Markets & Finance

S&P Cuts THQ to Avoid


THQ Interactive (THQI): Downgrades to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Jonathan Rudy

S&P is taking a less favorable stance on THQ primarily because of concerns over a further slowdown in consumer spending, in addition to THQ's lack of top brand video games for the market-dominant PlayStation 2 platform. Additionally, the company is currently in its seasonally weak part of its year, without any potentially positive catalysts until the Electronics Entertainment Expo at the end of May. However, a strong balance sheet, with about $6 per share in net cash and investments, and continued growth in the video game sector should mitigate the downside.

Baxter International (BAX): Downgrades to 3 STARS (hold) from 2 STARS (avoid)

Analyst: Robert Gold

S&P thinks that the recent sharp decline in health-care products maker Baxter has reduced the valuation to the point where downside risks are now largely built into the share price. Risks clearly remain on the company's 2003 guidance, given competitive pressures in the plasma business, the slowdown in the company's kidney disease products business, and prospect for gross and operating margin compression. Earnings quality is also an issue. However, S&P has established what looks like a worst-case 2003 operating earnings per share forecast of $1.90, below the low end of the $2.10 to $2.20 guidance. The shares are now trading at less than 11 times this projection.

KB Home (KBH): Maintains 4 STARS (accumulate)

Analyst: Michael Jaffe

KB Home posted better-than-expected February earnings per share of $1.25 vs. 95 cents. The gain reflects a 5% rise in home closings, 13% higher average prices, and better efficiencies. Prospects still look solid, as a 2% rise in unit orders brought a 15% increase in backlog (6% in units). S&P hiked its fiscal 2003 (Nov.) earnings per share estimate by 20 cents, to $7.95, and sees $8.10 in fiscal 2004. While a likely cycle top limits S&P's sector enthusiasm, trends should stay decent. Shares are trading at six times the fiscal 2003 estimate, in line with peers, but big positions in the entry-level area and the undersupplied California markets make it attractive.

Borders (BGP): Downgrades to 3 STARS (hold) from 4 STARS (accumulate)

Analyst: Jason Asaeda

Before charges, the bookstore chain posted January quarter earnings per share of $1.39 vs. $1.35. Comp-store sales declined 3% at Borders units and 6.1% at Waldenbooks units; international sales rose 29.7%. Results benefited from disciplined cost controls. Borders expects continued weakness in book and music sales in fiscal 2004 (Jan.). As a result, S&P is trimming the fiscal 2004 operating earnings per share estimate by five cents, to $1.55, in order to reflect a more conservative sales outlook and the likelihood of reduced expense leverage. With shares trading at 8.7 times S&P's fiscal 2004 earnings per share estimate, in line with peers, S&P now sees Borders as a market performer.

Adobe Systems (ADBE): Maintains 3 STARS (hold)

Analyst: Scott Kessler

Before investment items, Adobe posted February quarter earnings per share of 25 cents vs. 22 cents without acquired in-process R&D and amortization expenses, above S&P's high-end estimate. Revenues rose 11%, reflecting strength from Acrobat, InDesign and PhotoShop. Gross margin was better than expected at 92.5% vs. 91.2% estimate, on greater leverage and a more favorable revenue mix. S&P is raising the fiscal 2003 (Nov.) and fiscal 2004 earnings per share estimates by a few cents each on a better margin outlook. But with above-peers price-earnings and price-earnings-to-growth multiples, and sizable options exposure per S&P's Core Earnings methodology, S&P is keeping Adobe at hold.

King Pharmaceuticals (KG): Maintains 3 STARS (hold)

Analyst: Herman Saftlas

King's headaches worsened on news of an FTC investigation into sales practices used by Elan Corp. to market its muscle-relaxant drug, Skelaxin, which King has agreed to buy from Elan along with other assets. The news comes on the heels of an SEC inquiry of King's own sales practices, and raises doubts if the Elan deal will close. That may not be totally negative, since the Street has been generally lukewarm about the deal. For now S&P is keeping the $1.65 earnings per share estimate for 2003. On that basis, King is trading at a multiple of seven -- less than half of the specialty-drug group average.


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