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American Eagle Outfitters (AEO), Ann Inc (ANN): Thursday’s Top Upgrades (and Downgrades)

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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 a downgrade for American Eagle Outfitters (NYSE:AEO), an upgrade for Ann Inc (NYSE:ANN), and a brand new buy rating for a little company called Mazor Robotics. Let’s dive right in, beginning with why …

Bullish options trade on American Eagle looks for shares to extend runAmerican Eagle got its wings clipped
American Eagle Outfitters (NYSE:AEO) is falling like a (small) rock this morning, down nearly 2% in response to twin downgrades to “neutral” from investment bankers Citi and Oppenheimer. The stock’s now selling for $18 and change, and according to Oppy at least, that’s right about where it will be trading a year from now, too. The analyst says the stock’s worth about $19, no more.

But is Oppenheimer right? Is Citi? Let’s take a look.

Priced at just 16.6 times trailing earnings, and paying a 2.6% dividend yield, American Eagle Outfitters (NYSE:AEO) certainly doesn’t look expensive. Presumably, therefore, the analysts are focusing on AE’s presumed 11% long-term earnings growth rate, which falls short of the average estimate for the retail industry (12%), and is short, too, of the 14% or so growth rate we’d ordinarily want to see for a 16.6 P/E stock with AE’s dividend yield.

On the other hand, though, don’t overlook the fact that American Eagle Outfitters (NYSE:AEO) is a strong cash generator. This company threw off $308 million in free cash flow over the past 12 months — about 40% more than its GAAP-calculated “net income” would suggest. Valued on free cash flow, I see the stock trading for about an 11.5 multiple, which only seems appropriate given the growth rate … and perhaps even cheap, in light of the dividend yield.

Long story short, I see no reason at all to be short this stock today. AE is still cheap and still worth owning.

ANN-ie no longer an orphan
I see similarly good things — albeit with a caveat — ahead for shareholders of ANN, the parent company of both Ann Taylor and LOFT. Oppy just assigned an “outperform” rating to Ann Inc (NYSE:ANN) stock, and suggested a $38 price target — about 19% above where the stock trades today.

On the surface, the numbers suggest this is the right call. Ann Inc (NYSE:ANN) shares cost only a little more than 16 times earnings today. They’re therefore cheaper than AE stock, yet share the same 11%-ish projected growth rate. If this were all there was to the story, I think I’d be very bullish on Ann Inc (NYSE:ANN) indeed.

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