Friday'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 feature new upgrades for hi-tech industrialists Cubic Corporation (NYSE: CUB  ) and ITT Corporation (NYSE: ITT  ) . But the news isn't all happy in tech-land, so before we get to those two, let's find out why...

Westport Innovations just blew a spark plug
Shares of Westport Innovations (NASDAQ: WPRT  ) are innovating today, all right -- finding amazing new ways to fall farther, faster. The pioneer in natural gas engine manufacturing technology reported earnings yesterday, and when I say "earnings", I mean losses.

The company reported losing $0.61 per share in Q2, $0.12 worse than estimated, and with revenues falling about 20% short of expectations. Revenues are still expected to close out the year close to the high end of expectations ($178.5 million), granted, but that's not enough to turn analysts into believers given the size of yesterday's miss.

This morning, analysts at Raymond James noted that Westport's new revenue projection is about $20 million short of what it had been promising previously, and declined to raise its rating on the stock past market perform. Northland Securities, which had been optimistic about the company earlier, cut the stock a notch to market perform in response to weak earnings.

And I'm not much more optimistic myself. Unprofitable still -- unprofitable always -- the size of Westport's losses just keep growing and growing: $27 million lost in the 2010 fiscal year, then $42 million more in 2011, then a $60 million restatement, followed by a $99 million loss last year, and $136 million lost over the past year. Things just don't seem to be getting better at this bleeding-edge tech company, and the analysts are right to be nervous.

They're loving ITT!
Speaking of things people should be nervous about -- but aren't -- analysts at FBR Capital sounded the all-clear on ITT Industries this morning following the company's $0.02 earnings beat, and its promise of more profits to come in yesterday's Q2 earnings report. ITT is telling investors to expect as much as $1.92 per share in profits by year's end, and saying revenues will grow at least 10%.

FBR seems skeptical of this, with StreetInsider.com quoting the analyst lamenting how "FCF conversion has been significantly below peers (67% in 1H13 versus 90%–100% for peers). However, this does not seem to have affected shares and, unlike our expectations, has not been a key debatable topic with investors." As a result, FBR is throwing in the towel, pulling its sell-rating, and upgrading ITT to market perform.

I think that's a bad call, and I'll tell you why. It's true that ITT shares have performed most excellently for shareholders -- rising 69% over the past year, despite the company's poor performance. But just because investors have been buying ITT, doesn't mean they're right to do so. The company's P/E ratio of 20 looks too high for 11% earnings growth to support, and the modest 1.3% dividend isn't large enough to make up the difference. Plus, FBR is right about the weak free cash flow at this company. Free cash flow for the past year amounts to only $114 million, meaning ITT is really only generating about $0.75 in cash profits for every $1 it claims to be "earning".

As a result, ITT shares that look overpriced when valued on P/E, are even more expensive when valued on FCF.

And speaking of free cash flow...
Cubic Corporation finally generated a bit of free cash flow. Yesterday's earnings release showed the company generating nearly $47 million worth of greenbacks, and put an end to a six-quarter-long cash drought at the company. This fact, plus beats on both revenues and GAAP earnings, helped turn The Benchmark Company from a holder of Cubic stock into a buyer this morning. And if truth be told, this news is a real positive for Cubic.

However, the fact still remains that this San Diego manufacturer of fare collection systems, "smart" card readers, and military-grade electronics is still free cash flow negative for the past 12 months. It's still trading for more than 17 times earnings, and still expected to grow those earnings in only the high single digits, percentage-wise, over the next five years.

This all leaves the stock still looking overpriced. Now, if Cubic can string together a few more quarters of $50 million-ish cash production, I'd probably be inclined to think that the stock is closer to fairly valued. As things stand, though, one quarter does not a good buy thesis make. Cubic remains a show-me stock.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Cubic and Westport Innovations. The Motley Fool owns shares of Westport Innovations.


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