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 buy ratings for a pair of outdoor sporting goods stores -- Dick's Sporting Goods (NYSE: DKS  ) and recent IPO Sportsman's Warehouse (NASDAQ: SPWH  ) . But first, a few words on why the buy rating on...

AMC Networks just got canceled
Don't look now, but The Walking Dead network is among the walking wounded this morning. Last week, AMC Networks (NASDAQ: AMCX  ) , home of Mad Men and Hell on Wheels, reported earnings for its fiscal first quarter -- a $1.04-per-share profit that, while positive, fell $0.12 short of analyst expectations.

Revenues at the network spiked sharply higher, up 37% year over year, but with profit margins down, operating income grew less than half as fast, climbing "only" 16%. Frustrated at the disconnect, and at how it believes the company is taking too long to turn its investments into profits, analysts at Bernstein announced today they were withdrawing their outperform rating on the stock and downgrading to market perform. But did they jump the gun?

It depends on how you read the numbers. Based on GAAP accounting, AMC's 14.1 P/E ratio doesn't look at all expensive in light of analyst expectations that the company will grow earnings at 16% annually over the next five years. On the other hand, AMC's done a poor job of backing up those GAAP profits with actual cash production of late. In 2013, free cash flow at the company was actually negative. And even today, S&P Capital IQ clocks its trailing FCF at a mere $40 million -- just a fraction of the $300 million that the company reported "earning" over the past 12 months.

At a resulting valuation of 105.5 times trailing FCF, AMC is arguably a whole lot more expensive than it looks on the surface. For this reason, if no other, I believe Bernstein is right to be cautious about the stock -- and right to downgrade as well.

Could Dick's hit a home run?
Better news greeted fans of Dick's Sporting Goods this morning, as Credit Suisse announced Monday that it is initiating coverage of the stock with an outperform rating. CS gives the stock a $65 price target, which suggests more than 22% upside from today's share price of $53 and change. But is the stock worth even this much?

I don't think so, and I'll tell you why. Priced at nearly 20 times earnings today, but expected to grow earnings at only 16% or so, and paying a dividend yield of less than 1%, Dick's shares are no great bargain on their face. But in fact, the stock is probably even more overpriced than it looks.

A review of the company's past 12 months of FCF reveals that Dick's actually generated only $118 million in cash profits during the period -- versus claimed GAAP earnings of $337 million. Valued on its FCF, the stock would be selling for a multiple to FCF of more than 55, which seems far too rich a price to pay for a company that, when you get right down to it, is really just another specialty retailer and lacks much of a moat to defend it from the competition.

And speaking of competition...
The ranks of publicly traded sporting goods purveyors got a bit thicker last month, when Sportsman's Warehouse Holdings IPO'd at an asking price of $9.50 per share. The stock hasn't moved a whole lot since then, making a short-lived dash toward the $11-a-share range before falling back to today's price of $9 and change. But several analysts are voicing the opinion today that the stock could go back on a tear -- and soon.

StreetInsider.com cites a total of six new ratings on Sportsman's Warehouse this morning, with four analysts taking the buy position and the other two a hold. Piper Jaffray's argument is typical of the SW bulls: "The company focuses on smaller towns, lower price points on like items versus competitors and consumable products in order to drive consistent repeat traffic. In addition, lower capital requirements on new stores and a rapid payback make this concept attractive for growth oriented investors."

And no wonder. Despite selling for a slightly lower P/E ratio than Dick's, Sportsman's Warehouse is currently earning operating profit margins a bit richer than its rival can claim. Growthwise, consensus growth estimates aren't yet available for the stock. However, with a market cap of only $400 million or so, SW is a good 16 times smaller than its rival -- and correspondingly, it has more room to grow in the years to come.

Granted, FCF at the company is currently negative. That's a big risk factor for the stock, from an investor's perspective. However, SW generated positive FCF in each of 2011 and 2012. So there's reason to hope that 2013's performance was more of a blip than a trend.

Long story short, Sportsman's Warehouse stock is still too young for me to say for certain that it's a buy. But the prospects look good. This one bears watching.

Motley Fool contributor Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool recommends AMC Networks.

 


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