Lehman Woes Drive Worry

As the Dow, Nasdaq and S&P 500 all sell off roughly a percentage point as of mid-day Monday, an AP report cites a Wall Street Journal article from this morning about Lehman Brothers' (LEH) difficulties continuing.? Lehman may need to pre-announce losses for its 3rd quarter (ending August) report, and another $1.8 billion in writedowns may be forthcoming.?

You'll recall that this comes after the company's first reported loss in its Q2 report of $2.8 billion, amid extensive mortgage loan writedowns.? With the latest dire forecast including the possibility that Lehman may need to raise $6 billion overall, shares are down 4.5% thus far today, or 82% lower than?their 52-week high.

Analysts have remained busy lowering earnings estimates for the 4th largest U.S. investment bank; in just the past week, 3 analysts have downwardly revised August quarter estimates, and 4 have taken down expectations for fiscal year 2008 (ending November '08).? The Zacks consensus estimate for the coming quarter is -51 cents per share, whereas a quarter ago LEH was expected to fetch $1.28 in the term.

American Oriental a Play on China

American Oriental Bioengineering, Inc.'s (AOB) second-quarter financials were strong and exceeded our expectations. We expect the company to continue to deliver strong performance in the coming quarters due to relatively high growth in the Traditional Chinese Medicine (TCM) market in China. We maintain our Buy rating on the shares.

The company targets two rather large markets in China: the TCM pharmaceutical market and nutraceutical market. We view AOB as a China play stock and growth story. In the past few years from 2003 and 2007, the company achieved more than impressive top line CAGR of 66.6%. EPS grew from $0.15 in 2003 to $0.60 in 2007, a CAGR of 42.7 percent. Both topline and bottomline continued to grow in the first quarter of 2008.

We believe the company will ride the wave of Chinese economic growth and increased healthcare spending in the next few years. We think American Oriental will also continue to manage its growth through both organically and through acquisition. Although growth in the plant-based nutraceutical sector may level off in the next few years, we believe the company will achieve high growth in the plant-based pharmaceutical sector going forward.

Specifically, we model top line growth (CAGR) of 32.5% from 2008 to 2011, EPS growth will reach 29.7% CAGR. Our price target is $16. The price target corresponds to a P/E ratio of 17.4 x, 11.9x and 11x of our estimated EPS of $0.92, $1.35, and $1.46 for 2008, 2009, and 2010 respectively.=

Penn Virginia Adjusted, Still a Buy

We are maintaining our Buy recommendation on Penn Virginia Resource Partners L.P. (PVR) but decreasing our target price from $31.25 per unit to $28 per unit. The partnership's recent acquisitions in the midstream space have positioned it to grow throughput volumes but also diversify its operations into several of the most active basins in the U.S.

Backed by strong coal fundamentals, both of PVR's operating segments should see stellar results through '09 as throughput volumes look to ramp up significantly and coal doesn't seem to be slowing anytime soon. We estimate that PVR will increase its annualized distribution 9% to $2 per unit from its current annualized rate of $1.84 per unit over the next twelve months.

Our positive investment sentiment on PVR is based on the near-term cash flow growth from both favorable coal pricing and leverage to Central Appalachian (CAPP), the accretive acquisitions made in its midstream segment and the growth opportunities from them and the recent pullback across the energy sector. On August 14, PVR announced that it will pay to unit-holders of record on August 4 $0.46 per unit or an annualized rate of $1.84 per unit. This is a 9.5% increase over the annualized distribution for the same quarter 07.

We are increasing our 2008 earnings estimates slightly from $1.63 to $1.64 per unit due to minor adjustments to margins and other revenue assumptions. We are increasing our 2009 estimated from $2.12 to $2.30 per unit due to increases in throughput volumes from acquisitions in 2008, further supported by strong coal royalty revenues.

Hanger Orthopedic Group Inc.

Hanger Orthopedic Group Inc. owns and operates orthotic and prosthetic patient-care centers in the United States. The company has a market cap. of $435 million and is headquartered in Bethesda, Maryland.

Shares of HGR have been on a nice rally over the last two weeks, assisted by the company's excellent second-quarter results, reported on July 29. Sales were up 13% from the same period last year to $181.2 million. Net income jumped ahead 57.2% from last year to $8.0 million. This produced earnings of 25 cents per share, well ahead of analyst estimates of 20 cents per share.

Consistent Results

This is the fourth time in four quarters that Hanger has either beaten or matched analyst estimates, having done so by an average of 3 cents, or 20%.

Hanger reported strong growth from both if its primary segments, with the company's largest segment in patient care posting a 6.7% increase in same-center sales. Hanger's distribution segment, smaller by sales volume, posted a 23.5% increase in sales.

