Drew Industries, Inc. (DW), Arch Coal Inc (ACI): Wednesday’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 new buy ratings for both RV parts-supplier Drew Industries, Inc. (NYSE:DW) and miner Arch Coal Inc (NYSE:ACI). But the news isn’t all good, so before we get to those two, let’s find out why one analyst is …

Drew Industries, Inc. (NYSE:DW)

Zapping TASER with a downgrade 
TASER stock has been an absolute tear this month, rising 38% since its lows of midmonth — but one analyst believes that its run is done.

On Wednesday, mega banker JP Morgan announced it was removing its “overweight” recommendation on TASER stock, downgraded the company to “neutral” with a price target of $12.

Why? Quoted on StreetInsider.com, J.P. Morgan attributed TASER’s remarkable rise to reports that “a U.S. District Court judge recently ordered NYC police to pilot [test] body-worn police cameras, a potentially significant opportunity for TASER’s video solution.” Seconding that opinion, TASER CEO Rick Smith predicted earlier this month that the company’s AXON flex on-officer camera “will become standard equipment [at police forces] within the next 5-10 years.”

Be that as it may, J.P. Morgan warns that “we think the stock is trading at a fair multiple and EPS upside is unlikely near-term.” Moreover, “quarterly revenue can be lumpy, so there are risks.” On balance, the analyst still doesn’t see a case for TASER shares rising past $12 anytime within the next year.

I happen to agree with that sentiment, and think investors probably overreacted to a lot of speculation about the company’s prospects this month. That said, however, there is a case to be made for why a TASER shares could go even higher.

Priced at 39 times earnings today, TASER shares aren’t all that expensive in light of analyst expectations that the company will grow earnings at 30% per year over the next five years. What’s more, TASER has been doing a fantastic job of generating cash  from its business lately. Free cash flow at the company approached $24 million over the past 12 months — more than 56% better than GAAP net income.

Valued on its free cash flow, and giving the company credit for the $30 million in its bank account, I see the stock as trading for an enterprise value only 23 times as large as its annual cash profits. If TASER really can grow at 30% — and admittedly, this is a big if — I can see a scenario in which TASER, already up 38% over the past two weeks, could have as much as another 30% rise to go.

Could Drew Industries, Inc. (NYSE:DW) motor higher?
Moving on now to the day’s “buy” ratings, we begin with a new recommendation for Drew Industries, Inc. (NYSE:DW).

Citigroup initiated coverage on the RV and manufactured-homes parts supplier with a buy rating and a $51 price target this morning. Drew Industries, Inc. (NYSE:DW) shares are responding positively to the development, rising 2.7% in midday trading. Yet I see less of a case to be made here for why Drew Industries, Inc. (NYSE:DW) shares are undervalued than what we saw with TASER.

Priced at 25 times earnings, but only expected to grow these earnings at 15% annually over the next five years, Drew Industries, Inc. (NYSE:DW) shares look overvalued. Free cash flow the company, although positive, lags reported GAAP net income by about 46%. As a result, with annual income of less than $21 million in real cash profits, the stock seems steeply priced at more than 46 times free cash flow.

To me, that looks like too much to pay for a 15% grower. Accordingly, I cannot second Citi’s recommendation of Drew Industries.