Message-ID: <15375789.1075852669906.JavaMail.evans@thyme> Date: Mon, 1 Oct 2001 12:45:15 -0700 (PDT) From: david.morris@lehman.com To: larimore@enron.com, jordan.larimore@lehman.com Subject: The Morning Market Call - Monday October 1st, 2001. Mime-Version: 1.0 Content-Type: text/plain; charset=ANSI_X3.4-1968 Content-Transfer-Encoding: 7bit X-From: "Morris, David C." @ENRON X-To: Larimore, Jordan R. X-cc: X-bcc: X-Folder: \JSKILLIN (Non-Privileged)\Inbox X-Origin: Dasovich-J X-FileName: JDASOVIC (Non-Privileged).pst Good Monday Morning - Comments From The Local Guys! The Federal Reserve meets again tomorrow. The wide consensus is that they will lower short-term interest rates again by 50 basis points. At this stage, the markets have factored in a virtual halt in the economy and consumer spending. There is no good news that anyone is anticipating. Often, the consensus is wrong. In fact, it seems that the low in consumer sentiment has coincided with major lows in the market. Over the last 15 months, inventory levels have declined significantly. There has also been a great deal of fiscal and monetary stimulation. The dollar is strong. The markets may react more positively to any unexpected good news than anyone anticipates. The 30 -year bond yield is 5.37%. The 10-year is trading at 4.54%. The 5-year is trading at 3.76%. Spot crude oil is trading at $23.15 p/b. Natural Gas - Henry Hub - is trading at $2.22 p/mcf IMPACT CALLS Banks Jason Goldberg MidCapBanks: Where We Stand & 3Q Preview q Companies with liability sensitive balance sheets, mortgage banking operations and better "mousetraps" should do relatively better in the current uncertain environment. We are concerned with syndicated lending, consumer/sub-prime lending, asset sensitive balance sheets and market sensitive revenues. q We are looking for 3Q01 upside surprises from TCB, NFB, SOTR, NCF, FTN and CBH. In addition to CFR, which pre-announced, we are concerned with ASO, FMER, GBBK, PFGI and UB. q We continue to like the business models of CYN, CBH, MTB, NFB, and TCB. We believe the current valuations of CBSS, CFR and ZION are disconnected from their franchise value and like those names as well. We view WABC as good defensive play, and UPC has other earnings levers to pull in a difficult environment. q We expect the mid-cap banks to begin reporting 3Q01 EPS on October 9. The median bank is expected to increase EPS 10% linked quarter (annualized) and 7% year-over-year. q This quarter, we expect 31 of the 35 banks in our mid-cap universe to meet or exceed consensus expectations. This compares to 31 banks in 2Q01 and 27 in 1Q01. Brokers & Asset Managers Mark Constant Revised Earnings Models for Sept. q In anticipation of upcoming 3Q earnings releases, we are reducing our official earnings forecasts for all of the Asset Managers in our coverage universe, to reflect the dramatic reduction in the market value of equity assets under management (and, therefore, run-rate fee income) since our most recent formal model revisions for these companies (generally, following 2Q earnings releases in late July). In order to make our forecasts comparable with the Brokers who recently reported their F3Q (ended 31-Aug) earnings, we are also updating our estimates for Charles Schwab (SCH, $11.50, 3-Market Perform) and Merrill Lynch (MER, $40.60, 1-Strong Buy), to reflect recent global/market developments that have impacted them as well. q These changes are consistent with comments we have made in several recent notes, and should not come as a surprise to many observers, as periodic estimate revisions such as these are a "fact of life" in this market-sensitive sector (we could arguably revise earnings forecasts for some companies as often as several times a week). We prefer to spend our time trying to identify unanticipated fundamental catalysts and valuation opportunities, and continue to view market-driven estimate revisions as largely reactionary and perpetually belated (i.e., estimates have their greatest utility when viewed as a "point in time" metric). Leisure Felicia Rae Kantor Lehman Leisure Sensitivity Tool Kit q Given the uncertain operating environment, we thought it would be useful to create a tool that could hone in on potential opportunities in our sector and avoid possible value traps. This