Earnings Guidance

After the solid quarter, Hanger confirmed its previous guidance for the rest of the fiscal year, but proceeded to boost its full-year revenue guidance to a range between $680 million and $690 million. Hanger also raised its earnings target to between 80 and 82 cents per share. Analysts have the next-year estimate pegged at 94 cents per share, a 13% earnings growth projection.

Valuations

Based upon the current-year earnings estimate, this is not a cheap stock, trading with a forward P/E multiple of 22X, a sharp premium to the overall market.

The Chart

Shares of HGR have been rallying since finding a bottom below $11 in late April. Since then this stock has advanced beyond the $18.50 mark, establishing a new 52-week and all-time high in the process. Take a look at the chart below.

=

Fred's at Fair Value to $15

Fred's Inc. (FRED) reported solid second-quarter sales of $447 million, up 5 percent year-over-year, with comp-store sales growth of 4.9 percent. The company?s sales growth indicates that Fred?s continues to benefit from customers trading down to lower cost alternatives as well as the management?s strategic efforts.

We increased our second-quarter EPS by $0.01 to $0.10, which is at the high end of the management?s EPS guidance of $0.07-$0.10. For fiscal 2008, our estimate goes from $0.70 to $0.72 and our 2009 EPS estimate goes from $0.78 to $0.80.

Nevertheless, the company?s positive factors are offset by negative factors such as high food and energy prices and difficulties in its core business. Fred's stores target lower income customers, and those customers tend to be affected to a greater degree by higher energy and food costs. Fred?s results will most likely be negatively impacted by further pricing pressures.

Moreover, Wal-Mart (WMT) is putting pressure on the rest of the retail sector by regularly cutting prices on groceries, electronics, and home-related products.

With its stock trading at 20.3x our fiscal 2008 EPS estimate and 18.2x our 2009 EPS estimate, Fred?s has limited upside, in our view. All told, we maintain our Hold rating. Fred?s P/E ratio is in-line with its peers. We think the stock looks fairly valued at current levels. Our target price is $15, or about 19x our fiscal 2009 EPS estimate.

Home Depot Weakens but Beats

Even though top home improvement retailer Home Depot (HD) reported second quarter same-store sales down roughly 8%, its 71 cents per share in the quarter topped the Zacks consensus of 60 cents per share.? A day earlier, Lowe's (LOW) had reported its profits had fallen by 8%.

These results reflect the ongoing difficulty in the U.S. housing sector and the economy in general.? Even still, Home Depot shares were up in pre-market trading, but have since fallen 0.5%.? Headwinds for the company include wholesale prices reportedly rising at their highest rate in 27 years, and housing starts at their lowest level in 17 years.? Roughly 70% of Home Depot customers are do-it-yourself homeowners, according to an AP report today.

Analyst revisions have been mild but mixed over the past month.? However, at no time in the past quarter were HD shares expected to fetch as much as 71 cents per share (based on the Zacks consensus), so even though profits fell 24% in the quarter, investors may take today's report as good news.? This is also the second consecutive positive earnings surprise for Home Depot.

Sanderson Farms' Higher Costs

The improved efficiencies at Sanderson Farms, Inc.'s (SAFM) poultry complexes in Georgia and Mississippi, along with the new facility in Waco, Texas, should enhance improve unit operating costs and increase production levels in fiscal 2008. However, grain costs are expected to continue increasing in 2008. As a result, the construction of a new complex in Kinston, North Carolina has been delayed. The Hold rating is maintained.

The company?s new facility, which opened during the fourth quarter of 2007, added 18 percent to the existing capacity. Though construction is currently being delayed, the company plans to build a new feed mill, poultry processing plant, and hatchery in Kinston, North Carolina. The new complex at its full capacity will be equipped to process 6.7 million pounds of dressed poultry meat per week.

Int'l Rectifier: Low Visibility

International Rectifier Corp.?s (IRF) results have been held up by an accounting irregularity investigation. The company was the target of an acquisition bid by Vishay Intertechnology (VSH) that does not appear to be enough to strike a deal. Further the company has several patents expiring in 2008, which will result in a loss of $40 million in annual revenue. Consequently, we continue to rate shares of IRF a Hold.

The proprietary products business is expected to grow fast enough to replace the lost revenue, while supporting a total topline growth rate in the mid-single digits. Margin expansion should be a byproduct of the shift in product mix. Gross margins have already moved from the mid-30s to the mid-40s over the past two years, as the higher-margin proprietary analog and power systems business displaced portions of the legacy component business.

We see a potential ramification of attempting to increase the revenue quality and associated margins, while discarding active product lines. Though IR expects to displace these revenue streams with higher-margin ones, the fall in revenue due to divestments could be viewed negatively in the investment marketplace.

