Citigroup! Hunting around for a closer comparable ... Ford Credit had 50% more revenue than Regions Financial did last year.

    RF has a $12 billion market cap, so you have to wonder if Ford Credit is worth perhaps $18B all on its own? (Or more? or less)? $1.7B in pretax profit on $7.9B revenues is about a 21% profit margin, versus Regions' 32%, so maybe Ford's not as good of a "bank" as it should be ...

    Etc. Etc. It gets really complicated, really quick.

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