Smith Int'l Back Up to Buy

We are upgrading Smith International, Inc. (SII) shares to Buy from Hold following the stock's recent weakness, which has made valuation very compelling, in our view. The recent completion of the W-H Energy acquisition provides Smith with entry into new product lines with favorable growth prospects, particularly internationally.

Looking ahead, we expect the company to generate strong revenue growth and margin expansion, aided by demand acceleration, price increases and cost discipline. We have raised our EPS estimates (2008: $3.87 vs. $3.78; 2009: $4.90 vs. $4.69) and kept our price objective unchanged. Our price objective remains unchanged.

Performance of oilfield service companies, including Smith International, is closely tied to capital expenditures by oil and gas companies on exploration and production (E&P) activities. Peak cycle commodity prices have significantly strengthened producers' cash flows and balance sheets, enabling producers to ramp up their E&P spending gradually, particularly in the offshore markets.

Smith remains committed to returning excess cash to shareholders. It recently its quarterly dividend by 20%, after raising the same by 25% last year and 33% in 2006. Smith has also been fairly active on the buyback front.

Cummins Feeling Slump in U.S.

Cummins, Inc. (CMI) is set to benefit from fuel economy improvement, new emission trends, market share gains, growing international markets and increased prices. The company's financials are also rapidly improving. Cummins expects high gas prices and environmental concerns to increase demand in the U.S. for light-duty diesel engines, which are about 30% more fuel efficient than gasoline engines.

Management anticipates a 15% rise in sales for the full year 2008, up from the previous guidance of 12%. It expects to earn an EBIT margin of 10%. However, the slumping U.S. economy and a softening heavy-duty truck market, which forms over 50% of the company's business, raise concerns. As a result, we rate the shares a Hold with a target of $70.

There are market share gains in North American markets and continued strong demand from international markets. The global diesel engine market grows at 6-7% per year as gasoline engine markets shift to diesel. New emission regulations create opportunities for Cummins, such as the ability to raise prices, gain in market share and increase in engine content.

The company expects high gas prices and environmental concerns to increase demand in the US for light-duty diesel engines, which are about 30% more fuel-efficient than gasoline engines. The company plans to invest $21 million into existing joint ventures and joint ventures to be formed in 2008. CMI expects $2 million to be invested in 2008 and $19 million in 2009.

Plains Exploration Looks Strong

We are maintaining our Buy recommendation on Plains Exploration & Production Co. (PXP) and increasing our target price from $84 to $91 per share. The company is poised for solid growth over the next several years with Piceance, Panhandle and Gulf Basin assets helping to drive production in a meaningful way.

However, the recent 20% acquisition of Chesapeake Energy Corp.'s (CHK) Haynesville Shale play will likely be the cornerstone of the company's long-term growth story, as there are more than 20 Tcfe of reserves in place on its gross acreage. Additionally, the company has hedged a meaningful portion of its oil and gas production for '09 at favorable pricing, thus mitigating the risk of volatile prices.

We estimate that even if crude prices fell to $85/Bbl and natural gas prices fell to $6.50/Mcf, PXP would still realize oil and gas prices around $100 per barrel and $8 per Mcf in 2009, respectively. Based off of data taken in late Q2'08, we feel that on an enterprise-value-per-barrel-of-oil-proved reserves (EV/BOE proved) basis PXP is undervalued.

Its peer group averages approximately $22.50 per barrel of oil equivalent (BOE) while the company trades at an enterprise value of $17.37 per BOE proved reserves. Taking the peer average EV/BOE proved value of $22.50 with an assumed 600 MMBOE proved reserve base we arrive at a value of $91.00 per share. PXP usually has a forward P/E multiple that trades between 12x-14x while its peer group has a historical forward P/E of around 13x - 14x.

Group 1 Auto Stuck in Neutral

Group 1 Automotive, Inc. (GPI) has generated most of its recent growth through acquisitions. The recently reduced interest rates will provide further growth to the company. Group 1 manages its costs aggressively and has dealerships with above-average profitability.

Further, the company has strong geographical presence. However, a difficult car sales environment is affecting revenues. The company anticipates a modest 1-2% growth in revenues for 2008. Thus, we rate the stock a Hold with a target of $23.