This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines include a downgrade for Teck Resources (NYSE:TECK), but upgrades for McDonald's (NYSE:MCD) and Bed Bath & Beyond (NASDAQ:BBBY).
Bad news first
Might as well get the bad news out of the way first, so let's start with Teck. Worried about a fall in coking coal prices, this morning, Canadian broker TD Securities cut Teck Resources to "hold." As StreetInsider.com reports, TD is taking "the Q1/13 benchmark settlement as a cue to reset our average 2013 benchmark coking coal price forecast to US$185/t from US$200/t."
Or in English: The broker's extrapolating a recent decline in coking coal prices into the future, and lopping 7.5% off its projected prices for coal used in steel manufacture. In TD's opinion, this will have a somewhat disproportionate effect on Teck's earnings, and it is cutting 10% off its profits estimates for the new year -- from $2.80 down to $2.52 a share.
Granted, that's still an improvement over where Teck is now, and drops the company's forward P/E ratio down to 13.7, from the 15.3 trailing P/E it carries today. The problem is that over the longer term, most analysts expect profit declines to resume with a vengeance, and for Teck to average 12% annual declines in earnings over the next five years.
Result: 13.7 is less than 15.3 But as long as earnings are trending down, it's hard to call any P/E cheap. A downgrade sounds like the right call to me.
Golden arches? Or leaden?
Speaking of weak earnings, have you checked out McDonald's lately? Janney Montgomery Scott upgraded the shares to a buy rating this morning, and set a $104 price target on the stock. But to me, this seems overoptimistic.
Priced at nearly 17 times earnings, McDonald's carries a P/E ratio of roughly twice its projected 8% long-term growth rate. Debt levels are high -- about $11 billion net of cash -- and free cash flow is weak -- only about 70% of reported earnings. While McDonald's meaty 3.5% dividend yield may attract income investors, I just don't see a whole lot of beef in this equity meal.
My advice: Take the stock's strength on today's upgrade as an engraved invitation to exit the stock before the price turns the other way.
Bed, Bath a buy?
And where should you put your McDonald's winnings to work next? Funny you should ask, because as it turns out, another analyst has just the place for you.
This morning, ace investor Standpoint Research upgraded shares of Bed Bath & Beyond to "buy" on the theory that the home furnishings powerhouse is a great way "to play the rebound in housing." As Standpoint explains, Bed, Bath has basically sat out the rebound in share prices at rival retailers such as Wal-Mart and Target . This may be, as the analyst suggests, because even Bed, Bath looks "just a bit expensive at 13x trailing 12 months earnings and 11x estimates for next year." But as Standpoint further explains, "this is a high quality name deserving of a higher multiple. We expect BBBY to retest the September 2012 high of $71.60 within 12-24 months."
I agree... in part. 13.5 times trailing earnings really isn't all that expensive for a stock that most analysts expect to grow earnings at 13.8% per year over the next five years. My only real reservation about the stock is that Bed, Bath currently generates only about $0.89 in real free cash flow for every dollar it reports as net income.
Historically, though, Bed, Bath has generally produced more free cash than it reported as net income. A return to form here could therefore make the stock look like even more of a bargain than it already does.
My take: The stock's probably only a weak buy at today's prices, but it's got potential.