Sector Investing

[ReturntoSender]

From Briefing.com: Close Dow +44.02 at 10422.05, S&P +4.42 at 1214.62, Nasdaq +4.14 at 2110.78: Saddled by concerns related to the growing strength of Hurricane Rita and its ordained path toward the oil rigs and refining facilities along the Texas coast, market participants essentially began Thursday's session with the same sense of caution that led to broad-based losses on Wednesday... Once again, rising energy prices - and specifically rising unleaded gas and natural gas prices - were the focal point of concern that kept the indices on the defensive in the early-going... Losses were held in check, however, thanks again to the energy sector, which maintained its leadership position...

Unlike recent sessions, though, the energy sector wasn't the lone source of support for the broader market... In Thursday's trade, the consumer discretionary sector exhibited relative strength from the onset of trading as the recent pummeling the group has taken sparked some broad-based bargain hunting interest...

Better than expected earnings results from Bed Bath & Beyond (BBBY 39.70, +2.28) and KB Home (KBH 73.70, +2.98) acted as catalysts for the renewed buying interest that picked up steam in the afternoon session when crude, unleaded gas, and natural gas futures pulled back from earlier highs... The retreat within the energy complex was precipitated by some profit taking activity that followed reports Hurricane Rita had been downgraded to a Category 4 storm... That news, in turn, helped put a bid in the broader market and stirred some short covering activity that left each of the major indices in positive territory at the closing bell... The overall gains were modest in scope, but the turn in sentiment was evident in the increased volume and the improved standing of the ten economic sectors, eight of which closed higher for the day...

The two laggards were energy (-0.6%) and utilities (-0.7%)... The consumer discretionary sector (+1.60%) was the best-performer Thursday, but had influential company with the financial (+0.5%) and information technology (+0.2%) sectors exhibiting a positive bias that helped sustain the afternoon rebound effort... The consumer staples sector (+0.7%), aided by a better than expected earnings result from General Mills (GIS 46.19, +1.51), was another standout during the session that saw a return to fortune for consumer-oriented stocks in general...

Speaking of earnings, there were no profit warnings of note and that consideration also acted as an underpinning factor for the positive showing... On the economic front, weekly initial claims jumped 8K to 432K (consensus 450K) while Leading Indicators for August showed a 0.2% decline (consensus -0.3%)... Neither report had any real impact on the proceedings, though, as the spike in claims was written off to the Katrina-effect while the Leading Indicators data were considered to be dated information...NYSE Adv/Dec 1470/1831, Nasdaq Adv/Dec 1435/1586

4:11PM Palm beats by $0.04, ex items; guides in-line (PALM) :Reports Q1 (Aug) earnings of $0.41 per share, ex items, $0.04 better than the Reuters Estimates consensus of $0.37; revenues rose 25.3% year/year to $342.2 mln vs the $339.7 mln consensus. Co issues in-line guidance for Q2, sees EPS of $0.60-0.65 vs. $0.64 consensus; sees Q2 revs of $435-440 mln vs. $435.73 mln consensus.

2:53PM KB Home (KBH)
73.07 +2.35: Bubble, no bubble? Increasing concern about a slowdown in the soaring housing market has weighed on the homebuilding group for the past several months - even as homebuilders continue to report solid growth. Anxiety over rising mortgage rates and surging energy costs have led to somewhat somber expectations for what has been one of Wall Street's best performing sectors during the past few years. Furthermore, waning consumer confidence -exacerbated by the impact and aftermath of Hurricane Katrina - have helped share prices retreat from their July highs.

Despite the market's apparent concern, and subsequent halt in the industry's broad-based rally, positive fundamentals for homebuilders remain mostly intact. With interest rates remaining at historically low levels, combined with strong employment and solid economic growth, the sector's stronger performers are well positioned to weather a slowdown and continue to deliver meaningful results.

