Fifth Third (NASDAQ:FITB): Rochdale's Dick Bove upgrades to Buy from Sell

Rochdale's Richard Bove is upgrading Fifth Third (NASDAQ:FITB) to Buy from Sell and is raising his target to $15 from $9.

The earnings estimates have been adjusted as follows: a) the projected loss for 2010 has been reduced to $0.30 per share from $0.45 per share; b) the profit projection for 2011 has been increased to $0.58 per share from $0.38 per share; and c) an initial estimate of $1.28 per share is being made for 2012. The normalized earnings estimate has been increased to $1.75 per share from $1.69 per share.

- It appears that the automobile industry may have turned the corner. Ford reported a meaningful profit for the year (F/$11.41/NR). The President has requested tax credits for capital expenditures and job creation in the State of the Union message. This is the single most effective action Congress can take to maintain the economy’s growth.

Fifth Third’s key markets of Ohio and Michigan may have hope for the first time in three years. This potential turnaround is very apparent in the bank’s loan quality figures. The bank’s non-performing loans were down by 2.3% in the quarter, sequentially. Its net charge-offs fell by 6.3%. This is a clear indication that loans are not coming on to the books as quickly as they are being written off.

The improvement in charge-offs is showing up in every loan category except commercial real estate. However, even in this category non-performing loans are falling. Loans 90-days past due plunged by 42.8% in the quarter. Bove notes that no other bank that he covers comes close to this improvement.

Approximately, 57% of the bank’s loans are in the commercial sector. It still has part of the processing business it sold. Plus, it has a corporate services business and an asset management subsidiary so it is positioned properly – i.e., not consumer oriented.

The company’s infra-structure has been improved and a new management team has been crafted after a multi-year struggle. The time has come to buy Fifth Third.

Notablecalls: This is a pretty strongly worded call from Bove & it will likely capture the attention of investors. It's quite clear he is being conservative with his $15 target and will use coming improvements in fundamentals to up it.

Chart looks good for a breakout in the $13 range.

Regional banks have been strong of late (on hopes of tier-1 players coming in to buy some) & I expect that to continue in the n-t.

SIGA Technologies (NASDAQ:SIGA): Initiate coverage w/ Outperform; to be awarded a big gov. contract - RBC Capital

RBC Capital is picking up coverage on SIGA Technologies (NASDAQ:SIGA) with Outperform rating and $11 price target, while noting that depending on contract size SIGA's NPV could be as high as $26/per share.

Firm notes their positive thesis is based on the likelihood that SIGA Technologies, Inc. will be awarded a lucrative contract under Project BioShield to supply the U.S. Government with its oral treatment for smallpox (ST-246, tecovirimat). SIGA shares traded lower following an unexpected amendment to the Request for Proposals (RFP), which they believe creates an attractive entry point. The timing of a contract is uncertain but is likely to occur in the firsthalf 2010. The recent negative assessment of the U.S. Government’s preparedness also increases political pressure to get a contract signed, in RBC's opinion. The simple oral dosing, compelling animal data, anecdotal efficacy in humans against related viral infections, and secure and audited supply chain make ST-246 an attractive asset to the U.S. Government and others interested in effective counter measures against smallpox.


Key Reasons to Expect BARDA Contract
- Small pox counter measures are a high priority at Biomedical Advanced Research and Development Authority (BARDA) given the vulnerability of the population following the discontinuation of routine vaccination in 1972.

- Only two known drugs are vying for the government contract, and the amended RFP permits the government to acquire both.

- ST-246 has demonstrated safety in humans and efficacy across multiple animal species, including non-human primates.

- This week a bipartisan commission issued a scathing report giving the U.S. Government an “F” for preparedness, increasing the political pressure for the government to act now.


Initial Contract worth Approximately $500 million; Expansion Potential to over $1 billion
- Assuming $250-300 per course of treatment and an initial contract for 1.7 million courses, the total sale could be $425-510 million over a three-year period.

- The initial contract has an option to expand to 12 million courses (a blockbuster opportunity even if price is adjusted downward for the increased volume).

- Other governments are likely to place orders after the United States

Competition – Room for Two Drugs
- Privately held Chimerix Inc. is developing a competitive agent for the treatment of smallpox. Because Chimerix is private, there are limited public disclosures regarding the status of its program.

- CMX001 is Chimerix’s oral version of the broadly active antiviral cidofovir. It is active in most animal models of smallpox but cannot be tested in non-human primates, which may provide a competitive advantage for SIGA because the RFP requires that the company demonstrates efficacy in non-human primates.

Governmental Purchasing and Regulation are the Key Risks
SIGA is seeking government contracts for ST-246. As a result, SIGA is dependent on the vagaries of timing, purchase size and pricing. The U.S. Government could also change its mind or amend the contract. In addition, gaining FDA approval will require SIGA to use the ‘animal rule’ because efficacy studies in humans are not possible with smallpox. Although there are guidelines for approval based on animal studies, the path is not well trodden, and there remains significant regulatory risk. FDA approval is not necessary for initial government purchases, but it may be required for longer-term contracts or sales in other countries.

Government Funding History Suggests Strong Interest in ST-246
Over the past-two years, SIGA has received contracts and grants totalling $78 million specifically for the development of ST-246. This amount includes a $55 million contract to develop alternative intravenous formulations of ST-246 for seriously ill patients and a $20 million extension to a $16.5 million, 2006, three-year contract for the development of ST-246. Given the government’s investment in this program, and the advanced stage of clinical and regulatory development of the program, we believe a contract to purchase ST-246 for the Strategic National Stockpile (SNS) is highly likely.

Notablecalls: SIGA Tech (SIGA) certainly presents an interesting situation for traders here as RBC Capital seems to be the 1st firm to pick up coverage on this biodefense name. Biodefense (and homeland def. in general) has become a hit topic once again & contracts usually follow.

Note that SIGA has a long history getting funding from the U.S. Government. Since 2004, SIGA has secured approximately $122 million in government grants, contracts and awards to fund the development of ST-246 and other novel antiviral agents.

I really don't think the Government will leave SIGA empty-handed after plowing $100m+ into the co.

As noted, RBC estimates the stock could be worth up to $26 if everything goes right. That's some upside.

I think this call will get traders' attention and will serve to push the stock higher by 10%+, putting $7 level possibly in play.s

Amazon.com (NASDAQ:AMZN): Oppenheimer makes a call to Buy the stock ahead of Q4 results

Oppenheimer is making a positive call on Amazon.com (NASDAQ:AMZN) raising their estimates and target to $160 (prev. $130) ahead of Q409 results after the market close on Thurs., Jan. 28th.

Firm looks favorably upon AMZN shares into the company's upcoming announcement. Sales trends began to recover for AMZN in Q3 (Sep.). Over the past few months and particularly through the holiday selling season, the firm believes that top-line expansion at AMZN accelerated further. Oppenheimer's Q4 sales growth forecast of +39% compares with +28% in Q3. Better sales growth should further leverage an increasingly lean cost infrastructure at the company. AMZN shares tend to perform well upon quarterly EPS from the company. They believe that another "substantially" better than expected AMZN report will encourage investors to rethink the company's earnings power and potentially send shares higher.

Look for Q4 EPS to Easily Top Forecasts. Oppenheimer's new Q4 EPS estimate of $0.85 is up from a prior forecast of $0.67 and compares with a current Street figure of $0.72.

Firm notes they are optimistic that a better than expected Q409 report from AMZN will serve as a positive catalyst for shares. Consider:

1. Shares Off Recent Highs. Since Dec. 2, 2009, shares of Amazon.com are down about 15% versus a decline of 1% in the S&P 500 and 6% in Opco Hardlines Index and now trade modestly lower than the price to which AMZN rallied in the days following the company’s better than expected Q3 report in late Oct.

Firm illustrate in Exhibit below that since AMZN’s Q3 report, shares are up only 2%, in line with the S&P 500. This is largely consistent with the movement in shares ahead of prior quarterly EPS reports for the company.


