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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
Is the recession over? Is the bull market back? According to FBR Capital, the answer to both these questions is a resounding "yes!" -- and that's great news for energy stocks. Specifically, for energy stocks like coal plays Patriot (NYSE: PCX), Cloud Peak Energy (NYSE: CLD), and Consol Energy (NYSE: CNX), three recipients of FBR's coveted "outperform" rating yesterday; and for oil services giant Halliburton (NYSE: HAL) (likewise upgraded.)

What's got FBR feeling so frisky about energy stocks? According to the analyst, coal prices are set to rebound sharply over the next two years, rising 11% in 2011 and another 22% in 2012. FBR sees international demand for steam coal rising, along with greater demand for steel (and hence, coking coal), reflecting a "less negative view on China." Logically, all of this would be good for the coal mining stocks on FBR's Christmas list.

As for Halliburton -- the odd man out in FBR's upgrades, industry-wise -- FBR notes that this oil services giant is second only to Schlumberger (NYSE: SLB) in scale of operations today, and could gain share from its archrival as it ramps up operations in Iraq, India, Libya, and Russia. With Barclays Capital announcing last week that it sees an 11% rise in spending on oil services in the coming year, FBR thinks now's a great time to dig into Hally as well. But is it right?

Let's go to the tape
At first glance, you might think so. After all, Oil, Gas and Consumable Fuels is the No. 1 industry in FBR's coverage universe. This analyst covers more oil, gas, and mining stocks than any other kind of company in the world -- and on the surface at least, it does a good job of it. Over the past four years, FBR has amassed a grand total of 423 points worth of market outperformance on its picks.

Then again ... well, let's open up the portfolio, and you can see for yourself what it is that concerns me here:

See that Rosetta pick up above? All by its lonesome, that single stock is responsible for literally every point of market outperformance FBR has ever earned in the energy sector. With it, FBR is outperforming the market by about 4.4 percentage points per pick on its 96 guesses in the oil, gas, and coal industries. Without it, FBR is basically treading water, matching its record of 49% accuracy in the sector.

Can you dig the valuation on this stock?
And I have to say that that little factoid does some damage to FBR's reputation for excellence, in my mind. Similarly, I'm less than impressed with the majority of the picks it's making this week.

Take Patriot Coal for example. Will coal prices rise in 2011-2012, and will this be good news for Patriot? Undoubtedly. But analysts are already baking these prospects into the company's projected 5% long-term rate of earnings growth. And 5% growth on a company that's currently unprofitable, expected to lose money next year as well, burning cash today, and boasting a record of never having generated cash in the past? It just doesn't impress me, folks.

Nor, for that matter, does FBR's Consol Energy pick. While apparently fairly priced at 24 times earnings, and with 25% projected long-term growth, the fact remains that this company only rarely generates any free cash flow at all from its business -- and currently boasts a whopping $43 million worth of trailing FCF -- a far cry from its stated GAAP "profits" of $385 million. (Same story with Halliburton, by the way. Here we have a 25 P/E stock, growing at 15% per year, but generating free cash flow sufficient to back up only just 17% of its stated earnings. Bad, bad, bad.)

Foolish final thought
All that having been said, there is one FBR pick I do agree with this week: Cloud Peak Energy. With this one, I think FBR really may be onto something. The stock's selling for a bare 3.7 times trailing earnings, and less than 10 times next year's projected profit. Analysts forecast only modest, 8% annual long-term growth, but to me that seems more than sufficient given the company's propensity for producing prodigious profits -- of the free cash variety.(At $245 million, Cloud Peak's trailing free cash flow actually exceeds the company's reported profits by 15%!)

If I was the kind of Fool willing to gamble that right-half-the-time-FBR has picked one winner, this is the stock I would bet on -- and leave Patriot, Consol, and Hally to their digging.