Thursday'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, in our first batch of analyst moves of the new year, we'll look at a new pair of downgrades for Analog Devices (NASDAQ: ADI  ) , followed by pair of increased price targets for Molycorp (NYSE: MCP  ) and Seagate Technology (NASDAQ: STX  ) . Let's dive right in.

Digital valuation, Analog growth
Starting at the top, Analog Devices got hit by a pair of analyst downgrades this morning, with Wells Fargo dropping the stock to market perform and assigning a $48 price target, and Goldman Sachs going a step further -- downgrading to sell with a $41 target. Both analysts cite Analog Devices' expensive valuation as the primary reason for their downgrades, so ...

How expensive is it?

At 23 times earnings today, against a projected 11% long-term growth rate, the stock looks pretty expensive at first glance. But Analog isn't quite as pricey as it looks. While the company reported earning only $674 million in generally accepted accounting principles profit over the past year, actual free cash flow for the past 12 months has been a more robust $789 million. Factor in a cash-rich balance sheet, and the enterprise value-to-free cash flow on this micro-electro mechanical sensor maker is actually only about 15.2.

For an 11% grower with a respectable 2.7% dividend yield, I'd say this makes the stock look a bit overvalued, yes, but not egregiously so. On balance, I'm more inclined to agree with Wells' conservative neutral opinion on the stock than with Goldman's more aggressive sell rating.

Will Seagate soar in 2014?Continuing the tech stock theme, analysts at Pacific Crest have upped their price target on buy-rated Seagate Tech to $65 per share -- a 12% bump from their previous $58 price target. More pertinent to investors, Pacific Crest's new target promises 17% upside to those who agree with the analysis and buy the stock today.

But should they buy?

At first glance, all systems look green for a Seagate investment. The stock's P/E ratio of 12.3 appears anything but expensive, and free cash flow is a robust $1.9 billion (versus only $1.6 billion in reported GAAP earnings). Plus, Seagate pays its shareholders a tidy 3.1% dividend yield. So what could be wrong with that?

In a word: growth. After posting barn-burning rates of earnings growth over the past five years, most analysts agree that Seagate is poised to take a breather. Earnings growth has just about peaked, and the consensus is that Seagate shareholders can expect sub-3% growth annually for at least the next five years. Between the growth rate and the dividend yield, we're looking at less than a 6% total return for Seagate in coming years. For such subpar returns, even a 12 P/E ratio may be too high a price to pay.

Molycorp: Is the worst part over yet?Last but not least, we turn to erstwhile go-go growth stock Molycorp, a miner of rare earth minerals for the tech industry. Molycorp had a rough 2013, in which its shares lost roughly half their value from January to December. But DA Davidson imagines better things ahead for Molycorp in 2014, predicting we'll see the stock price return to $8 before the year is out.

I'm not so sure. With the company unprofitable today, most analysts agree it will be 2015 at the earliest before investors see any profits coming out of Molycorp. And while it's certainly possible that investors would try to get ahead of the curve on that, by buying shares early in 2014, it's just as likely that people will continue to question the company's prospects and continue to doubt that the promised profits will arrive.

Remember: At last report, Molycorp was burning through its cash at the rate of more than $610 million per year. Meanwhile, the company only has $174 million in its bank account. This all seems to suggest that Molycorp will struggle to pay down its $1.4 billion debt load in 2014. More likely is that the company will have to add to that debt load or issue stock to raise cash to service the debt, thus diluting existing shareholders. Davidson may think these developments will add to the stock's attractiveness and drive up its stock price. I disagree.


 
 
 
 
 
 

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