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 new buy ratings for both Buffalo Wild Wings (NASDAQ:BWLD) and Abercrombie & Fitch Co. (NYSE:ANF). But the news isn’t all good, so before we get to those two, let’s find out why…
Mead Johnson curdles
Markets are moving broadly upward this morning after a strong jobs report, but not everyone’s enjoying the green tickers. In particular, shareholders of Enfamil baby formula-brewer Mead Johnson Nutrition (NYSE:MJN) are watching their stock flatline, after being downgraded by Morgan Stanley today. According to Morgan, “pricing” could be a problem for Mead going forward, as customers balk at paying any more for its already pretty expensive product. But what does this mean for the stock?
Costing 23 times earnings at last report, Mead Johnson Nutrition (NYSE:MJN) already looked expensive based on analyst projections of an 11% long-term earnings growth rate. If Morgan is right, and hitting that target could turn out to be harder than analysts have assumed already, then that would give investors a second reason to sell the stock.
Granted, there are pluses as well as minuses affecting the basic valuation at Mead Johnson Nutrition (NYSE:MJN). On one hand, free cash flow at the firm is quite strong — $710 million over the past 12 months, versus only $613 million in reported “GAAP” earnings. On the other hand, Mead Johnson Nutrition (NYSE:MJN) is also lugging around about $500 million more long-term debt than it has cash in the bank, which tends to cancel out the positive effects of strong free cash flow on the stock’s valuation.
In the end, I see the stock as not quite as expensive as it appears at first glance. But with an enterprise value-to-free cash flow ratio of 20, on 11% growth, the stock still looks overpriced. Morgan Stanley is right to downgrade it.
Wings get a lift
And speaking of overpriced: Buffalo Wild Wings (NASDAQ:BWLD). The purveyor of chicken wings ‘n’ things scored an upgrade to “buy” from analyst Miller Tabak Friday. Miller sees same-store sales growing at Buffalo Wild Wings (NASDAQ:BWLD) and, with the cost of chicken wings falling, expects this will lead to outsize profits growth. Investors are reacting to the upgrade with enthusiasm, bidding up the shares 1.5% in early trading — but should they?
After all, at 34 times earnings, Buffalo Wild Wings (NASDAQ:BWLD) shares cost nearly 50% more than Mead Johnson Nutrition (NYSE:MJN) — a stock that’s clearly overpriced already.