American Eagle Outfitters (AEO), Ann Inc (ANN): Thursday’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, 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.