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 new upgrades for fertilizer stocks PotashCorp  (NYSE: POT  ) and Agrium (NYSE: AGU  ) . But it's not all good news, and before we get to those two, let's take a quick look at an even higher-profile stock, and find out why one analyst is...

Smacking down Facebook
It's been weeks since Facebook (NASDAQ: FB  ) shocked investors with its $19 billion purchase of WhatsApp, but not everyone has gotten over the initial surprise. This morning, Argus Research cited the "eye-popping price of the WhatsApp acquisition, announced on February 19" as one key reason behind its decision to downgrade Facebook shares to hold.

Quoted on StreetInsider.com this morning, Argus argued that "Facebook has had a very strong run over the last year despite concerns that teens might desert the site." In Argus' view, this is the right way to look at the stock, which it said still has the potential to exhibit "long term growth in the user base."

What worries Argus, though, is that "the immediate monetization of existing services" seems to be of secondary concern to Facebook: "We are concerned about the impact of this strategy shift and the risks of the WhatsApp acquisition." And Argus has good reason to worry.

Facebook shares cost an astounding 110 times trailing earnings, along with a cheaper-but-still-pricey 60 times free cash flow. At these valuations, the shares look overpriced even if the company achieves the 32% annualized profit growth rate that Wall Street has it pegged for. Argus' suggestion that Facebook may not be too concerned about boosting profit, meanwhile, suggests CEO Mark Zuckerberg may not be too concerned about achieving this growth rate -- with potential disastrous consequences for his shareholders if he "misses."

It's a scenario that cries out for caution, and Argus' cautious hold rating is the right way to play it.

Praise for PotashCorp...
Facebook's shares have been made more risky by their 155% run-up in price over the past year. In contrast, one analyst sees some "derisking" going on in shares of fertilizer producer PotashCorp, which have become 15% cheaper over the past 52 weeks.

Priced today at less than 17 times earnings, and expected to have relatively stable profits over the next year, PotashCorp shares are no great bargain given the stock's mere 7% projected growth rate. Worse, the stock's free cash flow continues to lag reported net income, with the result that Potash shares sell for a steeper price-to-free cash flow ratio of more than 18.

Personally, I think that's too much to pay for shares of a 7% profit-grower. But I do admit that the stock's dividend yield of more than 4% seems generous. In fact, this dividend yield may help to explain why this morning, Cowen announced it was upgrading shares from sell to market perform despite the stock's seemingly rich valuation.

While I wouldn't buy PotashCorp at today's share price, I understand why dividend investors, at least, might find it to tempting to sell.

... and for Agrium, too A second stock winning higher marks from Cowen this morning is PotashCorp's fellow fertilizer producer Agrium. Like PotashCorp, it's a profitable producer, and selling for a low P/E (of just 13.2). Like PotashCorp, Agrium pays a fine dividend yield (of 3.2%). And like PotashCorp, it's winning an upgrade to market perform.

But this one I don't agree with at all. PotashCorp is a stock with a low P/E and weak free cash flow that still gives it a nearly as low price-to-free cash flow ratio. But Agrium, despite having an even lower P/E ratio, currently generates no free cash flow at all. To the contrary, Agrium burned through about $101 million in cash last year, worsening the problems of a balance sheet that shows $3 billion more debt than cash.

The stock also hasn't shed as much market cap as has PotashCorp, either. Agrium shares fell only 7% over the past year, and consequently haven't eliminated as much downside risk as its peer.

Long story short, given the low quality of Agrium's reported earnings, I suspect the stock has farther to fall before it hits bottom. My hunch is that Cowen jumped the gun on this one, and removed its sell rating too soon.

 

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