U.S. Steel Demonstrates Strength
United States Steel Corp.'s (X) near-term profitability is expected to be strong due to higher flat-rolled contract prices and relatively low costs due to backward integration. The company also has strong cash flow, enabling increased dividend payments, stock buybacks and accelerated pension contributions. These factors lead us to rate the stock to a Buy with a six-month target price of $150.
Spot pricing is continuing to improve and is in the middle of a spike that started in early 2008. This is due to demand growth in China and other developing countries, high operating rates, rising input costs, a weak dollar and low inventories.
But U.S. Steel's domestic flat product volumes could suffer due to low steel demand from the automotive and residential construction sectors. There is the risk of volumes declining with the slowdown in the U.S. and global economy.
On July 29, United States Steel Corporation reported second quarter 2008 results. Net income was $5.65 per diluted share, more than doubled from $2.54 per diluted share in the second quarter 2007. Finally, net sales increased by 59% to $6.7 billion.
Ciena Target Lowered Again
Ciena Corp.'s (CIEN) FlexSelect platform has been gaining momentum and we believe the acquisition of World Wide Packets will further strengthen Ciena's base.
On September 4, Ciena announced results for the third quarter of 2008, ended July 31. Revenue for the quarter was $253.2 million, in line with our estimate, and included $223.7 million in product revenue and $29.5 million in services revenue. This was an increase of 23.5% from the $205 million reported in the third quarter of 2007, which included $182.1 million in product revenue and $22.8 million in services revenue.
However, for the third quarter, Ciena provided a bleak revenue outlook as a result of order delays from many of its Tier 1 service provider customers in addition to existing customer-specific challenges. Although we have yet to see this occur among its competitors, we believe this could be an industrywide phenomenon given CIEN's July quarter end.
Ciena is currently trading at 13.0x our reduced 2008 EPS estimate, a discount to the industry median. The company significantly lowered its guidance for Q4. We maintain our Hold rating on CIEN shares and again lower our six-month price target to $13, given the uncertain macroeconomic conditions. This price is based on P/E multiple of 8.4x our reduced 2009 EPS estimate of $1.54.
MGIC Overhangs Continue
MTG Investment Corporation's (MTG) core 2Q08 results were $0.09 per share below our expectations. The results continued to be impacted by increases in both the number of delinquent loans and foreclosures due to a further decline of home prices and slowing of economy.
In addition, higher loss severities, especially in California and Florida, also negatively impacted the results. The company has taken several combative actions to bolster its capital. We expect significant overhangs for the industry and for MTG, in particular, for at least the next several quarters. However, given 2Q08 results we have moderated our FY08 and FY09 EPS further to take into account expectations for continued pressures on the housing markets over the near term. We maintain our Sell rating on the shares.
The shares have retracted from the near perfection price to book multiple level of approximately 1.1x, which was driven by the pending merger of MTG with Radian (now terminated). Currently, the shares of MTG trade at 0.41x its 2Q08 book value of $22.92 per share (substantially above its peer group median). Our new six-month price target of $8.35 per share incorporates a blended median and MTG's current multiple, or 0.40x to our book value estimate of $20.90 per share for December 31, 2008.
We think the current valuation is tenuous at best, as any negative deviation from expected results or additional negative trends from the housing market data or overall economy should be expected to be amplified on the shares of MTG.
CVS Caremark Feels Wal-Mart Heat
CVS Caremark Corp. (CVS) is one of the leaders in the domestic drug store industry and the pharmacy services industry. The management embarked on an aggressive expansion strategy, including the merger of equals with Caremark.
There is substantial operational risk concerning the integration of the five significant acquisitions that were closed during the last two years. Also, generic drug introductions and Wal-Mart's (WMT) entry into the generic drug industry are negatively impacting the profitability of the drug store industry, including CVS Caremark. Therefore, the stock is rated a Hold.
Due to the company's periodic earnings disappointments and aggressive acquisition strategy, the stock is best valued on a price-to-sales basis. The stock traded in the range of 0.37 to 0.80 times sales over the last five years prior to the merger with Caremark and Osco & Sav-On drugstores.
