Bayer Shifting Segment Focus

Bayer AG (BAYRY) is one of the major players in healthcare and chemical industry. Bayer has been shifting its focus on the healthcare segment during the past few years in order to maintain a solid growth in the long run. The acquisition of Schering AG in 2006 should improve its product portfolio and we expect higher cost synergies from the acquisition.

However, sales in the healthcare segment has stalled from 4Q07 which creates great concern since healthcare business is Bayer's major focus and will be the key growth driver in the future. We maintain our Hold rating for Bayer's shares with a price target of $90.

Sales in the healthcare segment only grew by 0.9% in 4Q07 and 3.4% in 1Q08. The failure of Nexavar for lung cancer and the US court ruling against Yasmin will have a negative impact for the growth of healthcare segment. Therefore, we are lowering our estimates for this segment in 2008 and beyond.

The crop science and material science segments should stabilize in the coming quarters. Currently, Bayer stock is trading at 12.1x our 2009 EPS estimate of $7.05 (EUR4.52) per ADR. Based on the business outlook we mentioned above, we believe the risk/reward profile is balance for Bayer stocks.

Using our fiscal year 2009 earnings estimate of $7.05 per share, and a forward multiple of 15x, discounted at 20% for one year, we arrive at our price target of $90. The P/E ratio of 15 is between big pharma industry P/E of 18.6 and chemical industry P/E of 13.6. We choose this hybrid P/E because Bayer operates in both these industries and each segment accounts for about 50% of its total revenue.

Ongoing ArvinMeritor Expansion

ArvinMeritor, Inc. (ARM) has developed a leading position in most of the markets it serves. Presently, the company is undergoing dramatic cost reductions as well as implementing an impressive global growth strategy.

The company is also expanding geographically and outsourcing to low-cost countries. ARM is likely to benefit from the new business from Hyundai and the latter's focus on emerging markets. However, a downturn in the automotive industry leading to production cuts, coupled with rising steel and fuel prices, lead us to rate the shares a Hold.

On April 29, 2008, ArvinMeritor reported second quarter fiscal 2008 results. In the second quarter, net loss from continuing operations, excluding special items, was $0.37 per diluted share, compared to income of $0.17 per diluted share in the prior-year period. In the quarter, ArvinMeritor posted sales from continuing operations of $1.8 billion, up from the same period last year. Excluding the impact of foreign currency translation, sales were approximately flat due to a continued weak economy in North America, offset by strong sales growth in South America, Europe and Asia.