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 feature downgrades for both Lear (NYSE: LEA  ) and Mattel (NASDAQ: MAT  ) . But the news isn't all bad. Let's start off the week on a "bright" note, with...

A few words about Manitowoc
The Manitowoc Company (NYSE: MTW  ) , an industrial conglomerate with two main divisions, one manufacturing industrial cranes and the other... kitchen equipment (!), reported strong earnings last week. Fourth-quarter profits of $0.47 per share beat analyst estimates with a stick, sending Manny's shares soaring 17% on Friday, and earning the stock an improved price target of $33 a share from analyst Stifel Nicolaus this morning.

You'd think that investors would be taking this as good news and buying the stock, but you'd be wrong. Turns out, investors are focusing rather on a downgrade to neutral from analysts at Longbow Research today, and bidding the stock down instead of up. Is that the right call?

It depends. On the one hand, after last week's big run-up, it's hard to see how things can get much better for Manitowoc in the year ahead. The stock currently sells for 25 times earnings (and for cash counters, its enterprise value to free cash flow ratio works out to an identical 25 times). This could be a bargain valuation if the company achieves the 30% annualized earnings growth that Yahoo! Finance currently projects for it. (On the other hand, if all Manny can manage is the 15% annualized growth rate that S&P Capital IQ projects, the stock could be a bit on the pricey side.)

When you get right down to it, therefore, I'm inclined to err on the side of caution. Thirty-percent growth is an awfully fast pace to assume, and thus not an estimate on which to base a decision to buy the company. Fifteen-percent growth sounds more likely to me -- and if 15% growth is all Manitowoc can manage, then the company simply costs too much to buy today. Full stop.

Is Lear a loser?
Keeping our focus on industrials for a bit longer, we turn now to auto parts maker Lear Corp. While Manitowoc was reporting better than expected earnings last week, over at Lear, the opposite was true. Fourth-quarter profits of $1.55 fell $0.04 shy of consensus estimates, despite revenues for the quarter ($4.3 billion) exceeding estimates quite handily.

Based on its latest numbers, CRT Capital is removing its endorsement from the stock, and downgrading Lear to "fairly valued" this morning. Is it right to do so?

I don't think so, and I'll tell you why not: Priced at less than 14 times earnings, Lear isn't quite as cheap as it looks. Free cash flow for the company in 2013, which Lear puts at $367 million, was only 85% of the company's $431 million in reported GAAP profit.

That's still enough to give the stock a price to free cash flow ratio of only 16 times, however. And with Lear today slightly net cash (cash minus debt), the company's enterprise value to free cash flow ratio is essentially identical to its price to free cash flow. Both Yahoo! Finance and Capital IQ figures agree that the stock is likely to grow earnings (and presumably, free cash flow) at close to 18% annually over the next five years. When you add in the effect of Lear's modest 0.9% dividend yield, I think that makes the stock look quite attractive at today's prices.

Long story short, CRT is wrong to downgrade it.

Mattel's miss
And speaking of earnings misses, we close today with Mattel -- which reported a big miss on Friday, earning only $1.07 per share where Wall Street had been looking for $1.21 -- and unlike Lear, missing on revenues as well. Mattel blamed sales declines at Fisher-Price and Barbie, down 13% apiece, for much of its bad news, and thinks the problems can be fixed, but Wall Street's having none of it.

Analyst downgrades are coming fast and furious today, with Goldman Sachs' note particularly harsh. Calling for "dramatic" change at the company, Goldman blasts the company's "core brands" as being "all in decline." And according to StreetInsider.com, Goldman says that even Mattel's newer, stronger brands, such as American Girl, are "faded" and "no longer insulating MAT from weakness at its core. There is no visibility toward a new revenue driver emerging in the near-term," and according to Goldman, no reason to buy the stock.

I agree.

Priced at 13.5 times earnings, but projected to grow in only the single digits -- but actually shrinking its sales -- Mattel looks like a business in decline. Mattel sports a balance sheet with more debt than cash as well, and with free cash flow levels far below those of reported GAAP net income, the stock's arguably much more expensive than it already looks.

My hunch: Unless you absolutely, positively must have the 4% dividend income from this stock and don't care that the value of the company behind the dividend is decreasing, it's best to take Goldman Sachs' advice on this one and put Mattel back in the toy box.

Rich Smith has no position in any stocks mentioned -- and doesn't necessarily agree with his fellow Fools all, or even much, of the time. The Motley Fool recommends Goldman Sachs, and recommends and owns shares of Mattel.


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