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 be looking at a pair of upgrades for Aeropostale (ARO +0.00%) and Quiksilver (NYSE: ZQK) in the apparel industry, followed by a downgrade for DuPont (DD +0.00%).
Aeropostale is styling
For the second time in as many months, Wall Street is urging investors to take a leap of faith and buy Aeropostale. Last month, it was Standpoint Research arguing that, with Aero shares underperforming the S&P by 30 percentage points, any bad news the company could possibly report had already been "more than priced in." This month -- this morning, in fact -- it's FBR Capital coming to Aero's defense.
Urging investors to buy Aeropostale ahead of the company's third-quarter earnings announcement (due out Nov. 29), FBR argues that the shares are due for a 15% bump, and will hit $16 within a year. And believe it or not, FBR may be right about that. While on the surface Aero might not look particularly attractive at a valuation pushing 20 times earnings, this company generates strong free cash flow -- maybe even strong enough to make it a bargain.
Free cash flow for the past 12 months -- $95 million -- exceeds reported net income by more than half. At a valuation of less than 12 times FCF, Aero looks fairly priced for the 11%-plus growth rate that Wall Street assigns it. Back out the company's nearly $170 million in cash, with zero debt, and the stock actually looks a bit underpriced. Barring a miserable earnings report later on this month, the stock should do well.
Quiksilver looks more like lead
If only we could say the same thing about Quiksilver. This morning, analysts at Stifel Nicolaus gave their stamp of approval to the surf 'n' snowboarding stock. And it's not hard to see why. On the surface, Quiksilver looks like a better bargain than Aeropostale, boasting a low P/E ratio of just 11.3, against a faster growth rate (12.5%).
Problem is, while Quiksilver may look like a bargain, looks can be deceiving. Although technically "profitable" under GAAP, Quiksilver's cash flow statement shows that it actually burned $100 million in cash over the past year. This failure to generate cash is part of the reason that -- unlike Aeropostale -- Quiksilver is still struggling under a debt load of more than $783 million (against cash of just $82 million).
Granted, Quiksilver has done better than this in years past. As recently as 2010, for example, it generated cash at the rate of more than $150 million a year. So perhaps Stifel sees something that suggests the company's about to get back on track -- in which case, perhaps we will see this same something when Quiksilver reports earnings on Dec. 10. For now, though, I have to say that the prognosis doesn't look good.
Down on DuPont
And speaking of things that don't look good, Piper Jaffray just downgraded shares of DuPont to "neutral," lowering its price target in tandem, to $51 a share.
Now, astute investors will notice that $51 is actually 15% above where DuPont shares currently trade. Between the shares' low 14 times earning valuation and near-4% dividend yield, this may lead some investors to think the shares are a bargain. Don't.
Growth at this chemicals giant is expected to average an anemic 4% over the next five years. Debt at the company is an astounding $11.5 billion (net of cash). Plus, even the company's P/E ratio is deceptive, because at DuPont, free cash flow undershoots reported net income pretty significantly. In fact, if you factor in the company's debt, and its $2.5 billion in free cash flow (as opposed to its $3.05 billion in reported income), it soon becomes apparent that this "14 P/E" stock is actually selling for an enterprise value-to-free cash flow ratio of about 21.
Even given the dividend yield, that seems a bit much to be paying for a 4%-grower like DuPont. Fact is, Piper may have been overgenerous in downgrading this stock only to "neutral." Fact is, DuPont might really be a stock more worthy of a "sell."
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Aeropostale.