Legacy commodity products remain a drag on margins. In the last quarter, these products comprised 15% of revenue and generated gross margins in the high 20%'s, much lower than the corporate average. Prices declined -3% in the quarter, as competition remained intense. The management has no plans to divest this business, stating that margins are still higher than competitors.

Methanex Upgraded to Buy

The world?s largest producer and marketer of methanol, Methanex Corp. (MEOH), is benefiting from improving fundamentals, lower costs and declining average gas costs. New applications for methanol imply strong future growth. It has a strong cash flow that drives dividend increases and stock buybacks. We believe that a revaluation of the stock is warranted and feel the stock should trade at 11.5x 2008 earnings. This implies a $30 target and a Buy rating.

New markets for methanol such as dimethyl ether (DME) and biodiesel offer the potential for growth. Demand growth of 4% should exceed supply growth of 3%. DME could push potential demand growth as high as 10%. Supply growth will be absorbed by demand growth in China. Operating rates are 84% globally now. The company is benefiting from declining average gas costs as well. Each $1/Mcf decline in natural gas is worth $0.80 in EPS.

The methanol industry is a concentrated market, with Methanex being the largest and most powerful producer, controlling nearly 19% of the market. A $1.3M ton expansion in Egypt that will be on stream in 2010 will only enhance this position.

The core production hubs for Methanex in Chile and Trinidad have an annual production capacity of 5.8 million tons and represent over 90% of current annual production capacity. The company also produces 1.4 million tons per year of methanol in New Zealand and is a reseller for other manufacturers, which can be up to 20% of total volume.

Nordstrom Adjusts Realistically

Nordstrom, Inc. (JWN) reported second-quarter sales of $2.287 billion, which was in-line with its preliminary report, and EPS of $0.65, which was $0.01 above consensus. In addition, Nordstrom now expects to earn $0.49-$0.54 per share in the third quarter and $2.55-$2.65 for full-year 2008. The company?s previous full-year guidance was $2.65-$2.80.

As we previously wrote, Nordstrom?s consensus estimates were too high for the second half of the year and would have to come down. Those estimates are now moving closer to our estimates. As a result, we think the stock will be range-bound for the next six months. We maintain our Hold rating.

We expect the difficult retail environment to negatively impact Nordstrom?s results for the next few quarters. Nearly one-third of the company?s stores are in California, which is experiencing one of the worst housing markets in the country. While the interest rates are still low, consumers no longer have easy access to the credit markets because of record levels of household debt and lenders tightening credit standards.

We previously thought Nordstrom would be able to weather the slowdown because its core customers are more insulated from the negatives previously listed than middle-to-low income shoppers. It looks like the upper-middle income consumers are still shopping, but may be more willing to look for discounts. This is forcing Nordstrom to become far more promotional to attract customers.

JWN shares now trade at 12.4x our fiscal year 2008 EPS estimate and 11.9x our fiscal year 2009 EPS estimate. JWN shares trade in-line with its long-term growth rate, but well below its five-year average P/E of around 19x. Our target price is $32, which is about 12x our fiscal year 2009 EPS estimate.

Ultra Clean Carving a Niche

June quarter top and bottomline results for Ultra Clean Holdings, Inc. (UCTT) slightly missed consensus estimates. The company is expanding its product line to include frame assemblies, top plate assemblies and process modules.

The Seiger acquisition is progressing seamlessly and the company is transitioning several product lines to Shanghai. This has the effect of diversifying the revenue base as well as growing margins. Despite the progress, semiconductor weakness will provide a headwind for any non-semi gains. Consequently, we would recommend investing in shares of UCTT and are reiterating our Buy rating.

Ultra Clean has benefited from several trends in the market. Cost-cutting initiatives of original equipment manufacturers led them to increasingly outsource their gas panel requirements to companies such as UCTT. This is part of the disaggregation model in which it is economically advantageous to outsource complex sub-function components to specialist firms. The company carved a niche out in this market, although it is characterized by slow growth and lower margins.

The low growth profile of the gas panel business prompted management to seek other growth avenues to supplement its core business. In keeping with this strategic decision, UCTT started supplying subassemblies, which currently generate around 16% of quarterly revenue. With the first chemical delivery and process module shipments underway, the management expects this product line to be the primary growth driver for the company.

The ASP of the new process module is 4-5x the ASP of a typical gas panel supplied by the company. In the past year, Ultra Clean announced two new wins with existing large OEM companies outside the gas panel market. This doubles UCTT?s non-gas business projects from two to four. These four projects should combine for $40-$50 million once fully ramped up.

