Mulling Monaco

Chalk it up to a seasonally slow news day, but the one story that jumped out at me today was the news of an analyst downgrade.

Specifically, it was the news that on Friday, Pacific Northwest equity research house McAdams Wright Ragen downgraded RV maker Monaco Coach (NYSE:MNC) to a "hold" rating. But more interesting than the downgrade per se were some of the comments cited in news reports on the downgrade. For example:

• "The company appears strong," and
• "Positive momentum might be continuing to build," and
• "The motorhome maker may be within striking distance of a cyclical bottom," but
• "Monaco stock is a better value when it trades closer to its book value of $10.85 per share."

Hold on a sec. Is this a strong company, with building momentum, or is it a company approaching a cyclical bottom? Because it seems to me that you can't have it both ways -- either things are looking up, or they're not, but not both at once. What McAdams Wright was saying just didn't make sense.

Cognitive dissonance
I don't know about you, but when professional analysts spout apparent nonsense, I want to do two things. First, I want to check the numbers myself, to figure out what the facts truly are. And second, I want to check with the lay investors at Motley Fool CAPS to see whether their thinking aligns with my own.

In Monaco's case, the numbers failed to resolve my confusion. After pulling up Monaco's historical financials on Capital IQ, I found myself looking at a company that:

• On the one hand, had produced GAAP profits year in and year out for every fiscal year since at least 1991;
• But on the other hand, had produced a mere $85.2 million in free cash flow over this period of time -- an average of less than $6 million per year -- of which more than 90% was generated in fiscal 2003 alone.

Staring at the numbers, I came to two tentative conclusions. First: Monaco is not nearly as "profitable" a firm as it seems. Rather, by depreciating its capital investments over a long period of time, the firm made itself look more profitable than it truly was (on a cash profits basis). Meanwhile, capital expenditure requirements exceeded the cost of depreciation and amortization in every single year of the 15, sucking up nearly all the cash profits the firm produced.

My second conclusion was that this firm, which McAdams Wright saw as "approaching a bottom" and which the Portland Business Journal described as having "struggled in the past two years," has been doing nothing of the sort. Oh sure, margins have been under pressure -- I won't argue that. But sales that stumbled somewhat in 2005 are already reviving, with the company booking 7% more revenues through the first three quarters of fiscal 2006 than it booked in the same period in 2005. Moreover, the firm turned free-cash-flow positive again in fiscal 2005, and free cash flow through Q3 2006 is, like revenues, running ahead of the previous year's numbers.

CAPS to the rescue
Seeing the turnaround in free cash flow had me thinking two more things: First, I agree with McAdams Wright that Monaco is showing some positive momentum. But second, this doesn't look like a company approaching a "bottom." On the contrary, it looks to me like Monaco bottomed last year and is already on the rise today -- which makes McAdams Wright's decision to downgrade the stock look all the stranger.

With my conclusions tentatively in place, I next headed to CAPS to see what my fellow investors are saying about the company. I found that by a vote of 5 to 2, they like it. CAPS All-Star skc0001, for instance, calls Monaco "a value proposition." CAPS newcomer JoelKratz points out that "Monaco has taken market share during the down trend," while at the same time streamlining its operations to permit "creating a better product at a lower price." So overall, it's looking like CAPS players disagree with McAdams Wright's decision to downgrade the stock.

For my part, though, I remain unconvinced. Monaco's 15-year stretch of generating almost no cash profits just sticks in my craw. While the recent movement toward generating positive free cash flow looks good, I'm going to reserve judgment and watch to see whether Monaco can keep it up, or whether it reverts to its old, bad habits. Meanwhile, I think I'll take shortvest's advice and seek "better places for [my] money" in this sector. For example:

What do you think? Will Monaco outperform or underperform the market? At Motley Fool CAPS, you've got as much right to state your case as any wingtip-wearin' investment banker. So tell us what you think, and help your fellow investors in the process.

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Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked 67 out of nearly 19,000 raters. Drew Industries is a Motley Fool Hidden Gems pick. The Fool has a disclosure policy.