Message-ID: <9240774.1075840162450.JavaMail.evans@thyme> Date: Wed, 6 Jun 2001 11:22:07 -0700 (PDT) From: david.morris@lehman.com To: ordan.larimore@lehman.com Subject: The Morning Market Call - Wednesday June 6th, 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: ordan.Larimore@lehman.com X-cc: X-bcc: X-Folder: \jskillin\Inbox X-Origin: SKILLING-J X-FileName: jskillin.pst <> Good Wednesday Morning - Comments From The Local Guys! Yesterday, we received revised numbers on first quarter productivity, which came in at -1.2% quarter-over-quarter on an annualized basis. On a year-over-year basis, productivity remains at a relatively healthy 2.5% rate, although this is half the pace at which it was running less than one year ago. A slowdown in productivity is not unusual during an economic slowdown. Corporations face fixed costs, while business is declining. Unfortunately, that is why there are layoffs. With lower corporate costs, productivity should improve as the economy picks up steam. Tomorrow, the market will be receiving the weekly initial jobless claims, which are expected to remain near last week's level. Lehman Brothers' economists look for first-time unemployment insurance filings to total 415,000 for the week ended Saturday, June 2. The 30-year US T-Bond yield is 5.65%. The 10-year note yield is 5.25%. The 5-year is trading at 4.83%. Spot crude oil is trading at $27.44 p/b. Natural Gas - Henry Hub - is trading at $3.85 p/mcf. AD Time: New Federal Insider-Trading Rule (Rule 10b5-1) have been adopted by the SEC under the Securities Exchange Act of 1934. This rule greatly enhances an insider's/employee's ability to trade his/her corporate shares during blackout periods. Previously, without the protection of this new SEC rule, employees and insiders could safely trade only outside of designated blackout windows. Under this new rule, insiders/employees may have the ability to purchase and sell their corporate shares even during blackout periods if a written plan was established and in force when the insider/employee was not in possession of material, non-public information. The new rule contains other restrictions and should be reviewed carefully. Lehman Brothers has established a turn-key plan that take into account the regulatory procedures for establishing such a plan. Please email us or call us for more information. Lehman Brothers' Research. IMPACT CALLS Procter & Gamble(PG) 2 - Buy A. Gillin Lefever, .212.526.5801 Morphing Into An Attack Aircraft Carrier OLD NEW STREET P/E Price: $63.6 EPS 2000 N/A $2.95 N/A N/A 52 Wk Ra: $79 - 53 EPS 2001 $3.10E $3.10E $3.11E 20.5 Mkt Cap: $90.8B EPS 2002 $3.25E $3.25E $3.27E 19.6 FY: 6/30 Price Target $69 $69 Rank 3 2 *We are upgrading PG to a Buy (2) rating based upon what we perceive as a good trading opportunity in front of their June 15 outlook meeting. We expect the meeting to highlight (1) more aggressive actions to reduce PG's asset base than previously telegraphed; (2) expect FY 02's recurring earnings growth to be confirmed at the consensus-implied 6-8% rates and (3) expect previously stated long-term growth targets to remain in place. *Cost cutting /right-sizing remains the theme for the balance of the calendar year / majority of FY 02. A very focused effort will improve PG's competitiveness, but there is a reasonable probability PG will exceed the previously telegraphed $400-$800 M in incremental restructuring charges in order to further accelerate the restructuring process. *PG is slowly shifting its attention to sales growth but 4-6% long-term growth is at least one fiscal year out. Maximum upside is $72.00 absent any earnings-enhancing news. National Service Indus(NSI) 3 - Market Perform D. Zwyer, .212.526.2008 Lowering Rating As Stock Approaches Price Target OLD NEW STREET P/E Price: $25.73 EPS 2000 N/A $2.45 N/A N/A 52 Wk Ra: $27 - 18 EPS 2001 $2.00E $2.00E $2.07E 12.9 Mkt Cap: $1.1B EPS 2002 $2.30E $2.30E $2.30E 11.2 FY: 8/31 Price Target $27 $27 Rank 1 3 *We are lowering our rating on National Service Industries' stock to 3 (Market Perform) from 1 (Strong Buy) based on valuation. The stock has increased 37% since we initiated coverage on September 27, 2000, outperforming a 10% drop in the S&P 500, and is near our $27 price target. At about $26, NSI's stock trades at 13 times est. fiscal (August) 2001 EPS of $2.00, and 11 times est. 2002 EPS of $2.30. We do not see significant upside in the stock price from current levels, and believe the shares will move with the market in the near-term rather than outperform. *We continue to expect difficult earnings comparisons for the second half of 2001, with a flattish 3Q (May) and a lower 4Q compared with the prior year level. For the full year 2001, we expect lower earnings in all segments: lighting, chemicals, linen rental, and envelope. The risk to earnings going forward is a worse than expected drop in non-residential construction impacting the company's lighting business. Also, a drop in consumer spending would impact the linen rental business. Power D. Ford, .212.526.0836 No, The Sky is NOT Falling *A change in investor sentiment towards the wholesale market has resulted in a sell-off in the energy merchant stocks. We believe this sell-off has been overdone and would recommend buying shares of Aquila, Dynegy and Mirant. *In our opinion, the apparent change in sentiment has been the result of three factors: 1) a sector shift into tech stocks; 2) increased perceived political risks on both the federal and state levels; and 3) concerns about the potential for contracting commodity prices and margins. *While we do not see any catalysts that will stem this flow in the near-term, we believe that preannouncement and upside earnings surprises are just around the corner. *Our favorite picks are energy merchants: Aquila, Dynegy and Mirant. Global Crossing(GX) 2 - Buy D. Fletcher, .212.526.3375 Near-term Opportunity In Weighing Positives vs. Negatives OLD NEW STREET P/E Price: $12.94 EPS 2000 N/A -$4.04 N/A N/A 52 Wk Ra: $38 - 9 EPS 2001 -$3.25E -$3.25E -$3.17E N/A Mkt Cap: $11.4B EPS 2002 -$3.19E -$3.19E -$3.15E N/A FY: 12/31 Price Target $28 $28 Rank 2 2 *With the stock approaching all time lows, we believe positives outweigh negatives here, and stock offers good near term upside. *While long term challenges remain, such as dependence on IRUs for growth/funding, GX is off 24% in last two weeks, is making good progress in Commercial and is a clear leader in the bandwidth sector. We believe there is good near term upside. In terms of DCF valuation, we get to $15-$20/share, even haircutting our (below guidance) #'s by 20%. *GX has signed >$600M in Commercial contracts year-to-date, and Comm Svcs grew 7% seq, in Q1, and should grow 9%+ in Q2. *The subsea market is rationalizing, and the 4 major subsea players could become 2 over next 12 mos. *Long-term challenges include IRU sales, and 01 guidance may prove aggressive, though we believe that is in the stock, and we believe the company can hit our 01 Cash Rev number of $6.71B, +30% Y-Y. INITIATING COVERAGE Black Hills(BKH) 2 - Buy R. Gross, .212.526.3143 Initiate With Buy, Target Price $62 (A) OLD NEW STREET P/E Price: $55.20 EPS 2000 N/A $2.37 N/A N/A 52 Wk Ra: $55 - 22 EPS 2001 N/A $4.20E $3.77E 13.1 Mkt Cap: $1.5B EPS 2002 N/A $3.70E $3.35E 14.9 FY: 12/31 Price Target N/A $62 Rank N 2 *Strength In Western Power Markets Driving Near Term Results. Rapid Growth In Unregulated Power Generating Capacity And Successful Roll-Out Of Communications Network Drive Outlook Longer Term. *Strong, Low Cost Utility Franchise Underpins Earnings And Cash Flow. Rate Freeze Extended Through 2005. *Potential Four-Fold Increase In Unregulated Generating Capacity By 2003 Primary Source Of Mid -Term Earnings Growth. Coal Ownership Provides Opportunity