note summarizes our forthcoming 70-page report entitled, The Lehman Leisure Ledger. q We found that the cruise industry still demonstrates the most risk, despite current valuations. Recession, travel fears and oversupply do not provide a robust backdrop for price increases. Our worst-case scenario illustrates over 40% downside. q ERTS' risk profile is also not favorable, esp if the consumer balks at prices this Xmas. EA.com also continues to be a risk. q HAS falls into the 2nd tier of our risk profile. We see a floor of $12. Leverage to low-priced toys and must-see movies reduce risk. q We believe the ski cos likely already discount economic and travel-related risk. Separately, we are adjusting our price targets to more accurately reflect risk valuations: IDR to $19 from $23 and MTN to $20 from $25. q HDI could outperform the sector with worst-case downside of 9%. Sales of P&A and gen mdse could slow, but we believe that the 100th anniv could bolster sales as passion replaces necessity. We are adjusting our price target to $50 from $60, reflecting a more realistic premium to the mkt multiple. INITIATING COVERAGE Patterson Dental Lawrence Marsh Initiation of Coverage 1 - Strong Buy / 34.07 (USD) q We are initiating coverage of Patterson Dental with a 1 - Strong Buy recommendation and a price target of $43 q We view PDCO to be the gold standard in the dental products & equipment distr. industry, w/ a stellar record & very good prospects, one of our two defined "safety stocks" in the recession-resistant dental business. q PDCO is a product of a very success. 1985 LBO, best impl. & inspired by CEO Pete Freschette, w/ 10 yr. CGR in sales of 15% & in EPS of 18%. q The 4 keys to our call: 1) cont. solid expansion of share in a steady growing bus; 2) better acq. Environ. w/ fewer alt. for smaller co's 3) scale opps. W/ recently-acq Webster in dental; 4) boost in growth in FY03 w/ FAS142 and margin exp. q Our target is 27x cash C02; 1.3x growth rate. COMPANY / INDUSTRY UPDATE Wireless Services John Bensche Location Update - Where Are We? q Given the tragic events of Sept. 11, Americans are more focused on safety and communications. We think the first wireless carriers to offer E-911 capabilities could gain market share over their competitors. In terms of ability to roll out services near term, we rank the carriers in the following order: Sprint PCS, Cingular, AT&T Wireless, Verizon Wireless, VoiceStream, and Nextel. q No U.S. carriers will be compliant with today's deadline for the FCC's Phase II location services mandate. All have sought waivers, however, we think the FCC is focused more on seeing evidence that carriers are making progress on the location front, rather than on the deadlines themselves. q Due to the incident on Sept. 11, we would not be surprised to see an accelerated pace of contract signings as carriers seek to demonstrate their responsiveness to safety concerns. Lilly Eli Charles Butler Searching for the Angles - Visit to LLY 2 - Buy / (USD) q We remain quite bullish on the long term prospects for Eli Lilly. With 10 products to file over the next three years, Lilly is likely to have the best revenue and earnings appreciation in all of the pharmaceutical group. q We met with senior executives of Eli Lilly last Friday. Below we highlight comments from each. The key to the stock in the near term remains the Xigris panel outcome (October 16, Will the label be restricted?) and the outlook for earnings in 2002. Temple-Inland Inc Peter Ruschmeier TIN to acquire GCR 2 - Buy / 45.90 (USD) q Combining recent weakness on shares of TIN with significant accretion from their planned acquisition of GCR, we are reiterating our Buy rating on Shares of TIN. q TIN announced plans to pay $786 MM for GCR, including $1.80 for the equity and $686 MM for the public and bank debt. Given GCR's distressed situation, TIN is able to buy the enterprise for a 22% discount to it's recent value. q On a VERY conservative basis, we estimate $35 MM of interest savings and $25 MM of operating synergies which should add $7/share of value for TIN shareholders. q We estimate 16% accretion to mid-cycle cash EPS w/o synergies and 25% accretion with $60 MM of synergies. q We are reiterating our Buy with a 12-month target of $67. Gaming & Lodging Joyce Minor Cut