To that end, KB Home, which on Thursday posted record third quarter results and raised its outlook for full-year profits, highlights the industry's situation. The Los Angeles-based builder said earnings increased 93% to $227.5 million, or $2.55 per share, during the quarter, compared with $117.9 million, or $1.42 per share, a year earlier. The results exceeded the consensus EPS estimate of $1.39, driven by strong revenue growth and improved operating margin (14.9% versus 11.0% in the year ago quarter).

Revenue rose 44% to $2.53 billion - ahead of the average analyst estimate of $2.50 billion - as housing revenue increased 45%. The company said homes closed in the third quarter increased 22% to 9,812 homes, while orders reached 10,467 homes, up 17% from 8,982 homes in the third quarter last year. KBH stated that "net orders continued to show strength within our operating regions, providing important evidence of the fundamental health of our business." It added, "we continue to see high levels of demand in each of our product offerings - first time, move-up, luxury, and active adult buyers - particularly in markets where housing supply remains constrained."

That, combined with a record third quarter backlog of $7.06 billion, or 27,744 homes - up 47% from $4.82 billion, or 21,928 homes, a year earlier - suggests KB Home is well positioned to deliver strong fiscal year results. Accordingly, the company raised its earnings expectations for FY05 to $9.30 per share, up from its previous guidance of $9.00. The new estimate represents a 63% increase from the same quarter last year and reflects the company's strong year-to-date results and robust backlog levels. On average, analysts had projected earnings of $9.14 per share for the fiscal year.

Given the strength of KB Home's results and relatively favorable near-term outlook for interest rates and operating conditions, continued strong demand is expected to drive growth. In addition, the company's completed formation of Countrywide KB Home Loans, a 50-50 joint venture with the nation's leading home loan lender, should offer homebuyers a broader range of products and help drive higher capture rates in its mortgage business. The new venture should also help increase efficiencies, which should lead to lower operating costs.

Although bubble fears have clouded prospects for the industry, KB Home continues to deliver solid results. Given that business conditions persist in its markets and the pricing environment remains strong, the company is well positioned to perform ahead of its peers. Currently, KBH trades at approximately 8x the FY05 EPS estimate of $9.14. --Richard Jahnke, Briefing.com

12:49PM Sprint Nextel (S)

24.40 +0.85: Sprint Nextel Corp, now trading under the old Sears stock symbol "S", is moving higher in trading after raising the value of the expected merger benefits. The company came out Thursday morning with a merger-integration and financial update, increasing the benefit by 20%, or $2.4 bln, to $14.5 bln in savings, which it will use to invest in its wireless network.

CEO Gary Forsee, who made his way to Sprint via Bellsouth (BLS), said the additional value creation was achieved through an "effective integration process." The merger is planned to save the company $3.5 bln in operational and business synergies through job cuts and by reducing marketing spending. It also includes $3.7 bln in capital expenditures savings achieved by closing data overlay networks, $4.4 bln in IT consolidation, and $2.3 bln in network cost savings.

When Sprint agreed to purchase Nextel in December of 2004, it argued the $30 bln price tag would not only create the third largest carrier with 31.8 mln subs, but would bring about $12 bln in savings. We added the stock as a suggested holdings in a portfolio for active investors prior to the announcement due to its strong wireless business on both the top and bottom lines. The deal only added to our conviction, then and now, with the company estimating it will produce 40% EBITDA margins by FY08 or sooner.

Sprint plans to spend $5.6 bln on its wireless and long-distance network in 2005 and $6 bln in 2006. These accelerating capex plans are positive as Sprint aims its focus on its CDMA network, deploying high-speed wireless data services using EV-DO technology. Verizon (VZ) has already launched this 3G high-speed wireless option, available in many metropolitan areas. The benefit of EV-DO, officially called CDMA 1xRTT EV-DO, is speed. It opens a wide channel on a existing CDMA network just for data but does not alter the voice network. The competing technology is UMTS, which actually replaces GSM with different spectrum usages, but that is a whole other story.

