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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.

However, there are a couple of factors that suggest that just as it’s selling American Eagle Outfitters (NYSE:AEO) too short, Oppenheimer’s overoptimistic about ANN. First and foremost, if Ann Inc (NYSE:ANN) costs a bit less than AE, it lacks AE’s sturdy dividend yield. Second, and perhaps related to the lack of a cash dividend policy, ANN’s looking a bit light in the cash production department.

Free cash flow for the past year was only about $51 million, or about 54% of the net income ANN’s claiming to have “earned.” This works out to a price-to-free cash flow on the stock of about 29, or more than twice as expensive as AE shares look when valued on their ability to produce cash. As a result, given a choice between the two stocks — ANN, which Oppenheimer likes, and AE, which it doesn’t — I think I’m going to have to go with AE as offering the better value.

And now for something completely different
As today’s column winds down, we come to a new potential investment that’s starting to garner some excitement. Caesarea, Israel-based surgical robot-maker Mazor Robotics hasn’t been on the market long. It only went public back in late May . But it’s getting some positive coverage this morning from NYC-based broker  WallachBeth Capital.

WallachBeth initiated coverage of Mazor today with a buy rating and an $18 price target. So far, investors don’t seem impressed by the news (selling off the stock to the tune of 3.5%), and I can’t say I blame them.

While billed as a rival to America’s Intuitive Surgical, Inc. (NASDAQ:ISRG), Mazor actually bears closer resemblance to tiny Hansen Medical, Inc. (NASDAQ:HNSN). Lacking profits despite raking in nearly $15 million in revenues last year, Mazor doesn’t generate positive free cash flow like Intuitive Surgical, Inc. (NASDAQ:ISRG) does. Instead, it burns it like Hansen Medical, Inc. (NASDAQ:HNSN) does (albeit more slowly). Last year, negative free cash flows amounted to $2.1 million, which suggests that Wallachbeth’s endorsement may be a bit premature.

On the other hand, though, Mazor does have one thing going for it: It’s improving a lot faster than Hansen has. Cash burn in 2012 dropped pretty dramatically at the Israeli robots firm in comparison to 2011 levels. Meanwhile, capital spending remains minimal, which suggests that if the company can turn even marginally cash flow positive in future years, it should be able to fund its ongoing operations quite nicely, without need for shareholder support in the form of additional stock dilution.

Long story short — while I can’t endorse a cash burner at this early stage, Mazor does show some signs of promise. I wouldn’t buy it right away, but I would keep a close watch on it for signs of improving health.

The article Thursday’s Top Upgrades (and Downgrades) originally appeared on Fool.com.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Intuitive Surgical. The Motley Fool owns shares of Intuitive Surgical.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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