Monday's Top Upgrades (and Downgrades)

Analysts shift stance on Simpson Manufacturing, Builders FirstSource, and FLIR Systems.

Apr 28, 2014 at 2:40PM

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 a pair of upgrades in the housing sector -- Simpson Manufacturing (NYSE:SSD) and Builders FirstSource (NASDAQ:BLDR). But before we get to those two, let's take a quick look at what's happening at FLIR Systems (NASDAQ:FLIR) in the wake of Friday's earnings miss.

Is FLIR losing its glow?
See-in-the-dark optics specialist FLIR Systems got downgraded from buy to fairly valued at CRT Capital this morning, following a miss on earnings Friday.

Expected to earn about $0.25 pro forma in Q1 2014, FLIR instead reported $0.21 -- and a big decline in profits from the year-ago quarter, in which FLIR had earned $0.35. Revenues were up 1% at $351.5 million, with commercial revenues making up for a decline in military sales. And backlog was also up a bit. This gives at least some hope that despite near-stagnant revenues right now, FLIR will succeed in righting the ship, getting revenues growing smartly again, and achieving the long-term forecast for 15% annual earnings growth that Wall Street has assigned it.

Right now, FLIR shares cost more than 31 times trailing earnings, which seems quite a lot to pay for 15% growth. However, the company has been a strong cash producer historically, generating more than $302 million in positive free cash flow last year, for example -- 71% ahead of reported GAAP earnings -- and $304 million over the past 12 months. These facts, plus the company's modest 1.1% dividend yield, suggest that the stock is not quite as overvalued as it looks. While not a screaming bargain, the stock looks like a good value -- and will become even more attractive as an investment if today's decline in price continues and gains speed.

Building a buy thesis for Simpson Manufacturing...
Turning now to the upgrades, we begin with Simpson Manufacturing, a small-cap producer of construction products (connectors, screws, drill bits, and so on) for building houses. Simpson reported strong earnings last week -- 9% sales growth and earnings more than doubled year over year to $0.25 per share. These results were good enough to lift Simpson shares 2.1% in Friday trading, and they've won the stock an upgrade to buy from DA Davidson today.

Does the stock deserve it?

Reviewing the past 12 months of earnings results, we find that Simpson has generated a bit more than $58 million in GAAP earnings, resulting in a P/E ratio of 28 on the stock. Once again, the valuation looks stretched in relation to growth estimates. Analysts see Simpson growing a bit faster than FLIR, but only a bit -- 17% annually over the next five years, according to Yahoo! Finance. But here, too, is good news.

While Simpson hasn't yet released cash flow data for Q1, its financials show that the company generated positive FCF of just under $90 million last year. Relative to GAAP profits of about $60 million for the same period, it would appear that this company, too, is more profitable on a cash basis than initially meets the eye.

Assuming free cash flow held up in Q1, I put the stock's price-to-free cash flow ratio at roughly 18. On a 17% growth rate and factoring in the stock's modest 1.5% dividend yield, this stock appears to be trading for anywhere from a fair price to a modest discount to its intrinsic value. Meanwhile, if free cash flow in Q1 increased at anywhere near the speed at which Simpson's GAAP earnings grew (we won't know this for certain until the 10-Q is filed), the stock could be an actual bargain. Davidson is right to recommend it.

...and tearing one down for Builders FirstSource
Last (and least), construction supplies manufacturer Buiders FirstSource scored an upgrade of its own this morning, this time from Gabelli.

Sales were up 8% in Q1, the company reported last week. And with gross profit margins climbing, Builders FirstSource managed to cut its quarterly loss to just $0.03 per share -- much improved over last year's Q1 loss of $0.12. Granted, a loss is still a loss, but Builders' improvement was still significant enough to convince Gabelli that the stock is worth buying.

Me, I'm not so sure.

On a trailing-12-months basis, Builders FirstSource is, after all, still losing money. Free cash flow for the same period was likewise negative -- by nearly $28 million. Granted, Builders posted GAAP profits in two of the past three quarters, and positive free cash flow in all three. So it's possible that things are starting to look up for the company. But with a debt load still estimated at roughly $300 million more than its cash on hand, profits uncertain, and the housing market boom starting to look a bit long in the tooth, I have to wonder if the 30% gain the stock has enjoyed, over the past year is as good as it's going to get.

Long story short, while I see potential in the stock, I'm still not convinced that Gabelli is right to recommend it.

Rich Smith has no position in any stocks mentioned, and neither does The Motley Fool.

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