McGraw-Hill Finance Biz Down

The outlook for McGraw-Hill's (MHP) Financial Services (45% of revenue) segment is murky. Operating income shrank 17% in 4Q07. Given weak housing market fundamentals, we don't think Financial Services operating income will trough until at least 4Q08, and then it may likely remain weak through 2009. Rising mortgage defaults and the resultant resultant dropoff in the U.S. residential mortgage-backed securities market will not likely reverse itself for many quarters.

This weakness in Financial Services should be partially offset by mid-to-high single-digit growth in both the Education segment and Information & Media segment. Althought the stock is trading in line with our estimate of its 5-year growth rates, in our view, visibility in Financial Services is murky and therefore creates additional risk to our estimates.

The McGraw-Hill Companies, Inc. is a diversified publisher and provider of financial information, and also a provider of media services to customers in over 40 countries. The company is a leading textbook publisher and owns one of the top credit rating agencies (Standard & Poor s). It has three business segments: McGraw-Hill Education, Financial Services and Information & Media.

Kmart Weighing on Martha Stewart

Martha Stewart Living Omnimedia (MSO) is beginning to execute on its original strategy of leveraging its Martha Stewart brand across its business segments, signing a slew of high-margin merchandising deals since 2006, and repositioning its website away from on-line commerce to becoming an interactive, ad-generating aggregator of content from its publishing and broadcasting business.

As a result, Internet revenue is more than doubling, and we expect the segment's operating margins, which turned positive in 2Q06 to expand exponentially throughout 2008. Meanwhile, sales and operating earnings in the flagship publishing division have been growing vigorously since recovering in mid-2005.

Revenue from Kmart (SHLD), which accounted for 76% of the Merchandising segment's revenue and 21% of MSO's total revenue is set to decline sharply in 2008. Beginning February 1, 2008, the guaranteed minimum royalty payments Kmart is obligated to pay MSO will drop sharply to a maximum of $20 million and $15 million for the years ended January 31, 2009 and 2010, respectively. Total minumum royalties Kmart paid MSO for the year ended January 31, 2008 are $65 million.

Royalties from Kmart's sales lagged expectations as the discount chain suffered sagging same-store sales and store closings (Kmart retail sales in 4Q07 declined about 18% year over year on total store basis, and declined 17% on a comparable store basis). Although we expect the decline in revenue from Kmart to be somewhat offset by MSO's slew of new merchandising initiatives, the loss of Kmart royalites will clearly depress revenue growth in 2008.

Initiating on China Architectural

As the leader in China's high-end curtain wall systems market, China Architectural Engineeering, or CAE (RCH) is well-positioned to leverage the growth potential in commercial construction market. Its revenue and earnings in 2007 increased more than 30% over 2006.

We expect that CAE to grow its earnings over 20% annually for the next five years. However, a possible slowdown in the Chinese economy and its current capital market situation limit its stock's upside potential in the near future. As a result, we are initiating Hold rating on CAE's stock.

CAE has gained a leading position in this industry in China. CAE has worked with world-renowned architects and building engineers from China and other countries and has completed over 100 large, complex and unique projects throughout China, Middle East and Southeast Asia, including numerous award-winning landmark buildings such as National Grand Theater in Beijing and National Conference Center in Vietnam.

The stock is currently trading at 15.3x our estimate for fiscal year 2008 earnings per share, which is much higher than the industry mean.