For Further Significant Expansion. *Strong Backdrop For Offsystem Sales And Fuel Marketing Funding Ramp In Generating Capacity. Western Power Markets Tight Beyond Current Year *Communications Near Cash Flow Inflection Point As Rapid Acceptance Of Bundled Service Offering Coupled With Mid-Year Completion Of Network Drive Sharp Turn In Cash Flow And Valuation. FOCUS STOCKS McDonald's Corp(MCD) 1 - Strong Buy M. Speiser, .212.526.3255 McREIT? New tax ruling could spark spec of REIT spin-off OLD NEW STREET P/E Price: $29.41 EPS 2000 N/A $1.46 N/A N/A 52 Wk Ra: $36 - 25 EPS 2001 $1.46E $1.46E $1.49E 20.1 Mkt Cap: $40.7B EPS 2002 $1.66E $1.66E $1.67E 17.7 FY: 12/31 Price Target $38 $38 Rank 1 1 *A favorable IRS tax ruling on REITs can spark speculation that MCD can unlock value by spinning-off its multi-billion dollar real estate portfolio. With a new CFO to be appointed, this can further fuel speculation. Reit 1-Strong Buy *The IRS has reversed a tax ruling on treatment of REITs; this will present oppty's for co's with lots of real estate, like MCD, to spin-off real estate b/c it could now be done on a tax-free basis *In the US, MCD has about $8bil of property & equipment & earned $1.4b of rental income in 00 *The risk is the elimination of a steady income stream. But, the value of a REIT is the tax benefit & higher Returns to MCD; lower MCD earnings (no rental income) would be more than offset by ownership of the REIT & its tax-free benefits Back-of-envelope analysis yields $270mil in value ($0.20/share) due to shifting the rental income of owned sites under franchised stores to non-taxable status; other benefits are likely. Electronic Data Sys(EDS) 2 - Buy K. Keirstead, .212.526.0442 Addressing the Balance Sheet and Other Concerns OLD NEW STREET P/E Price: $61.90 EPS 2000 N/A $2.29 N/A N/A 52 Wk Ra: $67 - 38 EPS 2001 $2.63E $2.63E $2.64E 23.5 Mkt Cap: $29.6B EPS 2002 $2.98E $2.98E $3.00E 20.8 FY: 12/31 Price Target $75 $75 Rank 2 2 *EDS shares have underperformed the major indices and CSC shares since reporting strong 1Q01 results. We attribute this to some concerns around the recent acquisitions, the need to access the public markets to finance these deals and the increase in DSO's and the drop in cash flow reported in 1Q01. *Late last week we had a private call with the controller of EDS to address the balance sheet issues. We believe that the key issue is the volume of large deals ramping in 1H01. Receivable terms on large outsourcing deals are often extended in the early stages of contracts. On selected large deals, we also suspect that EDS (and perhaps others) may be offering up-front price discounts, adding to the cash flow requirement although average margins over the life of a contract appear stable. We do not expect DSO's to decrease materially until perhaps 4Q01. *At 23 times forward estimated EPS for a 15% EPS growth rate story with high visibility, we remain comfortable with EDS and our 2- Buy rating. COMPANY/INDUSTRY UPDATES Integrated Oil P. Cheng, .212.526.1884 Weekly U.S. Crude Oil & Refined Products Inventory Summary *Absent any new major refinery or pipeline accidents, we expect gasoline futures to drop to below $0.80 per gallon within the next several weeks. In addition, gasoline inventories should continue to build on average by about 0.5-1.0 million barrels per week over the next two months due to strong domestic output and weak demand. We continue to recommend an underweight position in the independent refiners group. Paper & Forest Products P. Ruschmeier, .212.526.9898 IRS Revenue Ruling Supports Bullish Timber Thesis *As we indicated yesterday (6/5/01), IRS revenue ruling 2001-29 has positive implications for the pending merger between PCL and TGP and positive implications for a structural shift in timber ownership from C-Corps to REITs over time. We are reiterating our favorable ratings on companies with the greatest