2. AMZN Typically Performs Well on Reports. Since early 2008 AMZN shares have risen on average 7% following the company’s quarterly earnings reports

3. Valuation Still Subdued. Oppenheimer continues to look upon the valuation at which AMZN trades as favorable. AMZN shares typically maintain a multiple of greater than 40x NTM P/E estimates in periods where sales growth exceeds or is expected to top 20%. They expect AMZN to maintain this growth level through at least FY11. Ahead of the company’s Q4 report that shares trade at a multiple that is about consistent with valuation levels prior to the company’s earlier quarterly earnings reports.

Data Suggests Strengthening Sales at AMZN. Expansion in Personal Consumption Expenditures (PCE) improved to +0.7% in Nov. from -0.7% in Jul. Comp sales trends in the CE category at Best Buy (BBY) accelerated to +8.0% in the third quarter ended Nov. from -2.4% in the fiscal second quarter ended Aug.

Expense Leverage Likely to Persist. AMZN surprised investors with signals of much better cost controls at the company in Q3. Expense leverage should remain a significant driver of EPS upside. Opco believes that improving cost controls reflect structural improvements in the model more than the benefits of a cyclical upturn in sales.

AMZN Story Much More than Kindle. Firm notes they have been encouraged by the initial success of Kindle and expect it to remain a key differentiator for AMZN. Kindle, however, is one of only many drivers for AMZN. They forecast Kindle will add just 2% pts. to sales growth at the company in Q4.

Notablecalls: I think AMZN is one to watch today. The stock is down nicely from the $140's & Opco's estimate and target raise only confirm the obvious - the quarter is going to be BIG.

With 2 days til earnings I think market participants will start thinking of buying some down here. Could easily be a 10-15pt play if AMZN delivers.

The market is a bit of a drag but down here I suspect the red we are seeing is induced by the sell-off we had overnight in Asia. But do note the Asian sell-off was due to S&P cutting Japan's credit outlook to negative. This usually sets the U.S market up for a bounce.

AMZN looks like the weapon of choice to play that bounce.

It's hard to give a target range for the stock here but I think that if they get the bounce going the stock could hit $123-125 in a jiffy.

Amlylin Pharma (NASDAQ:AMLN): Upgraded to Buy at Citigroup; Street high target of $27

Amylin Pharma (NASDAQ:AMLN) is getting lots of very positive commentary this morning after the FDA issued a press release announcing the approval of Novo Nordisk’s Victoza (liraglutide), a once-daily GLP-1 for diabetes.

- Citigroup is upgrading AMLN to Buy from Hold with a $27 price target (prev. $14) saying they are optimistic that FDA will approve LAR at some point. Firm believes this considerably raises Amylin's value. Citi's new Ttarget of $27 is based on new ’13E non-GAAP EPS of $1.28 (previously $0.63 on '12E) and 30x P/E (same multiple) discounted back 20% to ‘11E.

Assuming LAR approval, Amylin should become profitable in 2011, thereby raising its value as M&A target for the lucrative diabetes market.

Higher Price — Both the 1.2mg and 1.8mg Victoza doses were approved. Novo Nordisk will price the 1.2mg dose at ~$8-$9/day and 1.8mg dose at ~$12- $13.5/day. Given that LAR is more potent , Citi now prices it in-line with Victoza’s high dose. Previously, they priced it at parity to Byetta. Byetta is priced at $8.21 (5mcg) and $9.63 (10mcg) per day.

1st Line Use — Bear argument on LAR is that it won’t sell in 1st line. This is amplified by the boxed warning and lack of FDA approval of Victoza in these pts. To be conservative, they do not model sales there. However, FDA did approve Byetta w/o box warnings while did not approve Victoza in these pts. Thus, FDA views these drugs differently and this may be a positive for LAR.

Conservative Approval Timelines — There is a good chance that FDA will not approve LAR on the upcoming March 5 deadline. In their model, the firm envisions that LAR will be approved in Q4:10.

- Goldman Sachs expects Amylin shares to trade up significantly, as they believe the news increases the likelihood of approval for Amylin’s exenatide once-weekly (EQW).

They believe EQW appears to have less preclinical cancer risk than liraglutide, and the Byetta safety history may give the FDA increased confidence in the safety of EQW. Therefore, the firm believes the safety hurdle for FDA approval of EQW should be lower than that for liraglutide. Goldman believes the FDA approval deadline is 3/5/10. Although they are optimistic about approval of EQW, several factors could delay approval, incl. delays in manufacturing clearance, requirement for an Advisory Committee review before approval, or a request for additional data by the FDA.

- Jefferies is raising their target on AMLN to $26 (prev. $22) and reiterating their Buy rating as they see an increased chance of EQW approval later this year.

Victoza approval bodes well for EQW's prospects, both on approval and commercial prospects. Firm notes they have even higher confidence in approval, since they believe EQW has an even better profile on thyroid cancer risk (only one gender of rat affected and a higher safety margin in terms of the dose exposure at which tumors occur) and an overall more compelling efficacy and safety profile relative to Victoza. Commercially, the lack of onerous post-marketing requirements as part of the REMS for Victoza gives us increased confidence in the potential for significant GLP-1 market expansion. Jefferies estimates that global GLP-1 sales could reach $6b by 2015.

- Barclays is reiterating otheirOverweight rating on AMLN and increasing our price target to $24 following approval of competing long acting GLP-1 agonist Victoza. They believe approval of the first long acting GLP-1 drug bodes well for AMLNs once-weekly exenatide LAR and suggests a pragmatic approach by FDA to class related safety issues heading into AMLNs March 5th PDUFA.

Notablecalls: The Victoza (liraglutide) approval was surely a surprise, expecially for the 11 million shares strong Amylin short base (25%+ short interest), I suspect. Make no mistake about it - Victoza is no match for LAR as the Novo's drug is dosed once daily vs. once weekly for LAR.

The shorts must have been betting on further delays for the whole GLP-1 class of drugs but now it looks like it's not going to happen. The approval of LAR will put Amylin in the profitable biopharma camp & set it up as a possible takeover candidate for partner Lilly. Remember Lilly is facing a horrendous patent cliff and is desperate to make up for the lost revenues.

All this effectively puts Amylin stock on track to at least double over the next couple of years. Look at it this way - AMLN has $2-3 in EPS power after LAR is approved. Putting a conservative 15x multiple on that EPS yields a $30-$45 stock (vs. current $18). Considering the takeout potential, the risk is clearly towards the $45 (or higher). A short's nightmare, if you will. They have to cover. No way around it.

In the very short term I suspect the shares will have 10%+ upside towards the $19-$19.50 level. Note that Goldman put their rating Under Review overnight which probably means they are going to upgrade the stock. Goldman's blessing will surely serve to help the long case in AMLN.

Note that Alkermes (ALKS) is set to get royalties on LAR. Could see some buy interest.

Also, I think it's time to give kudos to Barclays' biopharma research team for upgrading AMLN back in Nov 2009 (see archives). Well done guys!

Dryships (NASDAQ:DRYS): Upgraded to Buy at Cantor, Deutsche reits Buy and $10 target

Dryships (NASDAQ:DRYS) is getting positive commentary from two firms this morning:

- Cantor Fitzgerald is upgrading DRYS to Buy from Hold with a $8 target (prev. $7) based on their 7.0x EV/EBITDA multiple to their new 2010 EBITDA forecast of $558 million (from $544 million)

With nearly all of its dry bulk fleet fixed under period charter contracts, the firm suggests the primary upside catalyst for the stock over the near-term will be securing employment and financing for the 5th and 6th drilling rigs.

They raise their 4Q:09 EPS estimate to $0.27 (from $0.26). For 2010, they now look for DRYS to report EPS and EBITDA of $1.05 and $558 million (from $1.00 and $544 million), respectively. Finally, the firm introduces their 2011 EPS and EBITDA forecasts of $1.22 and $743 million, respectively.

Management has stated its intention of growing the dry bulk fleet through potential distressed transactions over the near-term, with a focus on the Panamax and, to a lesser extent, Capesize vessel classes. However, Cantor believes the primary focus will be on fixing drilling rigs 5 and 6 under charter contracts, as those charters will likely be necessary before bank financing can be secured.

- Deutsche Bank reiterates Buy Rating on DRYS with a $10 price target.

