Markets & Finance

S&P Cuts Krispy Kreme to Avoid


Krispy Kreme Doughnuts (KKD): Downgrades to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Dennis Milton

Krispy Kreme shares have rebounded 50% from a May intermediate low, and now trade at 50 times S&P's fiscal 2004 (Jan.) earnings per share estimate of 90 cents, and 61 times the fiscal 2004 Standard & Poor's Core earnings per share estimate of 74 cents. While S&P is impressed with Krispy Kreme's growth prospects, S&P thinks the shares are overvalued at current levels. According to S&P's discounted cash flow model, which assumes revenue growth of better than 20% over the next five years, declining gradually thereafter, the shares now trade at a nearly 20% premium to their intrinsic value, and S&P would avoid them.

Expedia (EXPE) and InterActive (IACI): Downgrades to 4 STARS (accumulate) from 5 STARS (buy)

Analyst: Scott Kessler

With InterActive (formerly USA Interactive) approaching S&P's price target of $44, S&P is downgrading its shares and those of Expedia, which is 54%-owned by InterActive and is expected to be fully acquired by InterActive in the summer. S&P thinks InterActive will continue to benefit from an anticipated economic recovery, particularly in its online-travel business, which also includes Hotels.com.

There are several possible positive developments for InterActive with regard to its 5.4% stake in Vivendi Universal Entertainment (VUE). S&P thinks an acquisition of VUE by a financially stable parent could improve the prospects for InterActive's holding in VUE, and may also increase the value of InterActive's stake.

Moreover, S&P thinks Liberty Media's recently announced purchase of cable retail channel QVC could lead to closer ties with the Home Shopping Network, which is owned by InterActive. Despite being competitors in this market, Liberty is a large shareholder of InterActive, and Liberty CEO John Malone and InterActive chief Barry Diller are friends. S&P thinks QVC and the Home Shopping Network could consolidate some of their back-office operations, such as fulfillment, billing, and customer service. Such developments would enable the Home Shopping Network to cut costs.

Still, S&P is taking a slightly less positive stance on InterActive and Expedia shares based on risk-reward considerations.

Note: Beacause of an editing error, an earlier version of this article incorrectly attributed to Kessler speculation that InterActive will team with Liberty Media to purchase Vivendi Universal Entertainment (a view he does not hold), and omitted a reference to a potential partneship between InterActive and QVC.

CheckPoint Systems (CKP): Downgrades to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Jason Sanders

Shares have risen 49% since the start of 2003, which S&P attributes to an increased emphasis by enterprises on security, efficiency, and theft prevention. Although these issues will likely spur demand for CheckPoint's products in the long run, S&P doesn't think the current price level is warranted. S&P's discounted cash flow model, which assumes a long-term free cash flow growth rate of 5%-6%, indicates a fair value of $10-$11 a share. With shares trading at 19 times S&P's 2003 estimate of 80 cents -- a premium to the estimated 18 times for the S&P smallcap 600 -- S&P would avoid CheckPoint.

Microsoft (MSFT): Reiterates 5 STARS (buy)

Analyst: Jonathan Rudy

S&P believes Microsof's plan to grant Stock Awards, rather than employee stock options, should enhance the quality of its operating earnings per share. The Stock Awards would be actual Microsoft shares, and would vest over time. Also, in fiscal 2004 (June), Microsoft plans to expense all stock-based compensation, including previously granted options. While these moves are likely to lower Microsoft's operating earnings per share, they should narrow the difference between operating earnings per share and S&P's Core earnings per share. Excluding these moves, S&P estimates fiscal 2004 operating earnings per share at $1.06 and S&P Core earnings per share at 79 cents, with operating earnings per share already being of higher quality than peers.

Chico's (CHS): Upgrades to 4 STARS (accumulate) from 3 STARS (hold)

Analyst: Yogeesh Wagle

Chico's reported that total June sales rose 42%, driven by a strong 16.5% increase in same-store sales achieved despite a high 15% same-store gain in the year-ago period. Based on 31%-33% sales growth, along with likely gross margin expansion and increased expense leverage on the higher sales, S&P is raising the fiscal 2004 (Jan.) earnings per share estimate by 5 cents, to $1.01 -- up 29% over fiscal 2003. S&P believes Chico's rich valuation, at 25 times S&P's fiscal 2004 estimate, is justified by its above-peer earnings growth prospects as the company continues to exploit its niche market of mid-income to high-income baby-boomer women.

Alcoa (AA): Maintains 4 STARS (accumulate)

Analyst: Leo Larkin

Alcoa posted second-quarter earnings per share of 27 cents vs. 28 cents on a 5.9% gain in sales, ahead of S&P's estimate of 24 cents. The comparison with 2002 was aided by higher levels of non-operating income and a lower tax rate. Partly offsetting this was a 60% rise in a minority interest, a 13% increase in depreciation expense, and higher costs for employee benefits and energy. S&P is keeping its $1.02 estimate for 2003, and projects $1.50 for 2004. S&P remains positive on Alcoa with the stock yielding over 2.0% and given S&P's belief that aluminum prices have bottomed.


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