Sprint also provided a third quarter update, including a net gain of more than 1.2 mln total wireless subs. The cloud in today's press release was the number of postpaid net adds, coming in at only 700,000 weaker than many analysts had anticipated. This may be more of a timing issue than a demand trend, as Sprint didn't launch the new brand until Labor Day. We remain positive on the stock given the apparent success of the Nextel integration, further distribution, productivity, and cost opportunities ahead, and increasing wireless penetration. ---Kimberly DuBord, Briefing.com

11:13AM Bed Bath & Beyond (BBBY)

37.98 +0.56: Bed Bath & Beyond, which typically meets or exceeds earnings estimates, reported yet another meaningful quarter of growth - topping analyst expectations for the 15th straight quarter. The home-furnishings retailer on Wednesday said earnings for the period increased 17.8% to $141.4 million, or $0.47 per share, compared with $120 million, or $0.39 per share, a year earlier. The latest results were a penny better than the average analyst forecast, according to Reuters Estimates.

Net sales for the quarter jumped 12.3% to $1.43 billion - in-line with the consensus estimate of $1.44 billion - helped by a 4.5% gain in same store sales. The growth in same store sales comes on top of an increase of approximately 4.8% in the year ago period and amidst disappointing results at other home furnishings retailers, including Cost Plus (CPWM), Linens 'n Things (LIN), and Pier 1 Imports (PIR), over the past few quarters.

Separately, as a result of Hurricane Katrina, which struck the Gulf Coast at the beginning of the fiscal third quarter, and its aftermath, the company said that two Bed Bath & Beyond stores in the region have had to suspend operations. Although several other stores were affected by the storm as well, they have since resumed operations. Overall, the impact on operations is expected to be limited.

As evidenced by its solid second quarter performance, BBBY continues to demonstrate fundamental strength with gross margin up 30 basis points to 42.0%, operating margin up 40 basis points to 15.2%, and 10 basis points of SG&A leverage, as well as improving new store productivity. However, the stock, which is down nearly 20% from the 52-week high reached in July, continues to be unduly punished by investors. The decline arguably reflects the company's maturing growth prospects and the lack of upside surprises that BBBY has been accustomed to in the past. Although BBBY continues to generate consistent results, current growth prospects have seemingly been priced into the stock, effectively impeding price appreciation.

Nonetheless, BBBY remains the leader among home-furnishings retailers. Given its still meaningful growth potential, as well as significant opportunity to expand its Christmas Tree Stores concept, the company appears undervalued at the current price level. As such, the recent pullback in shares provides a compelling opportunity to capitalize on BBBY's market-leading position and attractive valuation. Currently, the stock trades at roughly 20x estimated FY06 earnings, a discount to its peers LIN and PIR. --Richard Jahnke, Briefing.com

10:35AM General Mills (GIS)

45.70 +1.02: After a downtrodden end to its fiscal year, General Mills pulled out an impressive first quarter with profits rising 38% from last year. Performance was driven by an improved balance between price and volume, with operational productivity offsetting cost input pressures.

General Mills reported earnings, excluding non-recurring items, of $0.68 per share - twelve cents higher than the Reuters Estimates consensus. Net sales rose 3% to $2.66 bln, as unit volume rose 1% worldwide. Segment operating profits increased 21% to $500 mln. Operating margins expanded 280 basis points to 18.7%, reflecting price realization, product mix, and productivity. US Retail sales grew 2% to $1.8 bln, and notably, were not driven simply by volume, but by net price realization and a favorable mix of sales. The favorable pricing and productivity mix flowed through to the bottom line.

The all-important cereal segment, Big G, did improve on price, but volumes were down 6% from last year's period. General Mills launched seven new cereals during the quarter, including three new varieties of Total cereal and two flavors of Yogurt Burst Cheerios. Also within the Retail segment, Yoplait continues to perform exceptionally well, up 19%. The Meals division grew sales by 4%, led by Progresso soup and Green Giant frozen vegetables. Snacks increased 3%, while Pillsbury USA finished down 1%.