Firm believes recent downside in DRYS provides an attractive entry point for the stock. They believe the thin UDW market has weighed on shares, as investors are waiting to gauge DRYS’ ability to charter at least one of its drillships as a sign that it will be able to fully realize its planned UDW fleet expansion. They believe elevated crude prices, increasingly fluid industry wide tendering activity, and DRYS’ strong cash position could all act as catalysts for DRYS’ first drillship charter and upside in shares, with its fixed dry bulk fleet underpinning stable cash flows.

DRYS Remains In Charter Negotiations For Its Drillships
DRYS remains in negotiations to charter at least one of its drillship orders over the near-term, with DRYS likely involved in most major tenders for 2011 employment (two currently active, with 4-5 more likely opening up in the coming months). From a geographical perspective, Brazil, Angola, Nigeria, and the North Sea remain likely landing spots for at least one of DRYS’ vessels, with Petrobras remaining the most active counterparty currently in the space. According to management, tender activity industry wide has picked up steadily over the past 8 weeks, however there have yet to be any awards. Eventually transactions and charters will resume in the UDW space, and they believe the high quality of DRYS’ newbuild fleet and its preexisting relationships should help DRYS find employment for its vessels.

DRYS’ Cash Position Acts As Safety Net
Steel cutting has already begun at Samsung for two of DRYS’ drillships, with construction on the third and fourth vessels likely beginning before the end of January and March, respectively. Typically 15%-20% installment payments are made upon steel cutting, which means DRYS will likely begin paying out more than $200 million in payments over the next two months, in addition to continual installment payments on the two drillships that are currently under construction (which remain unfinanced). While the lack of financing (and employment) for DRYS’ first two delivering drillships has clearly weighed on shares, Deutsche believes DRYS’ estimated Q4 cash balance of more than $800 million ($3.20/share) provides significant breathing room. They continue to believe DRYS will look to charter at least one of its vessels before securing the remainder of the necessary financing (which has proven to be difficult), and the firm thinks DRYS’ strong overall cash position should help fortify what has been a somewhat weak negotiation position.

Notablecalls: Should see some buy interest. Can trade towards $6.30+ levels if market plays ball.

Note the Cantor upgrade is part of a group call.

Basic Energy Services (NYSE:BAS): Upgraded to Buy at Deutsche; Target raised to $18

Deutsche Bank is out with a major call on Basic Energy Services (NYSE:BAS) to Buy from Hold with a $18 target (prev. $6).

Upgrading oil leveraged small cap to BUY
Deutsche notes they continue to favor leverage to a recovery in marginal oil directed activity. With its strong market position in the oil weighted well-service/ workover market, BAS is well positioned to benefit from this trend. A pickup in US completion activity should benefit BAS' other services lines as well.

Pent up demand in completion & workover market
Historically, workover/ remedial activity has been roughly 70% oil directed and typically recovers before drilling activity. Despite the high returns associated these projects at current oil prices and recovery in the drilling rig count, activity has barely budged. Deutsche thinks this is a function of hard caps on 2009 CAPEX budgets and other producer priorities. As 2010 budgets kick in, they expect a powerful recovery in workover activity. An expected pickup in completions in early 2010 from drilled but not completed wells also bodes well and should benefit BAS’ drilling and completion services business.

With about 70% of its well service business coming from oil directed activity and its overall oil/ gas mix approximately 50/50, BAS is well positioned to benefit from the recovery in customer spending. Workover and well service activity (BAS’ primary business) typically recovers before (and is highly correlated to) drilling activity but has yet to do so in the current cycle. Firm thinks this is a function of hard caps on 2009 customer CAPEX budgets. With commodity prices (especially for oil) remaining strong, they expect the historical relationship to return as customers are able to access fresh capital in 2010

Raising estimates
Given current commodity prices and the pent up demand dynamic noted above, the firm expects the historical relationship between commodity prices/ drilling rig activity and workover activity to return to historical (highly correlated) norms. They are therefore significantly raising their 2010 and 2011 estimates to ($1.02) and $0.05 from ($1.53) and ($0.45), respectively.

Valuation and risks
With the cyclical recovery more clearly under way, Deutsche notes they are shifting their valuation methodology from trough to forward EBITDA. Specifically their target price is based on 6.0x 2011 EBITDA which is the average forward EBITDA multiple for BAS since it went public in 2006. The biggest risk to their thesis is deterioration in oil prices to which BAS has more leverage than other US leveraged companies. Renewed weakness in well service demand/ pricing in an additional risk.

Notablecalls: This looks like a major call from Deutsche. Not only is their $18 target the new Street high by a mile (prev. was $12), it also looks like their Buy rating is about the only one out there. I see several other tier-1 firms still on Sells/Underperforms.

Also, note that the closest listed peer to Basic (BAS) is Superior Well Services (SWSI). SWSI has been on tear lately while BAS has lagged. Make no mistake about it, BAS is a big mover once it gets going. Especially intraday.

I think Deutsche's call has the ability to wake up the monster in BAS. I would not be surprised to see the stock up 7-10% today. This is a small-cap energy services play, so I think general market action won't have much bearing on its performance.

So let's see if it can hit the $11.30-11.60 range today.

Semiconductor Equipment: Cycle not “over” but see risk of ~30% correction - Citigroup

Citigroup's Semiconductor Equipment team is downgrading 5 equipment stocks to Sell and 2 to Hold.

Downgrading 7 semi equip stocks; cycle not “over” but see risk of ~30% correction — After adopting a more balanced cyclical view last Oct ’09, Citi is digging in their heels as tool shipments now running at levels that imply more significant capacity adds, chip inventory is building ahead of a potentially risky CQ2 based on recent seasonal trends, and capex is (they think) being pulled into 1H from 2H:10 and 2011. With as much as ~30% correction potentially in the offing over the next 3-6mos, firm is downgrading KLAC, ATMI, BRKS, ENTG and AEIS from Hold to Sell and downgrading NVLS and AMAT from Buy to Hold. They are removing AMAT from Top Picks Live. Firm maintains Sell ratings on ASML.AS and LRCX and a Buy on FORM given valuation and DDR3 exposure.

With respect to current business, clearly, it remains strong. To wit, checks suggest LRCX is set to ship the most tools in company history in FQ3:10 (Mar) and even when excluding ~20 clean systems, shipments look to be only 10- 15% shy of ’07 peak levels. Additionally, ASML is now guiding shipments to a level in CQ2:10 that equates to ~$45-50B/yr capex, or up ~125% Y/Y relative to the ~$20-22B capex in 2009. Because the Street is still modeling equipment company revenue growth of ~70% Y/Y in 2010, this implies estimates will move higher again through earnings season. However, Citi feels this is the last of the estimate increases for at least the next several Qs and the risk now shifts more to the downside moving through the year.

Semi fundamentals concern while signs of supply acceleration are evident — Recent history suggests CQ2 may be the new CQ1 from a seasonality perspective and Y/Y IC unit trends portend a period of multi-Q inventory build. While the firm acknowledges absolute levels remain low, this is potent dry kindling for the emergence of more choppiness in the supply chain. Additionally, surging tool shipments now equate to 1H:10 run-rate equivalent of ~$40-50B/yr in capex, historically a level that drives meaningful capacity adds. Even without meaningful capacity adds, they estimate IC units would have to grow ~20% Y/Y in 2010 to result in more widespread capacity shortages.

Citi notes they didn’t under-spend long enough to drive a multi-year sustained capex cycle just yet — Assuming a normalized level of ~$25B/yr in wafer fab equipment, a new analysis suggests the financial crisis simply worked off the excess created in 2006/2007 but spending didn’t remain bad for long enough to drive the type of big accumulated deficit that existed in 2003/2004. While technology buys remain robust, this implies the Street may be over-estimating the sustainability of the bounce-back. While NAND has yet to spend much, Citi estimates it could drive a few $B capex which may only go to offset declines in other segments like foundry.

The duration of the rally in the SOXX is becoming extended from a historical perspective. While hardly a fundamental factor, it is worth noting that the past six sustained rallies in the SOXX (defined as periods with corrections of no more than ~10%) have ranged from 53 to 75 months with an average of 66 months. With the SOXX now in the 61st month of sustained appreciation without a >10% correction, this could be another reason to believe the group is in for a breather. From the peaks in these sustained moves, the SOXX has pulled back an average of ~30% over the following 6mos and ultimately declined an average of ~45% peak to trough. While this sort of a decline appears unlikely given inventories that remain on the lean side by historical standards, the balance seems skewed to the negative and if inventory build continues, there would appear to be enough risk that they would rather step aside and come back to the group in another couple of Qs.