timberland exposure including WY, LPX, TIN, BCC, IP, BOW, & TGP. *Yesterday (6/5/01) we learned that the IRS reversed a 1973 revenue ruling that prevents REITs from engaging in the active conduct of a trade or business. *We believe the ruling is an important first step in paving the way for timber-rich companies to transition ownership of timber cash flow from a C-corp. structure to a tax-advantaged REIT structure. *We believe the ruling supports a favorable outcome to the PCL/TGP merger. Internet Healthcare R. Rouse, .212.526.7347 MORE CRO UPSIDE - THE BIOTECHS ARE COMING !!! *The CROs are poised to take advantage of two significant trends that we pose are underway: 1. the much anticipated "biotech bulge" may be upon us sooner than expected (a long-term catalyst); and 2. this is in addition to our previous call for efficiency gains and margin upside given a return to normalized late-stage trial volume (a near-term catalyst). *Proprietary pipeline analysis and industry anecdotes lead us to the proposition that the beginning of a wave of novel drugs is entering clinical development. This creates bottlenecks for drug sponsors and opportunities for service vendors. Diversified CROs (CVD, PPDI, & QTRN) and niche providers (AAII & ARRY) could reap benefits as early as this year while those more clinically focused (KNDL & PRXL) could see upside by the end of next year. Insurance/Life E. Berg, .212.526.2805 Estate Tax Reform: With New Focus Any Damage Will Be Minor *An effort by us to quantify the impact on life insurers of the change in the Federal estate-tax law passed last week by Congress is leading us to affirm our 1-Strong Buy ratings on Manulife, Nationwide, and John Hancock. *The bottom line to our analysis: While these three life insurers and others could lose as much as one-third of their existing estate-tax-oriented policies and growth in new sales of estate-tax-oriented life insurance could also slow by a third its still not a big deal. The entire loss, between existing and new policies combined, would translate only into about a 5 % to 10 % loss of revenues and earnings companywide because estate planning is only a portion of their business. Albertson's, Inc(ABS) 3 - Market Perform M. Adler, .212.526.7146 Right-sizing the business is still to come OLD NEW STREET P/E Price: $27.73 EPS 2001 N/A $2.08 N/A N/A 52 Wk Ra: $38 - 20 EPS 2002 $1.96E $1.93E $2.04E 14.4 Mkt Cap: $11.3B EPS 2003 N/A N/A $2.25E N/A FY: 1/31 Price Target N/A N/A Rank 3 3 *ABS is just beginning the arduous process of a turnaround, with a new CEO that is willing and able to lead. He is evaluating every aspect of the business, and is prepared to right size the company through divestitures of profitable assets that have weak long-term prospects. *ABS reported 1Q01 EPS of $0.46, $0.01 ahead of our estimates and consensus. Sales were in line with our estimates, but the operating margin deteriorated by only 39 bp versus the 60 bp we had forecast. *We have lowered our 2Q01 estimate from $0.47 to $0.45, and our FY02 estimates from $1.96 to $1.93. *With our new lower estimate, ABS' stock is trading at a 2001 P/E 14.4x, a mere 1.5 multiple point discount to KR, which we rate a 1- Strong Buy ($24.78). We think this gap is too narrow given the differences in earnings outlook and asset quality, so we are maintaining our 3-Market Perform rating 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 = Strong Buy (expected to outperform the market by 15 or more percentage points); 2=Buy (expected to outperform the market by 5-15 percentage points); 3=Market Perform (expected to perform in line with the market, plus or minus 5 percentage points); 4=Market Underperform (expected to underperform the market by 5-15 percentage points); 5=Sell (expected to underperform the market by 15 or more percentage points). 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. - MF June 6th 2001.pdf