Ests, So Can You, Model Available q We are lowering our 2H01 and 2002 lodging estimates to reflect our best guess as to the impact of the 9/11 terrorist attacks. Our new estimates assume that travel trends continue to gradually improve from unbelievably horrible (-62% RevPAR week ending 9/11) to really ugly (-25% in 4Q01) to still pretty bad (-15% in 1Q02, -10% in 2Q02). We assume trends bounce back against very easy comparisons to +10% in 3Q02 and +15% in 4Q02. This assumed trend produces painful revisions to our estimates, with 2002 EBITDA down about -15% to -20% for most from our prior estimates, and with EPS or FFO/share down -20% to -50%. Fortunately, we believe investors will eventually decide that 2002 estimates are an anomaly and irrelevant for valuation purposes. While lodging stocks rebounded to varying degrees last week (ended 9/28), as we see additional data points suggesting a gradual recovery we expect the stocks will see further upside. We see the most near-term opportunity in MeriStar Hospitality (MHX) and Marriott International (MAR). q Total Enterprise Values (TEVs) have declined -15% or so since 9/10 for most companies on what we project as -20% or so 2002 EBITDA declines. Marriott International's TEV is down -15% like the group, while we expect 2002 EBITDA will be down -14%, or less than the group. Similarly, MeriStar Hospitality's TEV is down an overly severe -18% since 9/10. Arch Coal Peter Ward Adjusting Earnings Estimates 1 - Strong Buy / 15.60 (USD) q Based on company guidance, we are adjusting our 2001 quarterly estimates for Arch Coal. Importantly, there is no change in our annual estimates at this time. 3Q is typically the weakest quarter for coal mining companies due to slow demand and miner vacations. q We estimate about 95% of Arch's 2002 production has been contracted. Those tons contracted in 2001 (about 25% of 2002 volumes so far) have likely been locked up at substantially higher prices than those realized in 2001. Investors need to keep in mind that realized coal prices tend to lag coal fundamentals by 1 to 2 years. q With a 2002 P/E of 7 and EV/EBITDA of 3.5, we believe these shares represent excellent value. Massey Energy Peter Ward Preannounces 4Q Earnings; Reiterate Buy 2 - Buy / 14.60 (USD) q Massey Energy preannounced last week that fiscal 4Q results would fall below its initial EPS guidance of $0.20 to $0.26. The company is now forecasting EPS of $0.04 to $0.10 in the quarter ending October 31. q We are reducing our fiscal 4Q estimate from $0.12 to $0.07. The company's initial guidance had included an anticipated asset sale gain that has been delayed. We had never considered the pending asset sale representative of earnings from continuing operations. Therefore, this disappointment is much more modest than it initially appeared on Wednesday. q The company reaffirmed its guidance for fiscal 02 EBITDA of between $400 and $460 million. With a P/E of 8 and an EV/EBITDA of 3.5, we believe these shares represent excellent value. Ferrellgas Partners Richard Gross F4Q01 Earnings In Line 2 - Buy / 18.80 (USD) q We reiterate our 2-Buy rating and our price target of $22. Our price target is based on a cash distribution of $2.00 and a yield of 9%. q FGP results of a loss of $1.38 were largely in line with our expectations. As a reminder, FGP typically experiences a loss in the fourth quarter due to the warmer weather. FGP, along with its peer propane MLP's, earns the bulk (60%-70%) of its cash during the heating season from October to April. Oil & Gas: E&P - Canada Thomas R. Driscoll Canadian Natural Gas Insight q ? We estimate that Canadian natural gas production in August was 6%, or 0.9 Bcfpd, above year-ago levels. We believe that the large year-over year increase in Canadian gas production has led to rapidly rising exports to the US and has contributed to weakening natural gas prices in both the US and Canada this year. q Canadian natural gas production in August fell 0.1 Bcfpd from July levels to 15.5 Bcfpd. However, this production level is 6%, or 0.9 Bcfpd, above year-ago levels. q We believe that natural gas production in Canada could be nearly 10% above year ago levels by the end of 2001. q Production fell unusually sharp from August to December last year (2.4%). This 2.4% decline from August to