Integration Risk for Coventry Health

Coventry Health Care, Inc. (CVH) lowered sharply its operating earnings outlook for the second quarter and fiscal 2008, citing unexpectedly high costs, including higher than expected claims in its Medicare Advantage private-fee-for-service business and heavy outpatient utilization in its commercial plan observed during the current quarter so far.

With the number of acquisitions executed in recent years, we believe the company will continue to benefit from ongoing operating improvements and margin expansion. Coventry should continue to focus on lowering overhead costs in recently acquired plans, while maintaining pricing discipline in its existing business. The acquisition of First Health diversifies Coventry's payor mix, and we believe it will deliver a national capability to Coventry and a solid platform for entering new markets.

While we believe Coventry will continue unencumbered at the smaller end of the mergers and acquisitions arena, we anticipate incrementally higher prices by vendors as attractive targets of significant scale diminish over time. Damage caused by Hurricane Katrina in the New Orleans region should continue to impact financials.

We have valued Coventry on a forward price/earnings (P/E) basis and by a comparison to similar firms in the healthcare facilities sector. We continue to regard the integration of First Health, given its size and scope, a significant integration challenge. We believe the acquisition of Concentra will enhance the company's service offering to workers compensation plans, an area of strength for the company, and maintain our Hold recommendation at current levels. Our $34 target price is derived using a multiple of 9.3 x FY08 EPS of $3.65.

Consumer Market Pressures Hanes

Since its spin-off in September 2006, Hanesbrands, Inc. (HBI) has reduced debt by $285 million. The firm's business model requires only modest sales growth to create substantial EPS growth. Earnings are being driven by brand-building and cost-reduction initiatives.

But the management is reporting non-GAAP EPS, excluding unusual actions, which may be distorting perceived earnings. Also, the company operates in the highly competitive apparel essentials market, which generally lacks pricing power. We maintain our Hold recommendation.

The company's growth model is expected to generate strong, consistent cash flow. The business model looks for long-term annual sales growth between 1% and 3% driven by investments in the company's large brands and retail partnership programs.

The management is consolidating the organization and the distribution network, in addition to developing a global supply chain in lower-cost countries. Hanesbrands' cost-reduction initiatives are ultimately targeted to generate gross annualized savings of $200 million.