Notablecalls: It's always interesting to read what the quantitatively oriented Citi Semiconductor Equipment team has to say. We have seen some sell-the-news reactions in the space lately which usually indicates that some market participants are feeling uncomfortable holding or buying around current levels.

It looks like Citi is quite aggressively taking down their target prices for some of the names, so I think there will be selling pressure there. Note that Citi's estimates for many of these names are still above consensus.

I would not be surprised to see some of the names (especially the smaller ones) trade down by 5%+ in reaction to this Citi call.

No comments

Notablecalls: No comments, really.

F5 Networks (NASDAQ:FFIV): Upgraded to Buy from Neutral at Merrill Lynch/BAC

Merrill Lynch/BAC is upgrading F5 Networks (NASDAQ:FFIV) to Buy from Neutral with an increased target of $65 (prev. $56). The upgrading comes following earnings out last night.

Firm notes they recently met management to discuss the opportunities and challenges for 2010. The meeting turned us more positive mainly on the expected strength of Viprion with telecom carriers, expected share gains in the core ADC market following recent product refresh and new significant opportunities in cloud computing and wireless segments. They also see limited risks to margins, which Merrill thinks will likely remain in the 32-33% range. F5’s quarterly results, reported last night, attested to the improving business momentum, leading them to increase their estimates, upgrade their rating to Buy and increase their PO to $65.

More value remains in the stock
Over the last 12 months, Merrill has increased the PO five consecutive times and remained cautious mostly on valuation. But the fundamentals keep improving, with revenue growth accelerating, competition getting weaker and new products and opportunities driving better growth rates and better margins. The company maintains one of the better growth rates in the industry (20-25% per annum) and one of the better margin structures (80% gross and 32-33% op). The stock was quick to trade up on the improving trends, trading up 137% last year, but we see additional upside. Ascribing a 23x target multiple (inline with industry levels) to their c2011 EPS estimate of $2.82, yields firm's new $65 PO. The stock is also supported by $8 in net cash.

Solid quarter and outlook
Revenues were up 15.5% YoY and 9.2% QoQ, with product revenues up ~11% and service revenues up 25%. In Merrill's view the improving momentum is also resulting in an increase in the deal size, with a large deal with a technology company signed last quarter and another large contract with a financial institution signed the quarter before. Operating margin grew from 25.4% to 31.7% YoY, and while they see limited additional upside to margins, sheer revenue growth should drive up EPS, in firm's view. On a fiscal basis, they increased their 2010/11 EPS estimates from $2.04/2.48 to $2.22/$2.68.

Accelerating market share gains
Firm expects F5 market share in the application delivery controller (ADC) segment to continue and increase, on the back of Viprion sales with carriers and a newly refreshed portfolio from several quarters ago. The company continues to extend its lead versus the competition, namely Cisco and Citrix, with relatively muted pricing pressure, which is mostly justified by its product leadership.

Opportunities within the cloud
Data center consolidation (cloud) is the leading opportunity for F5 core business. As customers scale up their data center and change the architechture, F5 sees an opportunity to offer the same level of its core application delivery, now across virtualized data centers deployed over multiple locations. Virtualization is the leading catalyst for F5’s momentum, and the company views its relationship with VMWare as strategic.

Classic ADC opportunities with wireless carriers
F5 is already in the Telco space, but mainly in the back-office. It is finding now new opportunities in the revenue generation-side to the telcos and mobile carriers. As the number of customer facing applications grows, carriers face server management issues, with a need to utilize F5 products in order to reduce the number of servers in the data centers. This is a classic functionality of F5’s ADC product, with years of similar deployments on the enterprise side. This new opportunity may therefore require very little R&D investment and could be accretive to margins.

Notablecalls: I think this call, helped by terrific earnings will drive the stock to multi-year highs. I see it up 2.5pts in the pre-market on very little volume. One can just hope it pulls back after the open enabling some decent fills.

It's likely headed to $56-$57 levels in the very near-term.

Ciena (NASDAQ:CIEN): Upgraded to Outperform at Credit Suisse; target raised to $19 - Actionable Call Alert!

Credit Suisse is making a major call on Ciena (NASDAQ:CIEN) upgrading the stock to Outperform from Neutral and raising their price target to $19 (prev. $15.50).

Firm notes they have increased their operating forecasts to $1.50 billion and $(0.42) and $1.94 billion and $0.70 for Fiscal 2010 and Fiscal 2011, respectively, and are introducing Fiscal 2012 estimates of $2.12 billion and $1.19. Their ratings upgrade and improved outlook are based on what they believe will be continued momentum in revenue growth, above current Street expectations, together with improved operating leverage. Longerterm, while the firm does not expect integration of the newly acquired Nortel MEN business to be trivial, they believe that the acquisition has both meaningfully improved Ciena’s competitive position and significantly attenuated its customer concentration. They also note significantly lower investor expectations given the (30)% pull-back in Ciena’s share price from its $16.50 peak on September 22, 2009, which includes an approximate (12)% pull-back since Ciena’s December 9, 2009 fiscal fourth quarter earnings announcement.

Revenue Growth
- CSFB says their field checks indicate continued momentum in revenue growth driven by ramping deployments by service providers of Ciena’s WWP Converged Ethernet platforms for wireless backhaul and, to a lesser extent, business service applications. In addition to ongoing sizable roll-outs at Clearwire and Comcast, they expect AT&T’s wireless backhaul upgrade together with additional new service provider wireless backhaul wins to drive meaningful incremental growth over the next 24 months.

At AT&T, CSFB's checks indicate that, while not finalized, AT&T will name Ciena as one of its two key optical “domain suppliers.” Their checks also indicate that, in an effort to future proof its network and get ahead of the surge in traffic created by the iPhone, AT&T currently plans to deploy 100 Gbps DWDM systems throughout the core of its network in calendar 2011 and that Ciena, by way of its soon to be acquired MEN 40Gbps platform, is the leading contender for this deployment, which they believe could amount to $100 million in 2011 and several hundred million over a two to three year period. As an increasing number of service providers join AT&T in making available the iPhone and similar smart phone devices such as Droid, Blackberry and Palm, the firm believes a number of these carriers will follow AT&T with similar upgrades of their optical transport infrastructure, which in turn should fuel a healthy upgrade cycle for the optical infrastructure market. Given the sizable, cyclical and lumpy nature of service provider optical transport build-outs, CSFB expects 10 – 20% market growth, with the potential for meaningfully stronger growth, over the next couple of years.

Operating Leverage
- The trading history of Ciena’s shares suggests to Credit Suisse that Ciena’s shares should respond very favorably if Ciena does in fact hold opex relatively flat and deliver solid above-consensus revenues in-line with or above their expectations.

CSFB notes they recognize that Ciena has a credibility issue when it comes to operating expense discipline given its poor historical opex management and almost exclusive focus on revenue growth. Fanning this issue, Ciena’s disappointing fourth quarter fiscal 2009 operating performance was both a reminder of Ciena’s checkered past in driving sustained operating leverage and a warning of potential pitfalls associated with the integration of MEN. They do not believe, however, that Ciena's shares at their current valuation are discounting much in the way of operating leverage. Ciena’s share price has declined by approximately (12)%, or $(1.60), since Ciena reported its fourth quarter fiscal 2009 operating results and as of December 31, 2009, short interest in Ciena's shares amounted to 18% of total shares outstanding.

Notwithstanding last quarter’s disappointment, the firm expects to see respectable growth in operating margin. Part of Ciena’s disappointing fourth quarter gross margin was based on what should be a nonrecurring obsolescent inventory charge while part of Ciena’s disappointing operating expenses was due to higher commissions from better bookings. There is significant overlap of platforms and personnel between Ciena and MEN that should allow for sizable operating expense reductions over time—and thereby enhanced leverage. Of course, as noted below, this overlap and the rightsizing of Ciena’s product portfolio and employee base also poses significant risk to the company.

