Monday's Top Upgrades (and Downgrades)

Motley Fool

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 downgrades for Johnson Controls (JCI) and J.C. Penney (JCP) . But on the bright side, one analyst is...

Tuning in to Pandora
The week dawned bright for Pandora Media (NYSE:P) shareholders, as analysts at Canaccord Genuity announced they're bumping up their target price on the buy-rated shares by 20% -- to $30 apiece. Canaccord says it sees third-quarter advertising numbers "tracking well" based on its reading of an "ad load survey." Last month, Canaccord noted that it saw "an average of 5.7 spots per hour" being listened to by Pandora users, "compared to 5.2 spots per hour ... during the July sampling." Today's announcement suggests that number moved up again in September.

Accordingly, Canaccord its getting more optimistic about the stock's chances -- but investors need to remember that just because Pandora is moving more ads on its network doesn't mean it's making money off them.

Last month's earnings report showed the company losing $0.02 per share in the fiscal second quarter. Over the past year, the company has lost nearly $49 million, with cash losses (negative free cash flow) less egregious, but still solidly negative at more than $21 million cash-burn. Worse, the clear trend from Pandora's results over the past several years is that the more revenues it makes, the more money the company loses. Annual revenues at Pandora have swelled nearly 10 times since 2010. Meanwhile, net losses are up nearly three times.

Canaccord's price target hike notwithstanding, it's hard to get excited about numbers like these.

J.C. Penney -- doing it wrong
And speaking of unspeakable losses: J.C. Penney. This morning, the department store chain lost one of its few fans, when Maxim Group pulled its "buy" endorsement after concluding that customers are not flocking back to Penney in response to renewed sales promotions. Citing a "precipitous revenue decline since 2011 and ... additional debt added earlier this year," Maxim worries that J.C. Penney is simply too overloaded with debt to recover.

According to StreetInsider.com , Maxim now estimates the company will lose a shocking $3.60 per share in fiscal 2014, and a potentially fatal $6.55 per share in 2015. Meanwhile, the company, which was (barely) free-cash-flow positive as recently as 2012, is now burning cash at the rate of nearly $2.1 billion per year.

Result: The $800 million that J.C. Penney is raising from a massive and dilutive 84 million-share stock sale ... could all be gone in less than six months.

Now, it seems to me that this is actually a better argument to downgrade the stock to "sell" than just to "neutral" -- but for the time being, neutral is as low as Maxim will go.

Johnson Controls -- doing it even worse?
One analyst showing more moxie than Maxim this morning is Morgan Stanley, which clambered out on a limb to offer a full-fledged sell rating, "underweighting" auto parts maker Johnson Controls and reducing its price target to $40 a share.

Johnson shares are reacting as you'd expect, falling 2.3% in response to the downgrade -- much worse than the rest of the market. And rightly so.

Priced at 26.8 times earnings today, Johnson Controls' shares are up 54% over the past year. Yet the stock's valuation at today's price looks heady in light of Johnson's mere 1.8% dividend yield, and 12.9% long-term growth prospects (according to Yahoo! Finance).

Don't get me wrong. As a business, Johnson Controls looks to be in fine fettle, only eking out revenue growth but transforming that into a strong increase in GAAP earnings last quarter. Quality of earnings is high, with $1.016 billion in free cash flow for the past year backing up more than 95% of reported GAAP income. The single, simple problem with this stock is that it costs too much given its only moderate growth prospects.

Long story short, Morgan Stanley is probably right to downgrade it -- all the way to "sell."

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Pandora Media.

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