Friday's Top Upgrades (and Downgrades)

Analysts shift stance on FLIR Systems, Mattel, and America's Car-Mart.

Jul 18, 2014 at 11:45AM

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 new buy rating for FLIR Systems (NASDAQ:FLIR), a sell for America's Car-Mart (NASDAQ:CRMT), and for Mattel (NASDAQ:MAT), a downgrade to hold.

Mattel's the one getting the most virtual ink today, so let's start with that one...

Barbie bombs
Mattel shares plummeted 6.6% yesterday in response to a poor earnings report. They're down again today on news that Needham & Co. has decided to downgrade the shares from buy to hold.

Net sales dropped 9% year over year at Mattel in Q2, with the toymaker's Barbie and Fisher-Price brands suffering double-digit revenue declines. Profits dropped more than 60%, as Mattel scrambled to unload wobbly piles of unsold merchandise at a discount after Christmas. Really, it seems that the only brand that did well last quarter was American Girl, where sales were up 6%.

After reviewing the numbers, Needham pulled no punches, castigating Mattel for turning in "a disappointing quarter that missed on nearly every operating metric and showed further deterioration in fashion dolls." Quoted on StreetInsider.com this morning, Needham pointed out that "weakness in Monster High leaves a gaping hole in both sales and margins that we believe will be difficult to fill... We lower our rating to Hold, as we believe that even with the sharp price drop following the report, the stock is fully valued."

I agree. Actually, I more than agree. Priced at more than 15 times trailing earnings, and with weak free cash flow that suggests the company's earnings aren't of particularly high quality in any case (S&P Capital IQ clocks free cash flow at just $653 million for the past 12 months -- 19% behind reported income), Mattel shares look expensive for the 8% long-term growth rate that Wall Street is positing.

Even worse, Mattel's P/E today is based on the $2.33 in earnings it's reported over the past year -- but Needham is warning that Mattel will probably earn only $1.75 per share this year, and $2.15 in 2015. That tells me the stock is more expensive than its P/E makes it seem -- and that Needham is right to downgrade.

Car-Mart drives into a ditch
Might as well get the rest of the bad news out of the way, so let's look at America's Car-Mart next. Here, it's Merrill Lynch beating up on the stock, and assigning Car-Mart an "underperform" (read: sell) rating on worries that a move to tighten lending standards on used-car purchases will "pressure near-term sales and earnings growth."

Bigger picture, Merrill also worries that a burgeoning supply of newer-model cars (less than six years old) is not going to help Car-Mart much, as its customers tend to gravitate more toward models six years and older. Supply in this segment of the used-car market, however, is "tight," with the result that Car-Mart has to pay more for inventory, and must charge its customers more on sales.

But the real worry for investors has to be the growth concern. Here's why: Priced at nearly 17 times earnings today, and paying no dividend, Car-Mart shares look richly priced for the 10% long-term annual growth rate Wall Street assigns the stock. Free cash flow -- weak here, as at Mattel -- means the stock looks even more expensive when valued on its cash profits (of less than $15 million). Indeed, valued on this metric, price-to-free cash flow ratio for Car-Mart is a heady 22 times FCF.

That's simply too much to pay for a 10% grower. So even if Merrill Lynch turns out to be wrong about growth being slower than analysts are predicting, this stock's already overpriced as is -- and the analyst is right to warn investors away from America's Car-Mart.

Seeing FLIR clearly
Last but not least, we're going to try to end on a positive note today, with a new "outperform" rating from Oppenheimer, as it urges investors to take a look at see-in-the-dark camera company FLIR Systems.

Priced at $33 and change today, Oppenheimer sees FLIR shares surging to $40 over the course of the coming year -- a 20% profit for investors who get in today. Is that likely to happen?

At 31 times earnings, and only 15% annual earnings growth projected for the company over the next five years, the "first look" answer to that question is probably no. But to see why FLIR might be worth buying, you need to look deeper. You need to look at the cash flow statement.

That's where you learn that despite reporting "earnings" of only $155 million over the past year, FLIR actually generated cash profits of more than $303 million -- nearly twice GAAP earnings. As a result, a company that's probably the premier name in forward-looking infrared sensors today sells for the low, low valuation of just 15.6 times free cash flow.

To my eye, that's an entirely reasonable price to be paying for 15% profits growth, and when you add in the fact that FLIR currently pays its shareholders a modest 1.1% dividend yield, the case can be made for FLIR shares actually being cheap.

Are they a screaming bargain? No. But in an overheated market like this one, we'll take any discount to fair value we can find. Oppenheimer is right: FLIR is cheap enough to buy.

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 Mattel. 

 

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