This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So, you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best …
New York investment banker Soleil Securities started off the trading week with a pair of downgrades this morning. Soleil pulled its recommendations on the twin titans of potash, PotashCorp (NYSE:POT) and Mosaic (NYSE:MOS), rating each a "hold" instead. In part, these downgrades were simple valuation calls driven by the stocks' run-ups in recent weeks, but Soleil also has concerns about the firms' ability to profit in the face of "short-term fertilizer demand destruction and longer-term lower potash prices."

Citing "growers' concerns over a price-cost squeeze," Soleil slashed its earnings estimates for Potash in both the short and medium terms, dropping both fiscal 2009 and '10 estimates by about 20%. Mosaic took a similar hit -- but more delayed. The analyst thinks the fertilizer maker will earn about $4.87 this year (within spitting distance of earlier estimates). Next year, however, is a different matter. Soleil predicts Mosaic will earn only $6.17 in profits -- fully one-third less than previously posited.

And yet, I cannot help but notice that -- even if Soleil is right about its new numbers -- they would make for a 27% bump in profits at Mosaic in 2010, and a 20% hike for Potash. Considering how many other companies are seeing their profits shrink these days, does it make sense to be downgrading a pair of double-digit performers, just because those digits aren't quite as big as Soleil used to think?

Let's go to the tape
Perhaps. After all, Soleil's not actually saying you should sell either stock -- just not buy more, and hang on to what you have. And judging from the firm's record on past agriculture plays (both upstream and down), I suspect you should take this advice to heart:

Now, nobody's perfect, and Soleil has certainly made its share of bad calls over the years. It's just that, generally speaking, this banker tends to do its bungling in sectors other than ag:

And overall, Soleil does what it does pretty well, guessing right on its stock picks only about half the time -- but doing so well when it guesses right that the average Soleil stock tip outperforms the S&P 500 by better than two percentage points.

Will today's recommendations do the same?

Buy the numbers
Since Soleil's advising investors to hold the stock, rather than out-and-out selling it, will this strategy help Soleil hold onto its gains? I think so.

You see, both of these stocks have run up so fast -- in terms of their profitability and their stock prices -- that at this point, there's precious room for further growth at either Potash or Mosaic. Sure, analysts expect to see profits grow in the short term, but consensus estimates for both companies currently call for just 3.5% profit growth over the next five years.

Since neither firm can be considered a growth story any longer, when evaluating the stocks today, I'm looking instead at how they might stack up if "run for cash." Here's how the numbers break down:

• Potash and Mosaic both produce comparable levels of cash: $1.8 billion in trailing free cash flow for Potash, $1.9 billion for Mosaic.
• However, the price you pay to own a piece of these profits streams differs greatly. Potash's enterprise value rings up at 16 times its annual free cash flow. Mosaic, on the other hand, can be had for a mere multiple of 10.
• Moreover, Potash is much more heavily leveraged than Mosaic. Whereas Mosaic has twice as much cash as debt on its balance sheets, Potash has more than 11 times as much debt as cash to its name -- about $2.8 billion in net debt (i.e., after you net out its cash).
• Finally, each stock pays a small dividend -- hardly worth mentioning, but at 0.5% for Potash, and 0.4% for Mosaic, it's at least a little walking-around money.

Foolish takeaway
Based on the above, I think that Mosaic is now selling for a fair price -- 10 times free cash flow being my usual cutoff for defining a stock as "cheap." While I would not necessarily buy it at these levels, I don't believe the stock needs to be sold.

Potash, on the other hand, I wouldn't touch with a 10-foot pole. Between the debt load, the unjustified (in my view) premium price when compared to Mosaic, and the lack of long-term growth prospects, I'd say that now looks like a fine time to cash in some profits and wait for a better price before re-entering the stock.

Of course, that's just my opinion -- and as my record shows, I've been wrong on Potash before. If you know the company better, and want to voice a contrary opinion ... have at it! Click on over to Motley Fool CAPS now, and sound off.

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