Lear Corporation (LEA), 3M Co (MMM): Monday’s Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we’ll be looking at a pair of downgrades for both Lear Corporation (NYSE:LEA) and Whole Foods Market, Inc. (NASDAQ:WFM), followed by an improved price target at 3M Co (NYSE:MMM) . Let’s start with that one.

3M gets an A
3M Co (NYSE:MMM) gave Wall Street a mildly pleasant surprise last week, reporting $1.71 per share in earnings, a 3% improvement over last year and either matching or a penny ahead of analyst estimates — depending on whose estimates you’re referring to. This news has Swiss banker UBS upping its price target on the stock Monday morning, with UBS now saying the shares could hit $128 within a year, and recommending a buy rating on the stock.

Is that prudent? I don’t think so, and I’ll tell you why. Right off the bat, you can see that 3M Co (NYSE:MMM) is a pretty pricey stock at its 18-times-earnings valuation. Earnings growth over the next five years is estimated at less than 10%, and the company’s 2.2% dividend yield, while nice, isn’t quite big enough to make up the difference.

Adding to the case against 3M Co (NYSE:MMM), its P/E ratio is about 50% higher than the average among industrial conglomerates (which as a whole sport a 12.1 P/E ratio according to data from Yahoo! Finance). Also, 3M Co (NYSE:MMM)’s profits are of somewhat lower quality than we’d like to see. Although the company reported nearly $4.5 billion in GAAP “earnings” over the past 12 months, actual free cash flow generated by the business fell short of $4.2 billion. That discrepancy pushes the stock’s price-to-free cash flow ratio up to nearly 19, while the addition of debt to the calculation gives the stock an enterprise value-to-free cash flow ratio of more than 19.

Long story short, the stock looks overpriced to me. I wouldn’t recommend buying it at today’s price, much less hoping to see 3M Co (NYSE:MMM) run up to $128.

Lear descends
Moving on now to the downgrades, we find UBS in the mix again, this time cutting its rating on auto parts maker Lear to “neutral.” That’s a bit counterintuitive, given that Lear, like 3M, beat earnings last week — and by a much more decisive margin, reporting pro forma profits of $1.62 per share versus analyst expectations of $1.37. Lear also beat estimates on revenues, and increased its forecast to a prediction of $15.8 billion in revenues, and operating profits of between $750 million and $800 million.

And yet… with its shares up 90% already over the past year, there’s an argument to be made that Lear shares already have all of this good news “priced in.” With the stock now approaching UBS’ $70 price target, the analyst is downshifting a bit — leaving its price target intact, but curbing its enthusiasm about actually buying the stock. Is that the right call?