This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we'll look at a new buy rating for Pier 1 (NYSE:PIR), a higher price target for Marathon Petroleum (NYSE:MPC), and finish up with a downgrade at Motley Fool-fave II-VI (NASDAQ: IIVI). Let's dive right in.
Fishing for value at Pier 1
Let's start the day on a bright note -- helpfully provided by Deutsche Bank, which just released a research note urging investors to buy Pier 1. According to the analyst, "PIR is benefiting from favorable industry trends which are among the best in hardline retail, along with multiple internal initiatives ... Along with market share gains ... the next several years will drive a 4-year sales CAGR of 9.7% and 4-year EPS CAGR of 22%."
Perhaps in honor of the election year, StreetInsider.com quotes Deutsche calling Pier 1 "The Comeback Kid" of retail, and predicts the stock will hit $25 within a year. Believe it or not, they just might be right about that. Twenty-two percent future earnings growth can erase a lot of historical blunders. But in fact, at a P/E ratio of only 11.5, Pier 1 could grow just half as fast as Deutsche is projecting, and still offer investors quite a lot of profit potential.
The key risk? The company's not currently generating a lot of free cash flow. In fact, at last report, the company was generating only about $0.10 in real cash profits for every dollar of "GAAP earnings" it claimed to be producing. If there's one number you should focus on to gauge the chances of Deutche's recommendation working out, it's this one.
Can Marathon keep up the pace?
Another company lagging in the free cash flow department today -- yet getting plaudits from pundits regardless -- is oil refiner Marathon Petroleum. Priced at just over eight times earnings, the company doesn't look like much of a bargain based on projected 5% long-term annual profits growth. It's an even weaker prospect when valued on the lower level of free cash it produces -- about $1.7 billion, versus reported income of $2.5 billion.
Regardless, investment banker Oppenheimer doubled down on its "outperform" recommendation of the stock today, arguing that Marathon could sprint ahead to $70 a share over the course of the next 12 months.
Don't hold your breath waiting for that to happen. While I'm no huge fan of the high price tag on rival Phillips 66 (NYSE:PSX), that stock's lower P/E, faster growth rate, and endorsement from Berkshire Hathaway's (NYSE:BRK-A) Warren Buffett all add up to greater chances of outperformance than you'll find at Marathon Petroleum. Phillips may not win the race, but it's more likely to show.
Playing "I spy" with II-VI
Last and least this morning, "I spy, with my little eye... a downgrade." Specifically, a cut from "buy" to "neutral" for II-VI.
This morning, analysts at Longbow Research pulled their endorsement of the laser components maker -- and it's not hard to see why. In fact, the better question may be why Longbow was in the tank for II-VI to begin with.
Priced at nearly 20 times earnings, II-VI isn't exactly cheap -- certainly not if all it's able to manage is the 13% long-term growth rate Wall Street has assigned it. Worse, the company's not a particularly productive producer of cash profits, either. Most years, free cash flow at the company lags reported net income rather badly. This past year, II-VI has generated all of just $45 million in positive free cash flow -- barely 75% of the net income it reported "earning" under GAAP accounting standards.
Result: Overpriced on its face, II-VI only looks more and more expensive the further you dig into the financials. "Neutral" is the worst Longbow is willing to say about it today, but if II-VI can't figure out a way to produce more cash, its next downgrade may read "sell."