Strategic Exit
As for recent press reports regarding the prospect of Nokia Siemens looking to acquire Ciena, Credit Suisse believes an acquisition of Ciena is ultimately likely, but relatively unlikely in the next 6 – 12 months. To put a fine point on the issue, they would assign a greater than 50% probability to Ciena eventually being acquired, but a less than 10% probability to such an acquisition in the shorter, near-term period

Notablecalls: I think this one can be called an Actionable Call.

Here's why:

- Credit Suisse's checks indicate large service providers like AT&T are ramping deployments, with tier-2-3 not far behind. The opportunities can be measured in hundreds of millions of dollars. That's new info. That's what I want to see.

- Note that Credit Suisse's fiscal 2011/2012 estimates are way-way higher than current consensus.

- Credit Suisse highlights Ciena as an eventual takeover candidate.

- The stock is down over 10% after reporting its quarterly results and down close to 30% from its October $16.50 highs. This means expectations are not high by any means.

- Short interest stands close to 20%, which is a lot for a name like Ciena. I suspect CSFB's call may turn the tables for shorts.

Over the past couple of weeks I have seen the name move intraday on all kinds of speculation and minuscule calls. This is somewhat uncharacteristic for Ciena and tells me the stock is ready to move.

I expect the stock to trade up 7-10% (or higher) putting $12.50 level in play with $12.80-13.00 levels not out of question if the market plays ball. Although I think this call may have the ability to look right trough any market action.

All, in all, Actionable!

Officemax (NYSE:OMX): Upgraded to Overweight at J.P. Morgan; target raised to $20

J.P. Morgan is making a major call on Officemax (NYSE:OMX) and Staples (NASDAQ:SPLS) upgrading both to Overweight from Neutral and raising price targets to $20 (prev. $13) and $30 (prev. $25), respectively.

Firm notes their upgrade reflects 1) the companies’ high correlation to modestly improving labor markets; 2) the significant potential earnings power in a stronger economic environment; and 3) their view that the back-to-business season in 1Q will be an important positive catalyst for the group. For OMX specifically, a recovery from depressed sales and earnings combined with structural margin improvement during the downturn should lead to outsized stock performance. For SPLS, sales growth in 2010 should drive accelerating margin progression from CXP synergies, product mix, and expense leverage, ultimately leading to upward earnings revisions. Finally, while both names have intriguing valuations, OMX is still trading near trough levels.

These rating changes are now in tandem with JPM's Overweight rating on ODP (upgraded in May 2009). Given the significant correlation to payroll expansion, they view this as a sector call once one expects a modest labor market rebound. At this point in the cycle, if one of these stocks works, then the others will likely do so as well (as they believe others over-estimate “structural” deficiencies at ODP). ODP and OMX are the riskier small-cap, depressed earnings recovery investments. SPLS is the larger cap, relatively lower risk, and best-in-segment investment (and one of the deepest management teams in all of retail). The corresponding risk-reward for ODP and OMX reflect this dynamic and offer higher potential upside. In other words, they view the choice as a risk tolerance question.

Substantially higher earnings power. Mid-cycle EPS for ODP and OMX center on $1.00 and $1.70, respectively, suggesting upside to ~$14 and ~$24 (using mid-cycle PE multiples of 14x). This represents potential upside of 109% and 73% for ODP and OMX, respectively. Using similar criteria, mid-cycle potential upside for SPLS is 15%. As one would expect, peak cycle reflects even higher potential appreciation.

OMX: Raising their Dec 10 price target to $20. JPM is raising their December 2010 price target to $20 from $13 previously, representing 45% upside from current levels. This is based on the following: 5.2x EV/EBITDA – this compares to its historical FY2 average of ~8x and a peak valuation of ~12x; 0.21x price-to-sales (per share) – this is below its historical average of 0.25x and compares to its current valuation of 0.15x, which is one of the lowest tracked valuations in their weekly Valuation Master report and the lowest in their coverage universe

Substantially Higher Earnings Power
As JPM highlights in the chart that follows, all three companies (ODP and OMX in particular) have significant earnings power in a normalized sales and margin environment.

Firm's mid- and peak-cycle sales assumptions are as follows: mid-cycle, they assume $13.5B in annual sales for ODP, $8.0B for OMX, and $26.0B for SPLS; during the peak-cycle, they assume $15.0B in sales for ODP, $9.0B for OMX, and $29.0B for SPLS.

Mid-cycle EPS for the beaten down “junior players” center on $1.00 and $1.70 for ODP and OMX respectively, suggesting upside to ~$14 and ~$24, respectively (using mid-cycle PE multiples of 14x). This represents potential upside of 109% and 73% for ODP and OMX, respectively. Using similar criteria, mid-cycle upside for SPLS would be 15%. As one would expect, peak cycle reflects even higher potential appreciation.

OMX Is at a Big Discount
OMX continues to trade at a discount compared to JPM coverage universe and historical multiples, while SPLS remains a compelling large cap, best-in-segment retailer.

For OMX, on a P/E basis, the company appears to be trading at a premium, but one must consider the significant earnings power highlighted above. Furthermore, using our EV/EBITDA and P/LTM Sales, OMX is arguably the cheapest stock in our coverage at 5.2x EV/EBITDA using our 2011 forecasts. As a reference, the company’s historical EV/EBITDA and P/LTM Sales averages are ~8x and 0.25x, respectively

Notablecalls: Make no mistake, this call is all about Officemax (OMX) and a lot less about Staples (SPLS). Take a look at what Office Depot (ODP) did when when JPM upgraded it on May 29 2009 (see archives) - it gapped up over 10% and resumed higher by 25% over the next 2 days.

Needless to say JPM's $20 target is the new Street high.

I would not be surprised to see OMX trade up 7-10%, putting the $15 possibly in play. Note that JPM is saying there may be even more upside than implied by their $20 target. This should create strong buy interest. Note there's a 14% short interest in the name.

We have Intel (INTC) and J.P. Morgan (JPM) trading weakish in the early going in reacting to earnings, which is keeping the general market in check & should give you possibly good fills already in the pre-market.

Oracle Corp. (NASDAQ:ORCL): Added to Best Ideas List at Morgan Stanley

Morgan Stanley is out quite positive on Oracle Corp. (NASDAQ:ORCL) raising their price target to $31 (prev. $29) and adding the stock to to Morgan Stanley’s Best Ideas list.

Firm notes they see three catalysts: 1) imminent closure on the Sun acq., whose benefits are being largely overlooked, 2) a return to organic growth in Oracle’s core as early as Q3, and 3) positive revisions. Morgan Stanley's FY11 EPS of $1.94 is well above cons. of $1.72, which does not reflect a) accretion from Sun, and strong execution should enable ORCL to meet/exceed its $0.15 target, and b) the level of improvement in the core bus. that they anticipate. With ORCL trading at 12X our CY11 EPS – a sub hardware multiple on software EPS and 25% below large-cap tech – they should see multiple expansion with accelerating growth and pos. revisions, driving the stock to firm's $31 PT based on 15x CY11 EPS of $2.09.

Sun should be positive catalyst: Based on Morgan Stanley's proprietary analysis of Sun published on December 22nd, they est. ORCL can drive at least $0.15–0.20 of EPS accretion if they execute well on the deal, and while cyclical rev. improvement is likely, it would be incremental to those ests. Further visibility from ORCL on the strategy will improve both investor comfort in Sun’s strategic value, as well as the financial benefits.

Core businesses improving: Firm's checks indicate that the applications & database market are improving, and the co. is seeing an uptick in ELA activity. Sun has taken investor focus off the core bus., yet they believe the co. will be a net share gainer as IT spending recovers. Cons. lic. targets reflect little improvement in CY10, while they think ORCL should see (cc) license growth accelerate for the next 4-6 Qs and upside to forecasts.

Major product cycles: For the first time in a decade, ORCL has product cycles in all major areas: Database 11g R2 (released in 9/09), Middleware 11g (released in 7/09), and Fusion Applications—which should be a cantilever for growth as IT spending improves.

ORCL’s multiple has contracted 30%+ in the last 5 years, suggesting the acquisition strategy is yielding underappreciated benefits in a) accelerating technology growth, b) accelerating margins and c) an ROIC above WACC.

