Markets & Finance

S&P Downgrades Sears to Sell


Sears, Roebuck (S): Downgrades to 1 STAR (sell) from 3 STARS (hold)

Analyst: Jason Asaeda

We think the market sees Vornado Realty's (VNO) 4.3% stake in Sears, disclosed in its 10-Q filing on Friday, as an asset play. We think Sears faces a tough turnaround, but do not see it selling off stores. In fact, we note its recent purchase of 50 stores from Kmart to support off-mall growth. We think valuation should continue to reflect Sears' prospects as an ongoing retail concern vs. an appraisal of its real estate. We cut our 2005 earnings per share estimate to $1.90 from $3 on a narrowed gross margin assumption. Our target price stays $33, on a blend of p-e and price/sales analyses.

Microsoft (MSFT): Maintains 5 STARS (buy)

Analyst: Jonathan Rudy, CFA

Microsoft announced that it has reached an agreement with 3-STARS ranked Novell (NOVL) to settle potential antitrust litigation related to Novell's Netware operating system for $536 million in cash. With over $64 billion in cash and short-term investments prior to its upcoming $32 billion special dividend, we believe that Microsoft has ample cash for this settlement. We also believe that the company has made significant progress in settling a number of lawsuits. With a strong balance sheet, in our view, and trading at a discount to our

discounted cash-flow-derived 12-month target price of $35, we would buy the stock.

McDonald's (MCD): Maintains 4 STARS (accumulate)

Analyst: Dennis Milton

McDonald's announced October systemwide sales increased 9.5%, year-to-year, in line with recent sales trends. The company's brand same-store sales rose 6.1%, despite difficult comparisons, reflecting growth of 7.5% in the U.S., 2.0% in Europe and 6.1% in the Asia-Pacific, Middle East and Africa segment. We are maintaining our 2004 earnings-per-share estimate of $1.91, 2005's at $1.97, and our 12-month target price of $33. At 15 times our 2005 earnings-per-share estimate, in line with peers, we think shares are attractively valued given our view of McDonald's strong sales momentum and new product development capabilities.

Motorola (MOT): Reiterates 5 STARS (buy)

Analyst: Kenneth Leon, CPA

While today's Wall Street Journal article questions whether Motorola can ship new handset models in high volume by the holiday season, we are encouraged by December-quarter outlooks from Motorola's leading customers, such as Nextel Communications (NXTL), Cingular Wireless, KDDI and T-Mobile USA. We think Motorola's handset strategy to grow share in the mid-to-high-end ASP range should enable it to sustain 10% operating margins in this division. Our target price is $22, based on sum-of-the-parts analysis. Based on our view of strong handset outlook, and priced at 1-time our 2005 sales estimate, we would buy.

Black & Decker (BDK): Downgrades to 3 STARS (hold) from 5 STARS (buy)

Analyst: Amy Glynn, CFA

With shares up about 75% year-to-date in 2004, we are downgrading Black & Decker. We think Black & Decker has been successful in executing on its 2002 restructuring plan, but see limited additional margin upside as we think cost savings will taper off in 2005. Our 2005 earnings-per-share estimate of $6.08, or 13% projected growth, assumes the improved cost structure, plus acquisition accretion, partly offset by rising commodity, pension and option expense. We are maintaining our target price of $91, based on a p-e of 15 times our 2005 earnings-per-share estimate, which is above the company's historical average.

Conseco (CNO): Upgrades to 3 STARS (hold) from 2 STARS (avoid)

Analyst: Catherine Seifert

Conseco posted better-than-expected 36 cents third-quarter operating earnings per share. In 2003, Conseco posted 17 cents earnings per share for the month of Sept. 2003, and its predecessor reported $2.2 billion of net income for July and August 2003. We raise our opinion amid the company's post-Chapter 11 progress at rebuilding its financial strength. However, our outlook is tempered by concerns that competition in some core lines is increasing. We are trimming our 2004 earnings-per-share estimate by 10 cents to $1.55. We see $1.80 in 2005. We are raising our target price to $20 from $14, assuming a peer average p-e of 11 times our 2005 earnings-per-share estimate and 1.4 times tangible book.

Berkshire Hathaway (BRK.A): Maintains 3 STARS (hold)

Analyst: Catherine Seifert

The company posts third-quarter operating earnings per share of $402, vs. $881, below expectations on a 26% increase in insurance-incurred losses. Berkshire Hathaway incurred $1.25 billion in pretax hurricanes losses, some 5% of the industry total, yet never pre-announced this event. We are reducing our 2004 earnings per share estimate by $600 to $3050 and 2005's by $185 to $3900. Our 12-month target price of $90,000 (down from $94,000), assumes a forward p-e multiple of 23 times our 2005 estimate, a premium to peers. We are disappointed by Berkshire's lack of proactive communication with investors and view the shares as fairly valued.

Novell (NOVL): Reiterates 3 STARS (hold)

Analyst: Jonathan Rudy, CFA

Novell announced that it has reached an agreement with Microsoft (MSFT) to settle potential antitrust litigation related to Novell's Netware operating system for $536 million in cash. With approximately $606 million in net cash/investments before this agreement, or about $1.50 per share, we believe that this settlement will significantly benefit Novell's balance sheet. However, given our view of the company's inconsistent execution and with the stock trading at a premium to peers on a p-e to growth basis, we would not add to positions.

News Corp. NWS: Reiterates 5 STARS (buy)

Analyst: Tuna Amobi, CPA, CFA

Shares are down after the announcement of a new shareholder rights plan, granting each voting/non-voting shareholder a right to buy News Corp./News Corp. Class A shares, or any acquiring entity's stock, at half price, on the acquisition of 15% or more of News Corp. The new poison pill does not surprise us, as it counters last week's unexpected Liberty Media (L) option to boost News Corp. (voting) stake by 8% to 17%. News Corp. exempts Liberty Media's option from the rights, but the plan could raise governance issues, as Murdoch firms 30% voting control. We think the risk is mitigated by new governace provisions as News Corp. moves to wrap its U.S domicile move.

ING Group (ING): Maintains 5 STARS (buy)

Analyst: Sonal Seth

Last week, ING posted strong third-quarter results, with year-to-date net profits growing 48%. Net operating profits from banking rose 60% on strong growth in ING Direct and lower risk costs. Net-operating profits from insurance grew 15% on new business growth in the U.S., underwriting improvement in Canada, and a positive third-quarter in Korea. Based on lower risk costs, more favorable tax assumptions, and higher capital gains and currency fluctuations, we are increasing our 2004 earnings per ADR estimate to $3.11 from $2.76, and 2005's to $3.26 from $2.90. We are raising our target price to $30 from $29.


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