This combination does not point to a higher stock price. We reiterate our Sell rating and reduce our target price from $2 to $1.
The management expects total net sales of $217-$228 million with same-store sales of -2% to +2% and a loss from continuing operations before interest and taxes of $19-$24 million. In January, the company announced plans to close 18 stores and reduce its corporate workforce by 10%.
The management indicated that the workforce reduction and the closure of underperforming stores are necessary to complete the turnaround in the midst of a challenging retail and economic climate. While we agree with the store closures and headcount reductions, we have to question the company opening new stores in the current retail environment.
Smith & Nephew Questions Remain
We are maintaining a Hold recommendation on Smith & Nephew, PLC (SNN) after the company's second quarter results.
The company follows an effective strategy of investing a significant amount in research and development (R&D) activities, to bring new products to market. This strategy has yielded results in the past, and should contribute to growth going forward. The company is benefiting from its Earnings Improvement Program (EIP), and the recent stock buy-back should provide support to the stock.
This program is designed to continue the company's investment at a level which will maintain above market revenue growth rates and to drive a renewed focus on costs. SNN expects the EIP to increase trading margin by an average of at least 1% per annum until the end of 2010, including a significant increase in 2007, followed by larger increases in subsequent years. In 2010 this margin improvement equates to at least an additional $150 million in trading profit.
Underlying sales growth in all divisions has been slowing, from over 10% in the previous years to below 10% in 2008. Moreover, Smith & Nephew's orthopedics division faces tough competition in both domestic and international markets.
The stock is trading below its peers, but with the uncertainty surrounding sales practices at its European subsidiary, there is little upside in the near term. The stock is currently trading at 19.9x our 2008 EPADS estimate which is higher than the average of its peers of 17.7x. Our six-month price target is $63.00.
Ferrellgas Prospects Staying Slim
We are reiterating our Hold recommendation, price objective and earnings estimates on Ferrellgas Partners L.P. (FGP) units. Sales volumes and earnings remain under pressure as the rising cost of propane squeezes gross margins and causes customer conservation. We are decreasing our 2008/2009 earnings estimates from $0.55 and $0.74 per unit to $0.47 and $0.63 per unit. The decrease is due to the negative effects of rising propane prices on gross margins.
We continue to believe that current valuation adequately reflects the partnership's lack of distribution-growth prospects, continued margin pressures and a relatively weak balance sheet. As expected, the partnership kept its quarterly cash distribution unchanged for the third-quarter at $0.50 per unit ($2 per unit annualized).
The retail segment, Blue Rhino, posted a solid performance reaching its volume goals while successfully passing through cost increases to customers. Blue Rhino is poised to have a good fourth quarter with expected adjusted EBITDA increasing year-over-year.
Currently, its outstanding debt balance is more than $1 billion, and given a near-term forecasted distribution coverage ratio of around 1.0, cash flows from operations will not be available for any near-term debt reduction.
Given the relatively high debt load and the fundamental variability in weather and gross margin relationship, FGP will likely need to maintain a higher coverage ratio before even considering any increase in its distributions. More importantly, while recent acquisitions have the potential to generate strong cash flows, we believe that the first priority on excess cash will remain towards debt repayment and not higher distributions. So, while the safety of current distributions is not in doubt, the prospects of future growth are rather slim.
Alpharma Buyout Offer to Raise
On August 22, Alpharma, Inc. (ALO) disclosed that it had received a buyout offer from King Pharmaceuticals, Inc. (KG), which was rejected by Alpharma's Board of Directors. King had made an all-cash offer of $33 per share to Alpharma, which represents a 37% premium over the closing price of Alpharma common stock on August 21.
The shares shot up 43% on the news, and are now trading well above the $33 offer. We previously had a Sell rating on the stock based on concerns regarding prospects for key product, Kadian's growth, as well as for the newly launched Flector Patch.' However, we are moving Alpharma back to a Hold rating with a $37.50 price target following the announcement of King's takeover bid.' We expect the deal to close at a higher price than the current $33 offer. Our best guess is a deal closing between $35 and $40 per share.
Despite the challenges being faced by the company's Animal Health business, Alpharma maintained its guidance for 2008. Management expects 2008 revenue growth from its continuing operations to be in the range of 30% to 35% over the $535 million in revenues in 2007.
Sales of Alpharma's lead product, Kadian, a morphine sulfate sustained release capsule, grew to $43.6 million, up 2.3% year-over-year in the second quarter of 2008. In order to maintain growth in the Kadian franchise, Alpharma is working on developing a second-generation opioid product, Embeda. It is a combination of an extended-release opioid and naltrexone, which is added as an abuse deterrent.
However, we are concerned that a generic version of Kadian could hit the market before Alpharma is able to launch Embeda. Alpharma resubmitted the NDA for Embeda in June 2008. But we do not expect the product to hit the market before the first quarter of 2009.