ORCL’s 12X CY11 EPS valuation is ~40% below Morgan Stanley's software group’s median P/E of 22X. As consensus EPS begins to move up, yielding 20% growth in CY11 earnings, investors should find multiple avenues for price appreciation in ORCL.

Notablecalls: Interesting call from Morgan Stanley. I think the stock will react positively with upside to the tune of $0.50-0.75 over the course of the day if the market plays ball.

Note that in addition of adding ORCL to MSCO's Best Ideas list, they have issued a Research Tactical Idea on the name which should create some additional buy interest.

Affymetrix (NASDAQ:AFFX): Downgraded to Underperform at Barclays; target lowered to $3

Barclays is making a major call on Affymetrix (NASDAQ:AFFX) downgrading the stock to Underweight from Equal-Weight and lowering their target to $3 (prev. $6)

Firm notes the downgrade is based on increasing visibility on new technologies that are rapidly rendering the company's products obsolete. New sequencing technologies are now becoming price competitive with Affymetrix's array (chip-based) products, especially for gene expression analysis, which has traditionally been Affymetrix's strongest end market; competitors are releasing new products in the coming months.

The genetic analysis space is evolving rapidly, with the cost of obtaining genetic data declining at a rate faster than Moore’s Law. This is a powerful fact and one that Barclays believes offers the promise to fundamentally change the practice of medicine just as the computer has changed society, though also means that companies involved in the space are under unrelenting pressure to innovate. Given the extraordinary advances in sequencing technologies in recent years, it is now possible to generate genetic information at a cost that is orders of magnitude cheaper than just a few years ago. Rather than slowing, the pace of innovation has actually increased recently, with numerous next-generation technologies close to market. By mid-decade, they expect these technologies are likely to enable the complete sequencing of a human genome for less than $1,000.

In the meantime, significant work is still being done on arrays, which generate less information but are cheaper. In some applications, however, work previously done on array platforms is now done on sequencing instruments given decreasing cost; new technologies available in the coming months are likely to be totally cost competitive (or even superior) on instruments that also allow more-advanced sequencing work. In particular, Affymetrix archrival Illumina recently announced the HiSeq 2000 platform, which has comparable cost and throughput to microarrays in a highly automated platform with minimal labor required. In a two-day run, researchers can perform epigenetic profiling on 200 samples for less than $200/sample. This is comparable or even superior to Affymetrix’s array technology.

Firm notes they do not believe that researchers are likely to commit to an entirely new generation of (not backwards-compatible) instrument from Affymetrix given the competition (which, in their opinion, also has superior brand equity given the last decade of what they believe to be AFFX’s strategic missteps, as well as missing an entire product cycle). There will likely remain some level of ongoing demand for arrays on the company's existing installed base, though this should diminish over time. To further complicate matters, the company has struggled with profitability even with more than $300M in run-rate revenues, making even post-restructuring AFFX among the least efficient companies in Barclays coverage. With a probable increase in pricing pressure from new technologies and declining revenues, they do not believe that this company can be profitable in the long-term without a substantial course correction that may well be too late.


Firm is substantially lowering their revenue estimates and widening their loss estimates for AFFX, especially in the outer years. In their view their estimates represent a conservative view on the company’s prospects though by no means a worst-case scenario, which could involve an even more rapid erosion of the installed-base demand for arrays to new competing technologies. In Barclays view, the company's core technology faces serious challenges to long-term viability.

Barclays is lowering their price target on AFFX to $3, or an EV/EBITDA multiple of ~8x their FY2011 estimate of $16M, a multiple in line with peers. Their old $6 price target was ~8x their old 2011 EBITDA estimate of $38M.

Notablecalls: I think this call has the ability to inflict some serious damage to Affymetrix's (AFFX) stock price today. Back in 2009 it seemed the co still had a fighting chance to overcome competition (See archives for Piper upgrade July 23) but now I think it's increasingly evident they won't.

Note how Barclays says their estimates (and the $3 price tgt) represent a conservative & by no means the worst-case scenario for AFFX. They are basically saying it could get a lot worse from here.

I would not be surprised to see AFFX trade down 10%+ today on that downgrade - putting $5.70 level in play.

Needless to say, Barclay's $3 target is the new Street low for the name. I suspect that many of the market participants that were betting on AFFX's revival will be throwing in the towel after this call.

MGM Mirage (NYSE:MGM): Upgraded to Buy at Goldman Sachs; target $16

Goldman Sachs is upgrading MGM Mirage (NYSE:MGM) to Buy from Neutral this morning with a $16 price target (unch).

According to the firm their upgrade is based on:

1) Their expectation that Las Vegas trends will start to get “less bad” over the next several quarters, 2) MGM’s earnings power currently being at trough levels, but even if it were to get back to the mid-range of its historic earnings potential, there is strong upside to the shares, 3) shares are undervalued on current and mid-level earnings, especially relative to those of its peers, 4) corporate finance activities could create a relief rally as balance sheet issues would weigh less on the shares, and 5) there will be little new supply in Vegas after current projects open.

Goldman notes thier upgrade offers both high risk and high reward, in that it is based on a Las Vegas recovery that is in very early stages and could stall out by a weaker-than-expected consumer or because they are underestimating the impact of room over-capacity. But they are lowering their MGM estimates: the firm now believe that earnings are close to trough levels and that valuation is closer to the mid-point of the historical range, creating great upside if there is a turn.

MGM, with its 40,000 Strip rooms (35,075 excluding the Las Vegas City Center) and approximately 27% market share, is the purest play on a Vegas recovery. The company has made a series of missteps that led the shares to underperform over the past two years. Notably, MGM did not rally in 2009 while nearly every other casino stock did, illustrating long-term investor concerns about the shares. MGM’s “mistakes” include 1) the build out of CityCenter which even in Goldman's best-case scenario will not make more than a 5% return initially; 2) basing cash flow and returns for City Center on selling high-end condos on the Vegas strip even while the city was facing an unprecedented building surge and after seeing resale weakness at MGM’s own Signature tower; and 3) not moving early to lower its debt load through a capital raise, which has left the company highly leveraged at 8.7X net debt-to-forecasted 2009E EBITDA.

Although some may view this as “water under the bridge” the firm notes they are not willing to give MGM “a pass.” To them, it illustrates the broader problem of Vegas developers in general that is not exclusive to MGM. For what has seemed like forever, casino executives have exhibited an extreme desire to build more casinos to “sustain growth” rather then trying to boost same store sales, improve ROIC/margins and return cash to shareholders to “create value.” Even with these broad-based concerns for all of the casino companies, they are upgrading MGM.

MGM is trading at a discount to its history along with LVS and Wynn non-Macau operations
MGM appears undervalued relative to other gaming equities. On Goldman's revised 2010 EBITDA estimate it has an 11.3X multiple, which is a discount to Las Vegas Sands and Wynn. More interesting is the comparison to Las Vegas Sands and Wynn looking at the implied value for non-Macau assets. Firm looked at Las Vegas Sands and Wynn and separated out the value of their free trading Macau equities and come up with a 16.6X multiple on Las Vegas Sands’ US and Singapore assets and a 13.7X multiple on Wynn’s Las Vegas assets. MGM’s multiple is several points below these data points. Even compensating for the higher leverage of MGM it seems that this discount is too high. They suspect this is due to investor concerns about the initial profitability of City Center, but given our long-term view that Las Vegas will recover with the broader economy, the valuation disparity just seems too wide.

MGM’s missteps over the past few years, coupled with its leverage, may have created a situation in which most investors have overlooked its earnings power. Furthermore, like Goldman, if investors want to benefit from a travel recovery they would rather buy the hotel stocks. Goldman agrees with this from a fundamental perspective, but given MGM’s discounted multiple and strong earnings power they are willing to take this risk given the potentially major reward.

Notablecalls: With a blessing from Goldman Sachs the shares of MGM can & probably will trade higher today. The futures are in the red in the early going (thanks Alcoa!) which may give you some decent fills in the pre market.

I expect MGM to trade up 5-7% today - $11.45-11.75 range.

Note that the short interest in MGM stands at a whopping 47%.

Goldman is also out somewhat positive on LVS & WYNN.

