Monday's Top Upgrades (and Downgrades)

Analysts shift stance on Moneygram International, JAKKS Pacific, and Big Lots.

Rich Smith
Rich Smith
Apr 21, 2014 at 2:34PM
Consumer Goods

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 feature new buy ratings for JAKKS Pacific (NASDAQ:JAKK) and Big Lots (NYSE:BIG). The news isn't all good, however, so before we get to those two, let's take a quick peek at why...

Moneygram shares are falling (again)
Last week was not a fun week to be an investor in Moneygram International (NASDAQ:MGI). News that Wal-Mart (NYSE:WMT) had pulled a fast one on its money-transferring business partner, starting up a dirt cheap "Walmart-2-Walmart" money transfer business that will compete directly with its partner, sent Moneygram shares tumbling 18% in a day.

Today, adding injury to insult, analysts at JMP Securities are warning investors that the damage isn't done yet -- removing its buy rating from the stock, and pulling its price target as well. That lack of guidance (albeit from an analyst that didn't warn them in advance of Wal-Mart's plans) is scaring investors this morning, leading to a further 11% sell-off in the stock. Is that warranted?

Not necessarily. Consider: Wal-Mart is a huge part of Moneygram's business, accounting for 27% of all revenues Moneygram took in last year. And Moneygram's stock is, accordingly, now down 27% from where it sat before the bad news hit. But Moneygram won't lose all it's Wal-Mart business. Walmart-2-Walmart, after all, only covers money transfers up to $900 in value... and only among Walmart stores... and only in the U.S.

Moneygram's Wal-Mart business is bigger than those caveats, so it's likely that at least some of its Wal-Mart revenues will survive this debacle. Conclusion: A 27% sell-off, because Moneygram will lose less than 27% of its business, is not warranted. Investors are overreacting, and JMP is several days late and several dollars short with its downgrade.

Big Lots, big opportunity?
Turning now to the day's good news, we begin with Big Lots, a company that's been quite the apple of Wall Street's eye in recent months, winning praise from KeyBanc, FBR Capital, and JPMorgan, just to name a few. One month ahead of earnings, Big Lots is once again winning praise on Wall Street this morning, as investment banker Piper Jaffray pipes in with an endorsement.

As related on this morning, Piper sees Big Lots trading for a "reasonable" valuation today, and being potentially underpriced for the performance Piper expects to see a couple of years down the road -- 6% operating profit margins and $4.25 per share in 2016. At today's share price, that works out to a "very forward P/E" ratio of less than 10 times earnings, three years out.

So far, so good. The problem with this analysis, however, is that Big Lots sells for 18 times trailing earnings today, and with most analysts forecasting less than 13% annualized earnings growth for the company, that seems a rather high multiple to earnings to be paying for a retailer with precious little "moat" around its business, weak free cash flow, and operating profit margins that are currently well below the industry average.

As for Piper's upgrade -- it's based almost entirely on an assumption that Big Lots will earn nearly 50% more profit in 2016 than anyone else thinks possible. (The consensus estimate for 2016 profit: $2.85.) If Piper's right, it's going to be very right, and investors will be well rewarded for the analyst's foresight. If Piper's wrong, though... then Big Lots is quite simply overpriced, and should not be bought at today's prices.

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JAKKS in the box?
 Last but not least, we come to toymaker JAKKS Pacific, subject of an upgrade to outperform by analysts at B. Riley this morning. Riley is projecting a surge from under $9 to as high as $11 in JAKKS stock over the next year. And this surge could begin as early as this week, given that JAKKS is expected to report earnings on Wednesday.

What might JAKKS tell us on Wednesday that would light a fuse to this potential rocketship? Well, to be blunt... it could tell us just about anything. Expectations for this unprofitable, cash-burning toy make, are pretty low right now. Low enough that more than 50% of JAKKS' share float is currently sold short. This raises the enticing possibility that JAKKS might say something to spook the shorts, causing a panicked rush for the exits on short positions.

Should JAKKS come out Wednesday and "beat earnings" by reporting a smaller than expected loss, or promise a larger than expected profit for the coming June quarter (when JAKKS is again expected to lose money), that alone could be enough to fulfill Riley's prophecy of a surge in price to $11 -- or beyond.

For now, the stock looks terribly overvalued based on past performance. But as early as Wednesday, this could all change. Kudos to Riley for pointing out the possibility.

Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.