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 upgrades for a pair of NYSE-listed stocks, AK Steel (NYSE: AKS  ) and Cabela's (NYSE: CAB  ) . The news on the Naz, however, is worse...

Lululemon lowered
My, how time flies. Nearly four months ago to the day, analysts at Oppenheimer were making a cameo in this column, urging investors to buy shares of yoga-wear maker lululemon athletica (NASDAQ: LULU  ) . Citing "growth initiatives being undertaken by new management" to revive a brand Oppy thought was both "premium" and "compelling," Oppenheimer predicted that investors in Lululemon back in February would soon see a 21% profit as the shares soared to $63 and beyond.

Oops.

With shares now selling far below their prices of mid-February, investors who took Oppy's advice back in February are now sitting on a 27% loss. Yet despite being proven wrong once, Oppenheimer is undaunted. This morning, its analysts came out with a new note on the stock, and while they're lowering their price target by $10 per share in response to poor earnings, Oppy still thinks Lululemon's a buy. Are they right this time?

Call me a pessimist, but I don't think so. Priced at a market cap of 22 times earnings, and an enterprise value-to-free cash flow ratio that's also 22, Lululemon's valuation is undeniably lower than its stock has sold for in years past. But earnings growth projections are lower, too -- down from 17% annualized as recently as Friday to just 15% annualized as of today (and according to Yahoo! Finance projections). With growth expectations still heading the wrong way, I'm of the opinion that it's still too early to call a bottom on Lululemon.

Should you call a CAB?
Looking for a better place to put your money? Feltl & Co. think they've found one in shares of outdoor gear retailer Cabela's. This morning, Feltl upgraded shares of the outdoor-enthusiasts megastore to buy -- but if possible, I'm even less enthusiastic about this stock than I am about Lululemon's.

Priced at a similar 22 times earnings, Cabela's is poised for a Lululemon-like growth rate of 16.6% annualized, according to Yahoo! Finance figures. But there the similarities end.

Unlike cash-rich Lululemon, Cabela's is lugging around a backpack full of debt -- $3.2 billion of the stuff, net of cash reserves. Also unlike Lululemon, Cabela's is currently generating no positive free cash flow with which to pay down its mammoth debt load. To the contrary, after generating modestly positive free cash flow over the past two years, Cabela's store-building spree has pushed it deeply into the red on an FCF-basis. The company burned through $212 million in cash over the past 12 months.

Long story short, I see neither a GAAP profits argument in favor of buying the stock nor an FCF-based one. Cabela's is quite simply overpriced, any way you look at it.

Does AK Steel deserve an "F"?
I wish I could end this column on an up note and tell you I'm more enthusiastic by our final upgrade of the day -- but I can't. Merrill Lynch's endorsement of AK Steel, announced this morning, looks to me like fully as bad an idea as Feltl's recommendation of Cabela's, or Oppenheimer's stubborn insistence that it's right about Lululemon. Here's why:

Over the past year, shares of steelmaker AK are up an astounding 80% -- four times better than the market at large. (Yet the company's market cap is still barely half as large as its debt load.) According to StreetInsider.com, Merrill thinks the good times for AK shareholders will keep on rolling, as AK is poised to benefit from lower iron ore costs, but is enjoying a demand surge in its high-priced electrical steel (used to manufacture, for example, electrical transformers and electric motors).

That may be true. It may not. What we know for certain is that, historically, AK has not navigated the twists and turns of the global steel market with aplomb. You might not know it from the stock price, but AK Steel is still deeply unprofitable today, with a trailing loss of $123 million by GAAP accounting's measurements -- and negative free cash flow more than twice as bad, at $289 million, according to S&P Capital IQ data. Historically, AK has earned neither a dime's worth of GAAP net profit in five years, nor a penny's worth of free cash flow, either. In fact, AK Steel has been burning cash steadily since 2007, and hasn't even generated operating cash flow since 2009.

Sure, things could turn around if electrical steel demand picks up. Anything's possible. But the company's poor performance, for so many years, doesn't lend much encouragement, and its $1.7 billion net debt load is still a deep hole that must be dug out of. Long story short, while this story could get less bad in the year to come, I still don't read it as particularly good -- or worthy of Merrill's buy rating.

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

 


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