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 focus on the retail and restaurants sectors, as Texas Roadhouse (TXRH) and Dunkin' Brands (DNKN) both score upgrades but one analyst says it's time to bag Coach (COH) .

Coach falls out of fashion
Let's get the bad news out of the way first, and deal with Coach. At first glance, this is a pretty attractive stock. Coach sells for less than 15 times earnings, pays a 2.5% dividend yield, and is expected to grow earnings at nearly 10% annually over the next five years. So far, so good.

Problem is, analysts at Canaccord Genuity see a lot of deterioration in the business, and they see it happening fast. StreetInsider.com reports that Canaccord is warning of a strong threat from upcoming rival Michael Kors , saying Kors' revenues are going to be up 30% year over year in 2014, versus only 3% revenue growth at Coach. Canaccord also predicts that a 6% decline in same-store sales will sap Coach's 30% market share, and hurt earnings as well.

And yet... the $3.61 per share that Canaccord sees Coach earning would still be enough to keep the stock's P/E ratio at 15 or below. Free cash flow at Coach remains strong, and the company maintains a good cash balance on its balance sheet, with no real debt to speak of. All in all, I think that unless the company's earnings growth starts coming in significantly short of consensus expectations, Coach remains a decent bargain at today's prices.

Don't mess with Texas (Roadhouse)
One thing's for sure: Coach looks like a better deal than some of the other stocks Wall Street is recommending today. Take Texas Roadhouse, for example, just upgraded to buy by the analysts at Miller Tabak.

On one hand, I'll admit that there are a lot of things to like at Texas Roadhouse -- in addition to the food, which is pretty good. The company has no net debt, and indeed boasts a balance sheet showing $45 million more cash than debt. Texas Roadhouse is a good grower, too, with most analysts expecting 13% annualized profits growth over the next five years, according to Yahoo! Finance figures. Free cash flow is strong, with cash profits closely approximating the company's reported $78 million in annual net profit. And this company shares the wealth with shareholders, paying out a tidy 1.9% annual dividend yield.

The problem here, quite simply, is the price we're asked to pay for a piece of these profits. Texas Roadhouse shares currently fetch more than 24 times earnings on the open market. That's both objectively an expensive price to pay for 13% growth, and also pricey relative to the shares of rival steakhouse Bloomin' Brands . Bloomin' shares cost only 23 times earnings, so a slight discount to Texas Roadhouse shares. But Bloomin's growth rate is nearly half again as fast as Texas Roadhouse's -- a projected 18% annualized over the next five years.

Long story short, this looks to me like a case of "good company, bad stock." While I'd happily eat at Texas Roadhouse, I wouldn't buy the shares.

Dunkin' Donuts: Is it worth the trip?
If you've been following our news updates here at the Fool these past few months, then you know that Dunkin' Donuts has been on a real expansion tear. The company's been opening up new restaurants all across the American Southwest -- and even the Asian Southeast. This rapid-fire expansion is a key reason why Miller Tabak decided to upgrade Dunkin' this morning.

According to Miller, Dunkin's U.S. store count alone is likely to keep growing at 4% to 6% annually through at least 2015. Add in expansion in Asia, and the analyst sees the shares hitting $53 within a year -- promising a potential 15% profit to anyone who buys today.

Unfortunately, Miller is wrong about that. Like Texas Roadhouse, Dunkin' is overpriced -- only more so. The stock's only expected to grow earnings a bit faster than Roadhouse (16%). But its share price, $46 and change, is about two-thirds bigger as measured by P/E, costing nearly 40 times earnings. Dunkin' also suffers from a sizable debt load (about $1.7 billion, net of cash), and unlike Roadhouse, generates less real free cash flow than it reports as net income ($112 million FCF, versus $128 million reported income).

Long story short, if you agree with me that Texas Roadhouse is expensive, then you pretty much have to conclude that Dunkin' Donuts is even more overpriced -- and that neither one of them deserves the buy ratings that Miller Tabak is assigning.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Coach and Texas Roadhouse. The Motley Fool owns shares of Coach.

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