New 5-STARS this week: During the trading week ended Oct. 17, the following issues were added to Standard & Poor's list of stocks with its highest investment ranking, 5 STARS (buy). S&P analysts expect those issues to outperform the S&P 500 index by a very wide margin over the next 6 to 12 months.
• Cadence Design (CDN ; recent price, $15)
S&P analyst Richard Tortoriello raised his rating on the chip-design software outfit from 4 STARS (accumulate on Oct. 16 after Cadence reported third-quarter pro forma earnings per share of 12 cents, vs. 15 cents one year earlier, on an 18% sales drop, in line with his estimate. Subscription backlog provided 70% of sales, vs. 30% in the prior-year period, and Cadence sees an average of 70% in 2004. The trend in operating margin is improving, says Tortoriello, and he sees Cadence strengthening its digital integrated-circuit product offering and already-strong analog design flow. The analyst raised his 2003 EPS estimate to 48 cents from 45 cents, and his 2004 forecast to 80 cents from 67 cents. He thinks Cadence is attractive at 3.6 times sales, which is slightly below the 10-year average of 3.8 times. Tortoriello's 12- month target price is $20 -- which is 5 times trailing sales, below historic peak levels.
• City National (CYN ; recent price, $54)
Shares of the California-based bank holding company were upgraded from 4 STARS by S&P analyst Evan Momios on Oct. 16 after the company reported third-quarter earnings per share of $1.05, vs. 94 cents one year earlier, 10 cents above S&P's estimate and 11 cents above the consensus Wall Street projection. Momios says this earnings surprise stems from improved asset quality and the fact that City National took no provisions for loan losses. He believes the company's guidance for minimal-to-no loan loss provisioning, implied in its 2003 outlook, will extend into 2004 and, combined with S&P's outlook for a better economy, boost EPS. He is raising his 2003 EPS estimate to $3.91 from $3.74, and his 2004 forecast to $4.30 from $4.11. Momios is also raising his 12-month target price to $66 from $58, or about 15 times S&P's 2004 EPS estimate, in line with City National's fast-growing industry peers.
• Mentor (MNT ; recent price, $24)
S&P analyst Robert Gold, who upgraded the maker of products for aesthetic and general surgery (plastic and reconstructive surgery) and urology from 4 STARS on Oct. 15, thinks Mentor is compelling regardless of the outcome of the FDA panel decision on Inamed's (IMDC ) silicone breast implant. Gold notes that Mentor, priced at 16 times his $1.31 2004 earnings per share estimate and 2.4 times his 2004 sales projection, trades at steep discount to Inamed and the medical device group, yet offers a 2.5% dividend yield and, in S&P's view, a solid balance sheet. Gold sees no change to Mentor's fundamentals if the panel rejects Inamed's product. If it is approved, he sees Mentor entering the market by the third quarter of calendar 2004 and expects the valuation gap to narrow considerably. (The FDA panel approved the product on Oct. 16.) He raised his target price to $30 from $26, based on a multiple of 20 to his fiscal 2004 EPS estimate of $1.50.
• ImClone Systems (IMCL ; recent price, $39)
In upgrading the biotech outfit from 4 STARS on Oct. 13, S&P analyst Frank DiLorenzo noted that ImClone shares were trading lower that day despite FDA acceptance of its Erbitux Biologics License Application to treat colorectal cancer, as well as a priority review, which could result in approval by February, 2004. According to the analyst, the next important news should be word on an FDA advisory panel meeting by early November. He continues to project early 2004 approval of Erbitux, with initial sales of $179 million in 2004 more than doubling in 2005, and peak U.S. sales of $1.5 billion by 2012. DiLorenzo still expects ImClone to reach profitability in 2005. He is maintaining his 12-month target price of $50, based on our his net present value analysis.
New 1-STARS this week: These stocks joined the ranks of 1-STARS stocks -- S&P's designation for issues expected by S&P analysts to underperform the S&P 500 index by a wide margin over the next 6 to 12 months -- during the trading week ended Oct. 17:
• Level 3 Communications (LVLT ; recent price, $6)
S&P analyst Todd Rosenbluth downgraded the shares from 2 STARS (avoid) on Oct. 15. He notes that since Level 3's third-quarter revenue warning three weeks earlier, its shares rallied more than 15%, reflecting, he believes, optimism in the broader market. More recently, the stock climbed 9% on Oct. 14 on what Rosenbluth feels is unwarranted enthusiasm surrounding a discounted Internet service offering from major customer AOL (TWX ). He does not think this offering will cause strong near-term demand for Level 3's core data transport services. The analyst remains wary of the company's lack of interest coverage and its above-peers valuation based on EBITDA (earnings before interest, taxes, depreciation and amortization). Rosenbluth's 12-month target price remains $4.