The International division generated net sales of $446 mln, up 11.0%, in which volume accounted for 7% and currency added 3%. A favorable product mix and operating efficiencies boosted operating profits by 69% to $61 mln, as margins widened to 13.7% from 8.9% last year. Bakeries & Foodservice declined 1% to $417 mln, but contributed to a greater degree on the bottom line as operational improvements and productivity boosts atoned for constraints caused by SKU rationalization.

Earnings were assisted by lower restructuring and interest expenses, as well as a lower share count. To that end, the company renewed its repurchase program, totaling 15.9 mln shares during the quarter at an average price of $46.95. This included 4 mln shares through a secondary offering. GIS does not issue quarterly guidance, but it gave full year forecasts that were in-line with expectations despite a strong Q1, indicating a level of conservatism. For FY06, it sees earnings of $2.85-2.90 per share vs. $2.91 consensus with net sales in the low single-digit range and mid-single digit operating profits.

We are certainly pleased to see the marked improvement in price realization, but the question is will GIS be able to maintain this level of performance in a challenging cost environment. GIS is hoping that the gap between price and volume will continue to narrow as the year unfolds, as merchandising picks up and price points become more competitive, resulting in further price realizations.

Faced with questions over its conservative guidance considering this quarter's performance, management noted on its conference call that just too many "unknowns" remain at this point regarding energy prices and the Gulf. It expects Hurricane Katrina and possibly Rita will cause disruptions, not only for themselves but other manufacturers due to high prices and delay schedules for raw materials - all adding to cost pressures in the second quarter. GIS does have a natural cycle to its fiscal year with a strong second quarter. It faces a challenging comparison of 4% net sales and 20% earnings growth in Q2FY04.

With shares down considerably YTD, the stock offers a strong investment at these levels. GIS has proven its ability to drive profits through price and product mix, along with facing cost challenges head on. Compared to its larger rival Kellogg (K), which trades at 19.4x, GIS trades at 15.8x and almost a 20% discount to its 5-year historical average.---Kimberly DuBord, Briefing.com

8:51AM Page One - Awaiting Rita

There isn't much to say this morning. The market is nervous about the impending impact of Rita on the economy and gasoline prices. The outcome depends significantly upon the unpredictable path of the hurricane. Stock futures suggest a slightly lower open this morning.

Clearly, the hurricane will have a devastating impact wherever it hits. The degree of damage to oil refineries in Texas, however, is uncertain. Those refineries appear to be less vulnerable than the ones in Louisiana; but after witnessing the impact of Katrina, few are comfortable hoping for the best with Rita.

The market will be closely watching the path of Rita and will be on "Rita watch" throughout the trading session today and tomorrow.

There are some earnings reports. Virtually all are good. Bed Bath & Beyond, General Mills, and KB Home all reported earnings above expectations and gave good outlooks. It is also noteworthy that there are no earnings warnings today. This good news will have little broad impact under current circumstances.

New claims for unemployment for the week ended September 17 rose 8,000 to 432,000. Filings are high from victims of Hurricane Katrina. The data provide no indication of underlying demand for labor and should not be over-interpreted.

We have no idea how much damage Rita will cause. If the damage is not severe, the market very well may snap back. At this point, however, it is highly unpredictable as to how the hurricane will track and the economic impact that will result. It is expected to reach land early Saturday, so at least the markets will have a couple of days to make a rational assessment of the implications for stock prices before trading resumes on Monday. -- Dick Green, Briefing.com

10:04AM First Horizon (FHN) Sun Trust Rbsn Humphrey downgrades Buy to NEUTRAL. Firm downgrades stock given an expectation of continued pressure on the co's NIM, specifically in the mortgage and capital mkts segments. Firm also says consistent downward earnings revision trends seem likely to continue into 2006. With an outlook of a further flattening of the yield curve, they think spreads in the co's mortgage warehouse and capital mkts business are likely to remain under pressure.
10:03AM Coldwater Creek (CWTR) Brean Murray upgrades Hold to ACCUMULATE. Target $28. Frm believes the shares have been unfairly punished over the past few weeks and the pullback represents an attractive entry point. Firm attributes the recent sell-off in the co's shares to the mkt's concern over consumer spending in the face of higher gas prices and interest rates. However, as the the co's customer belongs to a higher-end demographic, they are not worried about her spending declining significantly.

