Monday'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. Today, our headlines include twin upgrades for merging office-supply chains OfficeMax (NYSE: OMX  ) and Office Depot (NYSE: ODP  ) . Meanwhile, however ...

Boise Cascade plunges
It's been more than a month since lumber products supplier Boise Cascade (NYSE: BCC  ) had its IPO on the NYSE. Now, all of a sudden, everyone on Wall Street has become interested in it. This morning, no fewer than six separate analysts initiated coverage of BC.

Most analysts went with a neutral rating, but breaking from the pack with an "underperform" recommendation is DA Davidson, which set a $28 price target on BC, implying 12% downside in the stock. And to me, this looks like the right call.

Why? Well to be perfectly blunt, the reason is that BC costs too much today. Priced north of 22 times earnings and paying no dividend, Boise shares are priced at a premium to the rest of the lumber industry, where the average stock sells for closer to 18 times earnings. Boise's also a bit more expensive than it looks, as its balance sheet shows the company to be carrying about $220 million more debt than cash. Factor that debt load into the equation, and you could argue that the company's real P/E is closer to 28.

Boise Cascade is going to have to grow earnings awfully fast to justify that valuation. Unfortunately, most analysts expect to see earnings contract across the broader lumber industry -- falling 30% on average over the next five years. Result: Davidson may be the first analyst to urge selling this stock. It won't be the last.

March merger madness
Our other two featured ratings this morning are soon-to-merge OfficeMax and Office Depot -- and we'll discuss them together today, because KeyBanc Capital Markets upgraded them that way.

KeyBanc assigned a $4.80 price target to OfficeMax and a $14.50 target to Office Depot. The reason, as recited on StreetInsider.com: "[W]e view ODP-OMX as a compelling opportunity particularly for value and special situation investors." KeyBanc expects the merger to sail through FTC approval, and once they're merged, KeyBanc thinks the companies will produce enough value to make their current share prices look cheap relative to archrival Staples (NASDAQ: SPLS  ) .

KeyBanc sees a merged "DepotMax" growing earnings before interest, taxes, depreciation, and amortization at as much as two to three times as fast as Staples. Yet the analyst points out that right now, the shares of DepotMax's component parts both sell as a discount to Staples' valuation.

Unfortunately, I have to disagree.

KeyBanc has a point that the companies are getting short shrift when valued on their sales. If Staples shares cost 0.37 times trailing sales, the "DepotMax" shares are priced in the low-teens -- 0.11 times sales for "Depot," and 0.15 for "Max." But based on fiscal 2014 earnings estimates, Staples shares today cost about 9.6 times such forward earnings." OfficeMax, in contrast, costs 13.3 times forward earnings, while Office Depot's forward P/E is 31.4. That's the very opposite of a discount, and it's the opposite of logical, too, considering that Staples sports an operating profit margin several times larger than either OfficeMax or Office Depot.

Seems to me, to justify what's really a premium valuation being placed on DepotMax shares, you have to assume that merging two bad retailers in hopes of creating one good one will work, and one that will in fact be a viable competitor. Last time someone tried doing, that, though, it was the merger of Kmart and Sears to create Sears Holdings -- and we all know how that worked out.

KeyBanc's enthusiasm notwithstanding, I don't see any reason DepotMax would work out any better.


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