December of 2000 compared to growth of about 3.0% over the same period in 1998 and flat production over the period in 1999. q We expect that the addition of over 200 MMcfpd of additional gas from Ladyfern later this year could contribute to flat-to-rising Canadian natural gas production over the remainder of this year. Exelon Corp Daniel Ford Reiterating Our Buy Rating 2 - Buy / 44.50 (USD) q Yesterday, EXC signaled 2001 EPS would likely fall 2-5% short of guidance due to weaker energy prices prompting a 12% sell-off (20% since 9/11). We reiterate our 2-Buy rating and our target is $54 which is 10.2x our revised $5.27 2002E. q We are lowering our 2001 EPS outlook $0.16/share to $4.39 due to weaker power prices, economic slowdown, and a $0.07/share telecom write-off. q We also lowered our 2002 forecast $0.33/share to $5.27. Specifics are: 1) Weaker forward power prices (-$ 0.21/share) and 2) 0% sales growth (-$0.12/share). q EXC also set Q3 EPS at $1.10-$1.20 versus $1.27 pro-forma in 2000 and raised layoffs by 450 people. q The sell-off leaves EXC trading at 8.4x our revised 2002E or a 20% utility group discount. Mellon Financial Henry Chip Dickson Third Quarter Preview 2 - Buy / 31.70 (USD) q We expect MEL to report 3Q01 results of $0.38, which is $0.05 in line with consensus expectations. For 2001, we are lowering our estimate $0.10 to $1.70 anticipating a down fourth quarter. For 2002, our estimate is $2.00 on a new GAAP basis, which equals $1.85 on an old GAAP basis, or a $0.10 reduction of our estimate. We continue to rate MEL 2 - Buy. q We expect market driven revenues to decline this quarter, given the decline of most global markets. q Our estimates reflect continuing operations. Bank of New York Henry Chip Dickson 3Q01 Preview - Further Details 1 - Strong Buy / 35.00 (USD) q We rate BK 1 - Strong Buy. Its growth drivers are different than most other large cap financial institutions. It is more sensitive to market volumes than market levels. Actions taken to enhance market liquidity and improve economic conditions should be reflected first by a sustained increase in market volumes and therefore, BK's EPS growth rates should improve before most other large cap financial services companies. q BK estimated losses caused by WTC Tragedy at $125mm. Mgmt believes most, if not all, costs will be covered by insurance. q If Tragedy had not happened, mgmt believes BK would have at least met consensus of $0.52. So, the weak market conditions cost BK at least $0.02 of EPS growth. Credit costs do not appear to have risen dramatically. Compass Bancshares Jason Goldberg 3Q01 Preview: Resolution 1 - Strong Buy / 24.82 (USD) q We rate CBSS 1 - Strong Buy with a $34 price target. We continue to like CBSS due to its attractive valuation, improving operating leverage and asset quality, and franchise value. q We expect CBSS to report 3Q01 EPS of $0.53 on October 16. q We expect on-target results to evidence continued loan growth, a stable net interest margin, further fee income expansion and improved operating leverage. q We expect one large $28 million nonperforming credit, which totals one-third of total NPAs, to be resolved this quarter. Management expects to foreclose on this property in 3Q01, bringing it a step closer to resolution. q Towards the end of August, CBSS announced a 5% repurchase program. Mortgage Finance Bruce Harting Houisng Mkt & FNM, FRE; 3Q Preview q FNM and FRE are very well positioned to report strong 3Q earnings. Further, we believe 4Q can be even stronger. The housing market continues to show resilience, and the GSEs' earnings visibility in 2002 is very solid. We recommend FNM and FRE based on their strong fundamentals and attractive valuation, especially in the current market environment where "visibility" is very hard to come by. q FNM should report its earnings during the week of 10/8. Our estimate is $1.33 vs. the consensus estimate of $1.32. FRE should report during the week of 10/15. Our estimate is $1.07, the same as the consensus. Cendant Corp Jeffrey Kessler Guidance Better Than Exp; Reit 1-SB 1 - Strong Buy / 12.80 (USD) q On Friday, Cendant management provided updated financial guidance to reflect the affects of the WTC tragedy on its businesses. While we are reducing our estimates, the new guidance is substantially