10:02AM Xyratex (XRTX) RBC Capital Mkts downgrades Outperform to SECTOR PERFORM. Firm downgrades stock following Q3 results. Due to the recurring trend of degrading storage system gross margin, firm cuts their forward storage system gross margin assumptions. Turning to the disk infrastructure business, firm's FY06 rev outlook is relatively unchanged; however, thye note that the rev trajectory is now much more back end loaded. Firm also notes that the revised trajectory reflects: 1) a return to a more typical annual capex cycle at Seagate and Western Digital; 2) a front end loaded contribution from Oliver Design versus prior assumptions; and 3) a lowered outlook for servotrack writing equipment given pending product enhancements that improve throughput.

10:01AM XM Satellite (XMSR) Morgan Joseph initiates BUY. Target $40. Firm believes continued subscriber growth and leadership of the satellite radio industry should drive long-term stock appreciation. They expect the co's subscriber growth momentum to build and forecast the co will add another 2.9 mln subscribers in 2005 and 2.8 mln in 2006 to reach 8.9 mln. They think the satellite radio business should generate high margins over time and believe gross margins could surpass 65% and pretax margins could reach 45%.

9:58AM THQ Inc (THQI) Fulcrum initiates BUY. Firm also initiates ATVI with a Neutral. For THQI, firm cites the co's mix of "big brand" licensed content (Pixar, Nickelodeon and WWE licenses) targeted at late-cycle adopters with new big proposition original properties for next generation early adopters as well as an attractive valuation relative to its growth prospects. They believe both ATVI and THQI are well positioned to weather the transition storm while growing their mkt shares domestically and internationally, but believe THQI is best positioned to outperform the industry.

9:48AM Southwest Air (LUV) Fulcrum upgrades Neutral to BUY. Target $14 to $20. Firm upgrades stock based on their expectation that rev performance has started to turn a corner and that mgmt has identified areas of cost opportunity that will enable the airline to rein in costs to offset rising labor rates. In addition, firm expects the co to benefit from the right-sizing of Delta and Independence Air.

9:41AM Kraft Foods (KFT) Harris Nesbitt downgrades Outperform to NEUTRAL. Target $37 to $34. Firms expected higher commodity prices and a challenging operating environment in Europe to continue to delay the co's recovery and limit its operating and stock performance in the short-term. Aside from valuation, they think the co lacks a catalyst to outperform its peer group.

9:36AM Neustar (NSR) Avondale Partners initiates MKT OUTPERFORM. Target $34. Firm cities the following investment positives: 1) attractive foreseeable growth of 25% driven by communications industry expansion and change; 2) scalable business model; and 3) long-term contracts. Firm believes the co's long-term goal of $1 bln in rev is realistic. Although the co is trading at a premium valuation vs. the broad mkt indexes, they believe it is well positioned to benefit from these industry dynamics and over the next twelve months has the potential for earnings acceleration.

9:33AM Activision (ATVI) Janco Partners initiates BUY. Target $26. Firm believes that given the co's share volatility and the current transitional stress they foresee in the video game market, they recommend a longer term view towards the co's shares. Janco considers the 11% drop in the stock since Monday an opportunity to build or establish positions. Firm says the co has almost $800 mln in cash ($4 per share), zero debt, strengthening mgmt team, recently raised operational guidance, has historically beaten raised guidance, and has growth trends that compare favorably to their competitors.