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 are biased to the downside, with analysts reducing ratings on clothier Aeropostale (ARO) and catsup-maker H.J. Heinz (HNZ). But it's not all bad news.
An upgrade for Anadigics (ANAD)
Needham offered investors a potential "turnaround situation" this morning, in the form of semiconductor maker Anadigics. Pointing to the company's "new family of single-chip WiFi FEICs" (forward end integrated circuits) as the product that will turn the company around, Needham argues that "upside to our 2013 estimates is possible, [while] the ramp of these new products should also reduce cash burn and the risk associated with ANAD's cash position." According to StreetInsider.com, which reported the rating this morning, Needham now calls Anadigics a "buy" and encourages "investors interested in turnaround situation ... to take a fresh look at ANAD."
So let's do that.
After falling nearly 40% in value over the past year, Anadigics shares sell today for just a buck and change. Needham seems to think the valuation appropriate given today's level of sales, but expecting sales to double in short order, predicts a 0.8 times price-to-sales ratio on the shares (equivalent to today's valuation) could double Anadigics' stock price within a year. It could be right about that -- it could even be conservative.
Industrywide, your average semiconductor shop pulls down almost twice as much revenue as Anadigics does in a year, yet commands a P/S ratio of 1.3 -- half again what Anadigics shares fetch. Your average semiconductor shop is, of course, profitable (which Anadigics isn't). But if the company can transform increased sales into any kind of profit at all, Needham could be right. Anadigics could be a buy.
Aeropostale gets its wings clipped
On the flip side this morning, we're seeing banker Janney Montgomery Scott cut its rating on Aeropostale to neutral, with a price target of $14 that suggests there's even a bit of downside risk in the shares. Calling Aero the weakest of the "3 As" -- Aeropostale, Abercrombie & Fitch (ANF), and American Eagle Outfitters (AEO) -- Janney warns that retail clothing is generally a winner-take-most world, where one rival's gain probably means another rival's loss.
"Over Black Friday, we noted the biggest overall improvement in conversion at both Abercrombie & Fitch and Hollister, followed by continued brand momentum at American Eagle," opines the analyst. And logically, this suggests that shoppers who spent their dollars at these stores did not spend as much at Aeropostale.
With Aero shares selling for 19 times earnings, and pegged for only 11% long-term growth, you might think this logically implies a sell rating. However, Aero is such a good cash generator, producing $96 million in free cash flow over the past year, versus just $61 million in reported "net income," that even a weak Black Friday performance probably leaves the shares fairly valued. Janney's neutral rating seems appropriate here.
Little anticipation for Heinz
And finally, we get to the truly bad news. Stifel Nicolaus makes our second big downgrade of the day, reducing H.J. Heinz to hold. But in fact, this stock may well deserve the sell that Aeropostale dodged.
Priced at nearly 19 times earnings -- almost Aeropostale's P/E -- Heinz lacks many of the advantages Aeropostale shareholders enjoy. It's got a lower growth rate, for one thing (only 7%). It's got less free cash flow than it claims as net income ($968 million versus more than $1 billion reported "profits"). Topping it all off, Heinz shares come with nearly $4 billion net debt, versus Aeropostale's $179 million cash surplus.
Result: Even Heinz's beefy 3.5% dividend yield isn't enough to make these shares a buy. Stifel should have gone the extra mile, and downgraded Heinz straight to sell.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Aeropostale. Motley Fool newsletter services recommend American Eagle Outfitters and H.J. Heinz.