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 downgrades for world's-largest-steelmaker ArcelorMittal (NYSE: MT  ) and Level 3 Communications (NYSE: LVLT  ) . But on the bright side, at least ...

Someone still loves ExOne
 Earlier this week, Swiss megabanker Credit Suisse initiated coverage of the 3D printing market with three ratings: a buy for 3D Systems, a hold for archrival Stratasys, and for newcomer ExOne (NASDAQ: XONE  ) -- a sell.

That was bad news for the last company on the list, but today its shareholders are getting a bit of a reprieve. First, Mad Money's Jim Cramer gave the company a cautious endorsement as a "speculation" investment in 3D printing, and now FBR Capital has seconded that emotion.

Quoted on StreetInsider.com this morning, FBR says it is "very positive on the longer-term story" at ExOne, and believes that "ongoing improvements to the company's pre- and post-production processes could result in a rapid uptick in revenues and profitability."

FBR then begins throwing around numbers to explain its optimism: an "$8.0+ billion" market in 3D printing with "sand alone," "high" profit margins building machines that can create objects from sand, and a "$75" price target on the stock.

But I still don't buy it.

The company's got no free cash flow, no earnings currently, and costs 82.5 times what it might (or might not) earn next year, a P/E multiple more than twice what rivals 3D and Stratasys carry. Projections of hypergrowth in the future won't begin to impress me until ExOne first proves it can earn some profits in the present.

ArcelorMittal: As bad as it looks?
 Speaking of unprofitable companies, the biggest steelmaker in the world, ArcelorMittal, is showing trailing-12-month losses  of $5.6 billion, a number that suggests the business is deteriorating since posting a $3.4 billion loss last fiscal year. The bad news is beginning to erode support for the stock on Wall Street, too, with RBC Capital this morning announcing a downgrade from "outperform" to "sector perform."

I don't necessarily disagree. With Arcelor GAAP-unprofitable, and weighed down with $16 billion in net debt, the stock sure looks ugly on the surface. That said, it's not all bad news for Arcelor shareholders.

ArcelorMittal is still paying a decent dividend for one thing -- 1.4% annually, according to S&P Capital IQ. And if you're wondering how they can afford to do that with no profits coming in the door, well, the company actually is making cash profits. Free cash flow totaled $635 million  for the past 12 months, and unlike GAAP income, this number is actually moving up a bit in comparison to full-year 2012 results.

Granted, this still leaves the stock selling for more than 36 times trailing free cash flow, which is probably too much to pay for the amount of cash Arcelor is producing today. Then again, just five years ago, the company was producing nearly $9.3 billion in annual FCF. Right now, we're at a low point in Arcelor's business cycle, no doubt. But that cycle will turn around. Eventually.

And speaking of turnarounds ... 
Internet backbone company Level 3 Communications got hit by a downgrade to "equalweight" by analysts at Morgan Stanley this morning. Once again, we're looking at a company weighed down with debt, not currently profitable, and expected to be so minimally profitable next year that its forward P/E ratio is a nosebleed 62.5.

And yet, here, too, the news is not all darkness and gloom. For while Level 3 remains an unprofitable operator, and continues to burn cash, it's exceeded my expectations in a couple of respects. GAAP losses have been shrinking at Level 3 over the past 18 months, and while free cash flow continues to run negative, operating cash flow is increasing -- and crucially, it's increasing faster than capex can drain it away.

Over the past 12 months, Level 3 burned through $109 million in negative free cash flow. While that's hardly good news, it's at least less bad than the $165 million burned last fiscal year, and the $110 million burned the year before that. While I don't think anyone can say with confidence that Level 3 has charted itself a path out of the wilderness -- and therefore, I do believe Morgan Stanley is right to take a cautious stance on the stock -- Level 3 does appear to be moving, in fits and starts, in the right general direction.

It's not a "buy" yet, but as Level 3 gets closer and closer to producing real cash profits, it's starting to look like it might become one again.


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