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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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.
So perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.
Somebody puts BABY in a corner
It's never easy being a parent, but lately it seems to be getting harder than ever. Last week, The Wall Street Journal ran a column warning of a rash decision many parents have been making in response to tough economic times: As diaper prices soar, parents are cutting back on Pampers purchases and opting to buy more diaper-rash ointment instead. That's bad news for leading manufacturers of disposable diapers Procter & Gamble (NYSE: PG ) and Kimberly-Clark (NYSE: KMB ) -- but perhaps good news for Desitin manufacturer Johnson & Johnson (NYSE: JNJ ) . It also may help to explain, though, the downgrades that just hit Natus Medical (Nasdaq: BABY ) .
Natus has long been a favorite of Foolish investors. But yesterday, two separate analysts agreed to throw out BABY, bathwater -- the whole shebang -- when Natus diagnosed itself as having a massive case of corporate poopy-pants. In a preannouncement of Q3 2011 results, management warned that "delays in orders and in the United States also a reduction in order size" would cause the company to miss guidance badly. The company's likely to report only $51.5 million in sales this quarter (11% below previous estimates) and earn as little as $0.15 per share (25% below guidance). Sales for the full year are likewise expected to miss their targets.
Danger down below
Responding to the news, All-Star analyst ThinkEquity cut its price target on the stock by more than half, to $7 a share. A second analyst, CL King, pulled its previous $14 target entirely, afraid to even guess at how bad things might get. Yet neither analyst is quite ready to pull the trigger and sell the stock entirely. So far, the worst they've done to Natus is cut their recommendations from "buy" to "hold."
I wish I could tell you I agree with them. I wish I could tell you I still like the stock myself -- but I can't. Here's why not.
BABY's been bad
At first glance, there's a lot to like about Natus Medical at today's prices. At less than 1 times sales, Natus's P/S ratio offers a discount to the average P/S ratio on the Dow Jones Industrial Average (INDEX: ^DJI). Natus's 16 P/E ratio looks a lot cheaper than the multiples found at other makers of specialized medical equipment -- 36 times earnings at Intuitive Surgical (Nasdaq: ISRG ) , for example, or infinity times earnings at unprofitable MAKO Surgical (Nasdaq: MAKO ) . And 16 times earnings looks right in line with the 16% long-term growth rate that analysts project for Natus.
What worries me, though, is that growth rate looks in jeopardy right now. I mean, as a parent myself, I can tell you that every parental instinct I have tells me to spend whatever it takes to keep my children healthy and happy.
That's why the Journal story on parents who are cutting back on diaper spending -- and inviting a diaper rash in consequence -- worries me. It tells me that times are tough, and parents are cutting back spending anywhere possible. To the extent that expensive hospital tests on newborns are optional, therefore, I'd expect we'll see cutbacks there as well. Indeed, Natus' recent warning confirms that we already are seeing such cutbacks. It also suggests that parents might postpone having babies till the economy improves, and that would just about guarantee a slowdown in Natus' business.
Will this, too, pass, and will things get better for Natus eventually, and for the economy? I think so. I hope so. This company's work in catching childhood ailments early, in the newborn stage, is too crucial to allow it to wither on the vine. But as an investor, I have to put aside my emotions -- to look past the "should happens," and focus on what seems the more likely "will happens."
To me, Natus' slowdown in sales, combined with the company's continued subpar performance on free cash flow, and its P/E ratio that looks only fair -- and only fair if the growth rate doesn't slow further -- tells me it's time to put BABY in a corner.