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 buy ratings for housing market-revival plays Trex (NYSE: TREX ) and Owens Corning (NYSE: OC ) , but on the down side...
A big downgrade for Thompson Creek
Let's get the bad news out of the way first. This morning, analysts at Merrill Lynch announced that they have had enough of molybdenum miner Thompson Creek Metals (NYSE: TC ) , and reduced their rating to underperform.
On the one hand, this may be a simple case of "sour grapes." After all, Thompson shares are up a tidy 31% over the past year, and an even more impressive 50% since their April nadir -- which makes Merrill Lynch look pretty silly to have been sitting here saying it's only neutral on the stock, and missing out on the party. On the other hand, though... Merrill may have a point. After running up so far in price, Thompson Creek shares really do look more likely to underperform than sit at neutral.
I mean, the stock's not profitable at all right now. It's expected to turn about a $0.32 per share profit next year, maybe, and to grow a bit thereafter... but then go right back down to earning profits in the low $0.30 range by 2017. Basically, long-term prospects for GAAP earnings look flat.
Meanwhile, the company just keeps on burning heaps of cash: $56 million in negative free cash flow in 2010, $498 million in 2011, $846 million last year, and $684 million over the past 12 months. With results like these, it's little wonder that Thompson Creek is currently $600 million in debt, net of cash reserves. So while it's true that the company finally has its new Mt. Milligan mine up and running, and producing copper and gold concentrate, it remains to be seen how profitable this operation will become. All we really know right now is... Thompson has dug itself into a very deep hole. How fast it can climb out remains an open question.
After the run-up the stock has recorded over the past five months, Merrill Lynch might be right in saying it's time to sell out, and move on to brighter prospects.
Even buys aren't always worth buying
Now let's take a look at insulation-maker Owens Corning, which just got started with an outperform rating by FBR Capital. FBR says Owens "should be a meaningful beneficiary of increased new home construction and a rebound in industrial production, as well as a broad beneficiary of the global improvement in economic conditions." The analyst forecasts 4%-8% sales growth, according to StreetInsider.com, and earnings-per-share growth of 25% or better over the next three years.
Sadly, FBR's estimates may prove overly optimistic. According to S&P Capital IQ, most analysts on Wall Street think Owens Corning will only grow at about 16% annually -- a respectable rate to be sure, but about a third slower than FBR is counting on.
If truth be told, though, it probably doesn't matter even if FBR is right, and everyone else is wrong about the growth rate. Valued at 77 times earnings, and with a price to free cash flow ratio only a little bit cheaper (due to the fact that Owens generates 8.5% more cash profit than it reports as net income under GAAP), these shares are vastly overpriced for the 16% consensus growth rate, or the 25% growth that FBR expects to see -- either one.
The stock's quite simply overpriced, and with the risk of a Fed taper ultimately cutting short the housing rebound to boot, it's simply too risky to own.
Turning now to happier news and brighter ratings, with shares up nearly 1% already, Trex investors appear to have dodged Friday's market downturn. For this, they can thank the same friendly analysts at FBR Capital who picked Owens Corning, for also initiating coverage of Trex stock with an outperform rating and a $57 price target.
Trex currently trades for $48 and change, suggesting a nearly 19% potential profit on the stock if it moves to $57. But will it get there?
FBR thinks so, arguing that "the turnaround story that began in 2008 is complete and that the company is positioned for top-line growth and margin expansion as consumer confidence and home sales continue to improve over the next several years." FBR sees Trex innovating, creating new products, and parlaying its brand into greater sales, and higher price points on its products.
The only problem with this thesis, of course, is that Trex appears to have a pretty high price point on its stock as well, which costs 48.5 times earnings. On the other hand, free cash flow at this company is quite simply terrific -- nearly $38 million over the past year, or more than twice reported earnings of $17 million. That gives the stock a price to free cash flow ratio of only 21.5 -- a bit high, maybe, for the 20% long-term growth that Trex is expected to produce. But hardly unreasonable.
While I'm not wholly convinced the stock is a bargain, I can't deny that FBR has made a better case for Trex than it did for Owens Corning. This stock, at least, might very well turn out to be the buy that FBR says it is.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Trex. The Motley Fool owns shares of Trex.