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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock-pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)
Given this, 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.
Today, we're going to take a look at three high-profile ratings moves on Wall Street: A downgrade for Southwest Airlines (NYSE: LUV) and upgrades for Invesco Mortgage (NYSE: IVR) and Level 3 Communications (Nasdaq: LVLT). Let's dive right in.
No love for LUV
Bad news first: On Tuesday, discount airline Southwest warned investors not to expect a profit when it reports Q1 earnings. If the airline indeed reports a loss, this will be the third time in two-and-a-half years that it's done so -- and the second time in three quarters, as well. The increasing frequency of losses reported at Southwest suggests that high oil and jet fuel prices are hurting the airline even worse than previously believed and imperiling the company's reputation as the lone airline to report consistently strong profits in every economy.
Shocked by the news, Avondale Partners responded with a downgrade to "market perform." Even more concerning, the analyst now thinks Southwest shares are only worth about $10 apiece, versus a previous price target nearly twice as big at $18. But with Southwest shares already selling for more than 37 times earnings, and earnings set to decline, I wonder if the shares are even worth the $10 fare.
Should you Invesco in this?
Following on the heels of JMP Securities' upgrade for American Capital earlier this week, another three-letter analyst -- FBR this time -- has just upgraded shares of mortgage REIT rival Invesco Mortgage. With no major media outlets reporting on the news so far, details on why FBR issued its upgrade are hard to come by -- but I think we can guess.
Worries in the REIT sector have focused on the ability of these companies to maintain their beaucoup dividend yields. Invesco, for example, pays 14.5%. American Capital dishes a monster 17% payout, while investor darling Annaly Capital lags the pack with a 14.1% payout. American Capital helped reassure investors on this front, however, when last week the company priced a 62 million-share offering that could potentially net the company more than $2 billion if overallotments are exercised. Thus, "AmCap" demonstrated that these companies have access to capital when they need it. Then Invesco removed even more worry when it confirmed its next dividend check (for $0.65) will carry a 14.5% yield -- below what Invesco had been paying last year, but still pretty generous.
Viewed from one perspective, these look like positive developments. Dividend checks may be skimpier than in years past, but at least they're still coming. On the other hand, if the only way REITs can continue to afford even tinier dividend payouts is by diluting shareholders to raise cash to fund them, that doesn't necessarily sound like good news to me.
Level up?
Last but not least, we come to Level 3 Communications -- and Bank of America's big upgrade thereof. B of A just upped its price target to $37.50, and with Level 3 shares only costing $26 apiece today, the analyst told investors to go ahead and buy them. Why? As relayed by StreetInsider.com, which covered the upgrade, B of A thinks Level 3 offers "the best risk/reward" in the telecom equipment industry.
Now, a 44% potential profit certainly sounds like a nice reward -- but what about the risk? With $7.6 billion in net debt, Level 3's even more heavily leveraged than Alcatel-Lucent (NYSE: ALU). Like Alcatel, Level 3 has begun generating positive free cash flow in fits and starts. But overall, it's still a net cash-burner over the past 12 months. I won't deny that the company has potential, but so far, the company's performance suggests it remains a speculative investment in the extreme. Caveat investor.
Whose advice should you take -- mine, or that of "professional" analysts like Avondale, FBR, and Bank of America? Check out my track record on Motley Fool CAPS and compare it to theirs. Decide for yourself whom to believe.
