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, with mortgage rates continuing to decline, but with new home construction on the rise, analysts at Barrington Research have decided it's time to take a look at a few companies whose business it is to furnish these new homes. Without further ado, here are the ratings for ...

Pier 1 Imports (NYSE: PIR  )
Eclectic furnishings retailer Pier 1 doesn't report earnings until June 16, but already, Barrington is unimpressed with the stock. Priced at $17 and change, Pier 1 shares have underperformed the S&P 500 by more than 40 percentage points over the past year -- and Barrington doesn't expect them to make up the lost ground this year, either, rating the stock only a "market perform." Is that judgment too harsh?

At first glance, it seems so. After all, Pier 1 shares sell for only a little bit more than 17 times earnings. But analysts expect to see the company grow these earnings at more than 16% annually over the next five years, and the stock even pays a 1.4% dividend yield. These numbers, on their face, suggest the stock to be slightly undervalued with a total return ratio of under 1.0.

But here's the thing: Pier 1's earnings aren't really all they're cracked up to be. According to data from S&P Capital IQ, actual cash profits generated at Pier 1 over the past year (free cash flow) amounted to less than $79 million. That's barely $0.73 in real cash profits for every $1 that Pier 1 reported as "net earnings" on its income statement. So arguably, the stock isn't really as cheap as it looks.

Fact is, while all Barrington's saying at this point is that it doubts the stock can beat the market, there's a very real possibility that with quality of earnings this low, Pier 1 may actually underperform its "peers."

Ethan Allen Interiors (NYSE: ETH  )
Speaking of Pier 1's peers, we turn next to Ethan Allen. Here again, Barrington issues a downbeat prediction of no better than "market perform"-ance, and here again, I find myself in agreement. The situation at Ethan Allen, however, is almost the mirror image of what we see at Pier 1.

Viewed from a price-to-earnings perspective, Ethan Allen looks unattractive in the extreme. At a P/E ratio of 20, the stock looks more expensive than Pier 1. And with analysts projecting only a 3% long-term earnings growth rate, it's clearly the slower grower.

On the plus side, Ethan Allen does a better job than its rival at generating cash from its business. Free cash flow for the past 12 months comes in at $41.9 million, or about 23% better than reported income under GAAP. Problem is, this is still only enough cash profit to get Ethan Allen's price-to-free cash flow ratio down to about 16 -- which while objectively is not a horrendous valuation, still looks unattractive in light of the minuscule projected growth rate.

Long story short, even a modest valuation doesn't make up for the lack of growth prospects that analysts see at Ethan Allen -- and Barrington is right to suggest you avoid the stock.

Haverty Furniture (NYSE: HVT  )
But if Barrington's observations so far have you depressed, and thinking there are no bargains to be found in furniture retail -- think again. After rooting through the "seconds" room for a while, Barrington ultimately did find one furniture stock worth buying, and it's called Haverty Furniture.

Priced at 19 times earnings, and projected to grow at 18% annually over the next five years, Haverty looks even more attractive than Pier 1 on the surface. What's more, much like Ethan Allen, Haverty boasts superb free cash flow, and so is free of Pier 1's major blemish.

Valuing the stock on its $38.2 million in trailing free cash flow, rather than the $30.1 million it's permitted to report as "net earnings" under GAAP, I come up with an attractive valuation of less than 15 times free cash flow on the stock -- which is cheaper than either Pier 1 or Ethan Allen scores -- and again, this is for a stock with the best projected growth rate of any furniture stock we've looked at so far.

Topping it all off, Haverty boasts the advantages of a clean balance sheet, brimming with $67 million more cash than debt, and a penchant for sharing that cash with investors -- demonstrated by a modest 1.3% dividend yield. All in all, it looks like a fine prospect -- and Barrington is right to rate it an "outperform."

 


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