Nucor Feeling Auto Slowdown

Long-term steel contracts, constant cost-reduction efforts, higher steel prices, lower interest rates, strong cash flow position and a dominant acquisition strategy inspire our optimism with respect to the nation?s largest recycler of steel scrap Nucor Corp.'s (NUE) performance in the coming quarters. However, a slowdown in steel demand from the automobile sector and increased production in China are matters of concern. Thus, we rate the stock a Hold and raise our six-month target price to $55.00.

Nearly 55% of Nucor?s steel sheet volumes are under long-term price contracts, which will provide the company a cushion against higher raw material costs. It had been able to successfully pass on higher raw material costs through a mechanism of steel surcharges, which helped the company maintain or even improve its operating margins. Going forward, we believe long-term price contracts will help Nucor to maintain its near-term profitability.

Nucor?s Castrip technology will structurally lower its cost of production and lead to meaningful long-term savings. This process also reduces the overall environmental impact of producing steel by generating significantly lower emissions.

The company had successfully implemented three raw material projects which are expected to put at Nucor?s disposal over 2.5 million metric tons of high-quality scrap substitutes per year. Recently, Nucor upgraded its furnace at its steel recycling mill in Tuscaloosa, Alabama. Subsequently, production from the plant increased 15%.

Target Beats Lowered Estimates

The #2 big-box retailer in the U.S., Target (TGT), posted better-than-expected numbers in its Q209 fiscal earnings report -- 82 cents per share, wheras the Zacks consensus had been 77 cents per share.? This amounts to $634 million profit for the quarter, an 8% drop in quarterly profit according to a Reuters report this morning.

Analysts had been revising their quarterly estimates downward ahead of the company's report, however.? And as many as 6 analysts have lowered estimates within the past month for fiscal year 2009, which ends in January.? So even though TGT officially beat earnings, it marks the fourth straight quarterly profit decline for the company.

That said, the July quarter also represents the second consecutive positive earnings surprise.? For the October quarter, Target is expected to bring 56 cents per share, and $3.49 for the fiscal year.? These numbers have been trickling steadily downward over the past 90 days.

Fifth Third Estimates Cut

We maintain our Hold recommendation on the shares of Fifth Third Bancorp (FITB). The company reported GAAP earnings loss of $0.37 per share compared to $0.69 per share in the prior-year quarter, driven by charges related to tax treatment of leveraged leases.

FITB currently trades at 12.9x the consensus forward estimate, a 4% discount to the peer group median. On a price-to-book basis, the shares trade at 6% discount to the peer median, versus 6% premium previously. Relative pricing now looks expensive on a P/E-to-growth (PEG) basis, using the consensus forward estimate and the consensus long-term growth rate.

FITB?s PEG ratio is 2.39, an 18.9% premium to the 1.87 median for the peer group. On a price-to-book basis, the 6% discount looks stretched given an ROE 23% below the peer median. We think competitive market conditions, continuing deterioration in credit quality and collateral values within the company?s geographical footprint and the management?s decision to increase its loan and lease losses provision will weigh upon the stock for several quarters to come.

Besides, a substantial dividend cut will also put additional pressure on the stock over the near term. We have adjusted our 2008 earnings expectations to reflect the company?s 2Q08 and 2008 earnings guidance, as we think the uncertainties overhanging it and the industry, have yet to be eliminated.

Our new six-month price target of $15.40 per share equates to approximately 0.85x our projected book value of $18.12 per share six-months out (now December 2008), or 20.5x our 2008 earnings estimate of $0.75 per share. With $0.60 per share annual dividend this price target implies an 8.2% expected total return over that period.

Tenneco Downgraded to Sell

Tenneco Inc. (TEN) is suffering from elevated commodity costs, oil prices and sizeable production cuts at General Motors (GM) and Ford (F). This leads us to rate the stock a Sell with a six-month target price of $13.

Raw material prices for steel have been high due to strong demand from China, coupled with little new steel capacity. Since this is a major raw material for the company, any rise in steel prices constrains earnings.

Sales and pricing to automotive retailers like AutoZone Inc. (AZO) and Advanced Auto Parts, Inc. (AAP) have been soft as the auto distributors have been consolidating and forcing pricing concessions on suppliers such as Tenneco. The top 10 aftermarket customers account for 6.7% of sales. Due to demand for concessions from original equipment manufacturers (OEM), margins are under pressure.

Our outlook for the Auto and Auto Parts Sector industry is Negative. Tenneco is considered a Tier 1 automotive supplier. The industry has consolidated, which has allowed companies to produce at cheaper points on their average cost curve, due to the economies of scale that have been achieved. Tenneco has a competitive position, due to a strong brand name and reputation, which the company continues to leverage.