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 new buy ratings for semiconductor companies Atmel Corporation (NASDAQ:ATML) and QUALCOMM, Inc. (NASDAQ:QCOM). It’s not all good news, however…
Downgrade for CAT
Caterpillar Inc. (NYSE:CAT) investors were rudely awakened from their catnaps Wednesday morning, when Goldman Sachs Group, Inc. (NYSE:GS) announced it was downgrading the shares. Goldman Sachs Group, Inc. (NYSE:GS) only downgraded to neutral, mind you, but still, the analyst’s warning that the commodities market looks “over-supplied,” resulting in less need for Caterpillar Inc. (NYSE:CAT)-built mining equipment to dig more rocks out of the earth, doesn’t sound like good news.
Goldman Sachs Group, Inc. (NYSE:GS) cut Caterpillar Inc. (NYSE:CAT)’s earnings estimates by 10%, 13%, and 11% respectively over the next three years. According to StreetInsider.com, for example, Goldman Sachs Group, Inc. (NYSE:GS) sees Caterpillar Inc. (NYSE:CAT) earning only $7.66 a share, versus its earlier guess of $8.54. That’s a big enough change — if Goldman Sachs Group, Inc. (NYSE:GS)’s right — to swing Caterpillar Inc. (NYSE:CAT)’s forward P/E ratio from the currently estimated 9.0 all the way up to 11.0. But is it a big enough change that it should scare you away from the stock?
It depends. On the one hand, if you value Caterpillar Inc. (NYSE:CAT) solely on its P/E ratio and growth rate, then the company’s current 10 times earnings P/E ratio, or even the 11 times Goldman Sachs Group, Inc. (NYSE:GS) is predicting for next year, doesn’t look particularly pricey relative to expectations for 14% long-term earnings growth. On the other hand, though, CAT has been producing very little real cash profit of late — a mere $165 million in free cash flow over the past 12 months, versus the $5.7 billion it’s claimed to be earning under GAAP accounting standards.
That’s a big enough discrepancy, in my view, to warrant caution on the stock. It’s more than reason enough to justify Goldman Sachs Group, Inc. (NYSE:GS)’s downgrade.
Next up: QUALCOMM, Inc. (NASDAQ:QCOM)
As Goldman busied itself writing up a downgrade on Caterpillar, over at Northland Securities they were doing the opposite for QUALCOMM, Inc. (NASDAQ:QCOM) — initiating the stock with an outperform rating and a $80 price target. Sadly, I expect this target to also fall short of the mark.
Sure, on the surface Qualcomm looks safe enough. The stock costs a bit less than 18 times earnings, but is growing at 15%, and pays a 1.5% dividend. The price looks fair on the surface — a bit overvalued, but not egregiously so.
Problem is, Qualcomm suffers from similar — if not quite as bad as Caterpillar — problems with cash production. Last year’s haul of $5.1 billion in free cash flow was downright respectable, but also far short of the $6.6 billion the company claimed as GAAP net income.
Result: Even if Qualcomm’s share price is sort of defensible on a PEG valuation basis, it’s not defensible when valued on free cash flow. While I won’t go so far as to call the stock a “sell,” I will say that Northland’s decision to recommend buying it is… imprudent.
Olly, olly — Atmel Corporation (NASDAQ:ATML)?
Our final Street recommendation today — Qualcomm peer Atmel Corporation (NASDAQ:ATML) — is going to hurt some feelings, I fear. Last night, you see, Atmel announced that Chief Financial Officer Stephen Cumming is resigning from the company to be replaced by interim CFO Steve Skaggs. Investors reacted to the news with worry, bidding down Atmel shares. Over at FBR Capital, however, they’re throwing a ticker-tape parade.
No sooner had Cumming been shown the door, you see, than FBR rushed out an upgrade of Atmel to “outperform.”So the analyst is essentially saying it thinks Atmel will do better without Cumming than with him. (Which isn’t necessarily an unreasonable assumption. Cumming’s administration has seen Atmel shares lose 30% of their value over the past year, after all).
Still, FBR’s announcement has got to sting. And really, is a simple change in management all it should take to turn Atmel into a “buy?” I mean, the stock already costs 94 times earnings — that’s a hard fact to change, and changing the nameplate on the CFO’s office won’t do much to affect it. And while Atmel’s doing a good job of better job of producing cash ($162 million last year) than of reporting income ($30 million in earnings), this still leaves the stock selling for nearly 18 times cash profits. That seems a lot to pay for a company whose revenues slipped 10% last quarter, and whose earnings are projected to decline, rather than rise, over the next five years.
Long story short: Atmel’s problems can’t be fixed by just a CFO change. I fear FBR may have jumped the gun in recommending this one.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of Qualcomm.
The article Wednesday’s Top Upgrades (and Downgrades) originally appeared on Fool.com.
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