better than the worst case scenario many investors had feared. We believe that management's assumptions are reasonable, and would be aggressive buyers of CD shares, trading at only 11x our new 2002 EPS estimate of $1.15. q In the wake of the share price decline, CD provided a positive update on its balance sheet strength, including plans to reduce its debt by over $1B during the next few weeks. q Cendant plans to close both the Galileo and Cheap Tickets acquisitions this week, and, contrary to many people's fears of dilution, announced that the acquisitions should still be nicely accretive to 2002 EPS (by $0.07-$0.09). Business & Professional Services Adam Waldo Business & Professional Services Weekly q VVI and WSTC preannounced 3Q01 results last week. Top picks remain the low economic sensitivity "defensives": ASF, ASGN, MMS, PAYX, VVI, WSTC. q We cut our 3Q01 and 4Q01 EPS estimates for Viad, and reduced our one-year, DCF-derived price target from $36 to $34. q We also cut our 3Q01 and 4Q01 EPS estimates for West Corp., and reiterated our 2 Buy rating with a one-year price target of $41. Safeway Inc Meredith Adler Reported 3Q of $0.60 1 - Strong Buy / 39.72 (USD) q Safeway remains, in our opinion, an extremely well-managed company that has substantially improved its franchise value in recent years through initiatives to improve efficiency at the stores and lower the cost of product, while making a number of accretive acquisitions. Current valuation, which is close to an 8-year low, does not reflect these improvements. q SWY reported adjusted 3Q01 EPS of $0.60, $0.01 below our estimate but in line with consensus, with strong improvements in gross margins and an 0.8% identical-store sales increase, slightly weaker than the 1.2% we had expected. q We are maintaining our 4Q01 estimate at $0.81, but lowering our FY01 estimate to $2.59 to reflect the $0.01 miss in 3Q01. FY02 EPS remains unchanged at $2.98. David C. Morris Sr. VP Lehman Brothers 713-652-7112/800-227-4537 dcmorris@lehman.com Disclosure Legend: A-Lehman Brothers Inc. managed or co-managed within the past three years a public offering of securities for this company. B-An employee of Lehman Brothers Inc. is a director of this company. C-Lehman Brothers Inc. makes a market in the securities of this company. G-The Lehman Brothers analyst who covers this company also has position in its securities. Key to Investment Rankings: This is a guide to expected total return (price performance plus dividend) relative to the total return of the stock's local market over the next 12 months. 1 = Buy (expected to outperform the market by 15 or more percentage points); 2=Outperform (expected to outperform the market by 5-15 percentage points); 3=Neutral (expected to perform in line with the market, plus or minus 5 percentage points); 4=Underperform (expected to underperform the market by 5-15 percentage points); 5=Sell (expected to underperform the market by 15 or more percentage points); V=Venture (return over multiyear time frame consistent with venture capital; should only be held in a well-diversified portfolio). This document is for information purposes only. We do not represent that this information is complete or accurate. All opinions are subject to change. The securities mentioned may not be eligible for sale in some states or countries. This document has been prepared by Lehman Brothers Inc., Member SIPC, on behalf of Lehman Brothers International (Europe), which is regulated by the SFA. ?Lehman Brothers, Inc. ------------------------------------------------------------------------------ This message is intended only for the personal and confidential use of the designated recipient(s) named above. If you are not the intended recipient of this message you are hereby notified that any review, dissemination, distribution or copying of this message is strictly prohibited. This communication is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial product, an official confirmation of any transaction, or as an official statement of Lehman Brothers. Email transmission cannot be guaranteed to be secure or error-free. Therefore, we do not represent that this information is complete or accurate and it should not be relied upon as such. All information is subject to change without notice.