Arch Coal (NYSE:ACI): Upgraded to Overweight at Morgan Stanley

Morgan Stanley is upgrading Arch Coal (NYSE:ACI) to Overweight from Underweight and raising their price target to $35 (prev. NA). Firm EPS estimates are raised significantly.

Morgan Stanley notes they are getting more constructive on a recovery for US thermal coal as the timing for an inflection in utility coal stockpiles may come sooner than expected. ACI is one of the most leveraged names to play a bullish thermal coal theme, in firm's view. The stock underperformed in 2009 as the market penalized it for having a significant unpriced thermal coal position in a weak environment, and Powder River Basin (PBR) exposure. Morgan believes the market will reward these very characteristics in 2010, and have lifted their 2011 EPS estimate by 59%, to $2.80, or 57% ahead of consensus. ACI trades at 5.5x their 2011 EBITDA estimate, and our $35 price target offers 30% upside.

Market to reward PRB exposure. For now, the market views Central Appalachian (CAPP) producers as a better leverage play to a cyclical recovery in thermal coal demand. But PRB producers have managed supply well through the downturn, and a combination of improving power demand and supply challenges in Eastern US coal should translate to higher market share and pricing power for PRB miners. Longer term, the economics of PRB coal make it a key fuel source for the utility industry.

Western Bit segment improvement not appreciated. Operating rates are improving, costs are falling, and below-market contracts are rolling off in 2011. Morgan Stanley thinks Arch’s Western Bit segment can expand margins, driven by significant unit cost reduction this year and a repricing to market of 50% of production next year.

Opportunity in met coal. They now model ACI’s met coal sales at 5 mmtpy in 2010, up 67% from their prior forecast. Firm believes the current scarcity of premium hard coking coal will create opportunities for Arch to increase its mix of higher margin, high-vol met coal.

Investment Debates Summary:

1. How leveraged is the Powder River Basin to a recovery in thermal coal demand?

Market’s view: Central Appalachian producers are a better leverage play to a cyclical recovery in thermal coal demand. Excess regional capacity and weak demand will weigh on PRB coal prices.

MSCO view: PRB prices should rise with Central App Historically, PRB prices have lagged CAPP, but they expect PRB prices to rise in tandem in this cycle. PRB prices could be sluggish near term, but should benefit as Eastern US coals are pushed toward being the marginal fossil fuel for electric power. Longer term, the firm thinks PRB volumes will grow as it increases share of the US thermal coal market at the expense of Eastern US coal, which faces significant structural challenges.

2. Timing of return of thermal coal pricing power

Market’s view: A late-2010 or 2011 event at best

MSCO view: Favorable weather has accelerated drawdown; supply may lag potential utility term coal demand growth they had expected a turn in the utility coal inventory cycle in 2H10. A favorable winter burn has accelerated the winter stockpile drawdown, and we believe may bring utilities back into the market to secure term contracts. Given the amount of supply currently idled, contract prices could move higher.

3. Western Bituminous margin expansion

Market’s view: Fundamentals could remain depressed

MSCO view: Operating rates are improving, costs easing, and 9 mmt of below-market contracts are rolling off. Firm sees significant Western Bit margin expansion taking place in phases. First, they expect significant unit cost cuts in 2010 as mine operating rates recover. Second, 9 mmt of below-market contracts will roll off in 2011; despite weak thermal coal markets, pricing today is still +20% above the average contract.

Notablecalls: MSCO looks to be somewhat late with their ACI call. Yet, the stock looks uber-strong in the very short term, helped by economic news out of China & the upgrade.

I'm guessing this one will trade above the $28 level today with $28.50+ not out of the question.

PS: Careful out there. We may get some surprise selling in the n-t. Just a gut feel.

Chipotle Mexican Grill (NYSE:CMG): Upgraded to Overweight from Underweight at Morgan Stanley

Morgan Stanley is making an interesting call on Chipotle Mexican Grill (NYSE:CMG) double upgrading the stock to Overweight from Underweight while raising their target to $111 (prev. $76).

Specific reasons they would own this stock in 2010:

- CMG will be the leading restaurant growth stock of any meaningful market cap, based on firm's work only 40% saturated in the US, with the ability to at least double and perhaps triple its current store base. That growth potential, combined its current rate of growth should command a valuation commensurate with that superior growth; today it does not

- 2010 EPS consensus is too low by ~10% just holding current margins flat

- CMG has more pricing power than investors believe and will use that to defend margins in 2010;

- SSS, specifically traffic, are poised to rebound with the economy, easier comparisons and company-specific drivers such as the introduction of kids meals and easier to navigate menu boards.

Pricing survey and store saturation analysis highlight opportunities. Morgan Stanley's proprietary pricing work suggests CMG’s prices are ~5–10% lower than peers on most items, providing pricing opportunities the market does not see and allowing CMG to hold best-in-class operating margins. Working with Morgan Stanley AlphaWise, their updated store saturation analysis suggests that CMG is only 40% saturated in the US.


There’s also a broader reason: With tighter budgets and less time, consumers are seeking out dining options that save time and money, especially relative to the casual dining alternative. CMG is one of two clear leaders in this “quick-casual” category (the other being Panera). At the same time, consumers are increasingly aware of food quality and wholesomeness. CMG is a pioneer in this area among restaurants and has created a significant competitive advantage with its all-natural supply chain.

How this call fits with out broader thinking: Stock picking in 2010 for restaurants is likely to be more idiosyncratic, with a bias toward growth (both domestic in the case of CMG or PFCB) and international (in the case of YUM). While early in the year we have a bias toward the casual diners as the consumer recovers, they think QSR will look attractive by midyear as we begin to lap the slowdown of last summer.

Morgan Stanley is raising their estimates on CMG for 4Q09 (to $0.89 from $0.84) and 2010 (to $4.45 from $4.00). Much of their increase is predicated on belief that the current run rate of restaurant margins will carry over into 2010 (24.7% now vs. MSCO's prior estimate of 23.8%), as well as their increased confidence in SSS growth (now +3% vs. prior +1.6% estimate).

CMG is the fastest grower in restaurants — with still industry leading returns. Entering this recession, there were no fewer than a dozen public restaurant chains that could claim the mantel of a growth stock, each with unit growth rates of 15%+ and EPS growth rates of 15%+. Exiting this recession, that list has been pared to just 3–4 companies that can maintain unit growth and EPS growth of mid teens and low 20% respectively, and only one, CMG, that has a market cap of more than $1 billion. CMG has not only the best rate of growth but also the best unit economics in the cohort. In firm's view, this scarcity of growth should be reflected in a premium valuation for those companies that have demonstrated growth. Currently, CMG shares do not reflect that growth scarcity premium that they think they ought to.

Raising their price target on CMG to $111, or 25x 2010e EPS. Firm notes they believe this multiple, below the historical average P/E of 32x since the 2006 IPO but still a premium to current valuation, is reasonable in light of expected 20–25% future EPS growth and best-in-class ROIC. Their target multiple represents a PEG ratio premium of 1.0–1.2x, a far lower PEG ratio than historical averages for best-in-class growers of 1.4x, but more appropriate in firm's view given the expected more muted consumer spending environment over the next few years. The 20-year average PEG ratio for growth restaurants is 1.0x, and they feel given CMG’s best in class returns currently that it warrants a 10–20% premium to that historical average.

Alternative valuation metrics also supportive. On an EBITDA basis, CMG shares trade at under ~9x 2010e EBITDA, a slight premium to peers especially in light of the fact that CMG has no funded debt. Similarly, on a FCF-yield basis, shares trade at ~4%, lower than peer average of ~10%, largely due to deploying cash into growth. Unlike many peers, CMG has not slowed growth through this recession (developer delays not included).

Notablecalls: Growth story, best in class operating margins & Morgan Stanley reversing their previous negative stance saying there could be 10% upside to current consensus EPS. All this coupled with a ~40% short interest.

The shorts lost an important ally.

This one should work. I'm guessing CMG can trade to $90 and $91.50 if the market plays ball & we get the stock moving.

Let's see how it works out.

