Markets & Finance

S&P Cuts Foot Locker to Avoid


Foot Locker (Z): Downgrades to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Yogeesh Wagle

Shares are down Friday after Nike said this shoe retailer would not participate in any of its key footwear product launches after February 2003 and would no longer be a major distribution point for its elite and statement level products in footwear or apparel in the U.S. S&P thinks this is a setback for Foot Locker, which relies on marquee products and the "buzz" they create to drive traffic through its stores. Foot Locker shares are trading at nine times the $1.20 earnings per share that S&P sees for fiscal 2004 (Jan.). However, given the company's poor earnings visibility and concerns about its underfunded pension, S&P would avoid the shares.

News Corp. (NWS): Maintains 4 STARS (accumulate)

Analyst: Tuna Amobi

On the heels of the collapse of the Echostar and Hughes Electronics merger deal amid regulatory opposition, press reports say that News Corp., with the largest non-controlling shareholder Liberty Media, revived its bid for General Motors' 30% stake in Hughes' DirectTV satellite TV unit. While more suitors may emerge, and a management buyout, IPO or retention of the unit are still options for General Motors, S&P thinks News Corp. is well-positioned to ultimately acquire these synergistic assets, capping a long drive to create a truly global satellite television company.

Scholastic (SCHL): Reiterates 4 STARS (accumulate)

Analyst: William Donald, Thomas Graves

The stock is down sharply Friday after Scholastic said it expects fiscal 2003 (May) earnings per share to approximate fiscal 2002's $2.50. Also, November quarter earnings per share of $1.85 vs. $1.69 is below analyst estimates. Although fiscal 2003 is shaping up as a disappointment, S&P thinks that the longer-term picture bodes well for the stock. S&P expects Scholastic to benefit from a strong focus on literacy and technology-based educational products. Also, S&P thinks the fifth Harry Potter book will provide profit as early as fiscal 2004. The stock is appealing at a below-market 12 times the $2.95 earnings per share that S&P sees in fiscal 2004.

Nike (NKE): Downgrades to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Yogeesh Wagle

Nike posted November quarter earnings per share of 57 cents vs. 48 cents, a penny above the Street's mean. Revenues rose 7.6% as strong gains in its European region outweighed 8% lower U.S. revenues. Nike's U.S. sales have been hurt by a drop in orders from its largest customer, Foot Locker, which said its 2003 Nike products sales could be cut by about $300-$400 million, more than it had earlier planned. Nike said it expects flat earnings per share for the third quarter of fiscal 2003 (May) with growth resuming in the fourth quarter. At 15 times S&P's $2.72 fiscal 2003 earnings per share estimate, reduced from $2.80, S&P would avoid Nike for now, given the less visible revenue outlook.

Prudential Financial (PRU): Maintains 4 STARS (accumulate)

Analyst: Catherine Seifert

S&P views positively Prudential's plan to acquire American Skandia from Skandia Insurance for $1.3 billion. The deal appears to be accretive, and will likely boost Prudential's return on equity to the mid-teens level. This acquisition will greatly increase Prudential's presence in the variable annuities and mutual fund arena. More details will come in conference call Friday afternoon. S&P is upgrading its 2003 operating earnings per share estimate by five cents, to $2.60. Although there is execution risk here, and S&P is taking a cautious stance toward Prudential's earnings per share guidance, its shares are nevertheless undervalued.

Lehman Brothers (LEH): Maintains 5 STARS (buy)

Analyst: Robert McMillan

According to reports, regulators plan to announce Friday that several large firms have agreed to pay $1 billion and change their organizations to settle allegations that their investment banking units had a conflict of interest with their research divisions, which led to tainted research. In addition to the fines, investment banks agreed to provide funding for independent research. S&P says the news is welcome and should remove some clouds, but is unlikely to stimulate improvement in the capital markets or corporate finance activity, which are key industry drivers.

S&P also reiterates its 4 STARS (accumulate) ranking on Bear Stearns (BSC); and is keeping its 3 STARS (hold) recommendations on Goldman Sachs (GS), Morgan Stanley (MWD) and Merrill Lynch (MER), which previously agreed to pay $100 million.

Paychex (PAYX): Reiterates 4 STARS (accumulate)

Analyst: Jonathan Rudy

The provider of payroll and billing services announced November quarter earnings per share of 20 cents vs. 18 cents, two cents above S&P's estimates. Revenues rose 15%, with 14% growth in payroll service revenue, and 23% revenue growth in the broader Human Resources segment. However, results benefited from Paychex's recent acquisition of Advantage Payroll Services. Results were hurt by lower interest rates, with 15% less interest on funds held for clients. Checks per client improved to an 0.8% decline, from a 2.1% decline from the August quarter. Operating margin remained strong at 37%. S&P says this highly profitable company is attractive at a discount to its intrinsic value.


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