Bank of America (NYSE:BAC): Upgraded to Outperform at CSFB; Added to Focus List

Credit Suisse is making a major call this morning upgrading Bank of America (NYSE:BAC) to Outperform from Neutral with a $21 price target (prev. $17) and is adding the stock to their Focus List.

Firm notes they are recommending Bank of America, as the current risk/reward on the shares is attractive at current levels. BAC is the cheapest of their large cap banks on “normal” earnings trading at about 6.1 times (vs. large cap peers at 7.6x) and will build book value rapidly during 2010. Based on a pre-tax pre-provision earnings estimate of approx. $65 billion and net income of $27 billion, CSFB's normalized EPS estimate stands at $2.65. Furthermore, they look for book value growth in 2010 which marks an inflection point from a 23% decline in book value in 2009. are currently forecasting 7% growth in book value and 15% growth in tangible book value in 2010. Firm expects Bank of America to earn $0.90 per share in 2010, realize a mark-to-market gain in 3Q’10 related to CCB shares, as well as generate approx. $3.0bn in capital due to asset sales (CSFB incorporated into 3Q’10 estimates) which will support book value growth in 2010. Firm's revised price target of $21 (from $17) equates to 1.5 times est. forward tangible book value and 7.9 times normalized earnings

The repayment of the entire $45 billion of TARP preferred relieves a significant overhang on the shares, particularly given the intense regulatory and political scrutiny surrounding the company and its receipt of government money. Bank of America was one of only a few banks categorized as receiving “extraordinary assistance” from the government, which likely pressured the company to take more proactive actions to exit the program. The nearterm financial implications of the capital raise and repayment are favorable including both near-term EPS and tangible book value accretion. While the capital raise is about 10% dilutive to CSFB's normalized earnings per share estimate ($2.65), the capital raise is about 3% accretive to tangible book value. With a fairly significant capital raise behind the company and bolstered capital levels (pro forma Tier 1 common equity ratio of 8.5% vs. large cap peer median of 7.5%), they expect shares to outperform over the next 12 months.

Furthermore, CSFB notes they are encouraged by the slowing growth in non-accruals at Bank of America. The deceleration in problem asset growth began in 1Q’09. While part of the slowdown is attributable to the higher base of problem assets, there is a discernable slowdown taking place (up at 10% pace vs. peak q/q growth of 66% in 4Q’08). We would expect the slowdown to continue into 2010, and they are currently projecting that problem asset growth will turn negative in 2Q’10.

Firm recognizes that a primary risk to their thesis is that credit quality deterioration is worse than they are currently anticipating and consequently it takes longer for the company to achieve their “normalized” earnings estimate. Separately, another risk lies in the company’s successful integration of Merrill Lynch.

Earnings Estimates
Bank of America’s recently announced capital actions are accretive to near-term EPS. Factoring in both the capital raise and TARP repayment, they are raising their 2010 EPS estimate to $0.90 from $0.80 previously. The elimination of the $3.6 billion in annual preferred costs provides a significant near-term EPS lift, given depressed earnings levels.


Capital
CSFB is currently forecasting 7% growth in book value and 15% growth in tangible book value in 2010. This will mark an inflection point following a year in which book value per share declined 23%. While the next two quarters are likely to result in book value pressure (TARP repayment in 4Q’09 and FAS 166/167 implementation in 1Q’10), they look for improved growth in 2H’10. Firm expects Bank of America to earn $0.90 per share in 2010, generate a mark-to-market gain in 2H’10 related to CCB shares, as well as realize $3.0bn in capital due to asset sales (they incorporated into 3Q’10 estimates) which all serve to support book value growth in 2010.

Notablecalls: I think this is exactly what the stock needed to get to $17 in the very n-t. CSFB Focus List is something that I have grown to like & respect over time as The Credit Suisse Investment Policy Committee's recommendations have outperformed the market quite nicely over the past years.

I would compare the current BAC upgrade to the Morgan Stanley (MS) upgrade(s) we got couple of days ago. These show the analysts are getting comfortable with the names again which in turn means more money will pour in. This serves to push the stocks higher.

All in all, a good one. I expect it to trade $16.75+ today and closer to $17 if the market plays ball today.

Salix Pharmaceuticals (NASDAQ:SLXP): Top Pick for 2010; raising target to $58 - Piper (Actionable Call Alert!)

Piper Jaffray is out with a major call on Salix Pharmaceuticals (NASDAQ:SLXP) this morning calling the stock their Top Small Cap Pick for 2010 and raising target to $58 (prev. $29).

The firm believes that Street estimates (including their own) have been significantly underestimating the pricing power associated with Xifaxan in its expansion markets. They are raising their Xifaxan estimates to better reflect pricing expectations cited by SLXP at its analyst day in November 2009. As such, they are raising their price target to $58 from $29. Piper remains confident that Xifaxan,with label expansions on the way in hepatic encephalopathy (HE) and non-constipation irritable bowel syndrome (IBS), will emerge as a blockbuster product and would continue to be enthusiastic buyers of SLXP shares.

Significant Xifaxan pricing power justified in both HE and IBS settings. Piper recalls that SLXP at its analyst day in November 2009 cited a price of up to $23 for the 550 mg pill that will become available for the new indications. In HE, this translates into a daily cost of $46 (1,100 mg per day) and an annual cost near $16,600. This is reasonable in their view given the significant potential for reduced HE-related hospitalizations. In non-constipation IBS, the daily cost could be as high as $69 per day (a daily dose of 1,650 mg) and a cost of $966 for 14-day treatment course. Three 14-day courses per year translates into an annual cost of near $2,900. They also believe this is reasonable. Firm notes that other GI agents such as Shire's Lialda and Warner Chilcot's Asacol can cost as much as $5,000 per year.

Raising Xifaxan sales estimates; over $1B in sales by 2014. Piper's EPS estimate rises to $7.55 by 2014, up from $3.42. With a relatively concentrated GI prescriber audience, and therefore modest sales force expansion requirements, they believe that margin expansion over the long-term could be compelling. SLXP has suggested that it can reach 70% of the IBS prescriber audience (plus the entire HE audience) with a sales force of 400 reps (it is already expanding its sales organization to 240 reps).

Confident in positive outcome for 2/23/10 FDA panel meeting for Xifaxan in HE. Piper believes that the panel meeting will go smoothly for a number of reasons:

1) compelling efficacy from Phase III showing a reduction in the risk of a breakthrough HE episode of over 50% for Xifaxan relative to placebo;

2) a relatively clean safety profile in Phase III HE study and in its experience on the
market both in the U.S. and overseas; and

3) lack of documented antibiotic resistance. On this last point, Xifaxan has been available overseas for well over a decade and is approved in 10 countries for HE. As such, the lack of documented antibiotic resistance over its lengthy commercial life overseas should give the panel greater comfort in this respect.

INVESTMENT RECOMMENDATION:
With Xifaxan peak sales in excess of $1.0B realistic, Piper Jaffray believes Salix is the most
compelling small-cap growth story in the specialty pharma space. They base their $58.00 price target (up from $29) on their 2014 EPS estimate of $7.55 (up from $3.42), times a P/E of 12x, discounted at 15% (up from 11%, and better reflecting greater commercial risks associated with their higher estimates).

Notablecalls: Actionable Call Alert! - this call is the one that makes the tiny hairs on the back of my neck tingle with excitement. And that, my dear readers hasn't happened in a while!

So, what makes this one so special?

- Piper analysts David Amsellem & Michael Dinerman are raising their estimates for Xifaxan way-way past every firm on the Street. Their revenue estimates are now almost double of their peers. I'm sure others will need to catch up & will do so in the n-t.

- The $58 price target from Piper is the new Street high. The previous Street high was $36.

- Take a look at the chart on this one. It's ready to break to new highs. There is nothing stopping it. Nothing!

Right now people are looking for these kind of plays that have potentially big upside for 2010. They don't care about buying the DNDN's and HGSI's of the world. There isn't enough upside there. They WANT the SLXP's.

I must say this one has big upside for today. It will likely trade up above the $28 level today and I would not be surprised to see $29.

This baby wants $30 in the n-t. It wants it and I don't see anything stopping it. This is the type of call that will make the stock trade up for days. This one is a game-changer.

PS: This one has a 18% short interest - phew! The pain. The PAIN. I didn't realize the number that that high.