S&P Cuts Circuit City to Avoid

Also: Analysts' opinions on Interstate Bakeries, Corinthian Colleges, McDonald's, and more

Circuit City (CC ): Downgrade to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Tom Graves, CFA

The company's November-quarter 10 cents loss per share, vs. 4 cents in EPS a year ago, is a few pennies better than estimates. However, we see the stock being hurt by concerns about gross margin pressure, lower finance income, and absence of February-quarter EPS guidance. We are reducing our fiscal year 2003 (ending February) EPS estimate to 40 cents from 43 cents, and fiscal year 2004's to 42 cents from 52 cents. We view CC as being in a transition mode, with both years including 14 cents per share of store remodeling or relocation costs. However, we at S&P are wary of its shares at about an 11% p-e premium to the S&P 500 index (based on calendar 2003 profit projections).

Interstate Bakeries (IBC ): Lower to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Richard Joy

IBC reported November-quarter EPS before special items of 33 cents, vs. 41 cents, 15 cents below expectations. Sales declined 0.3% on lower branded bread and cake volumes. Gross margin narrowed 80 basis points on higher ingredient, healthcare, and pension costs. IBC is feeling the impact of higher cocoa and sugar costs. We believe cake weakness will continue and have slashed our fiscal year 2003 (ending May) EPS estimate by 68 cents, to $1.30, on a competitive environment and cost outlook. We would avoid IBC shares, given the lack of EPS visibility and absence of near-term catalysts.

Corinthian Colleges (COCO ): Starting coverage with 5 STARS (buy) recommendation

Analyst: Michael Jaffe

COCO quickly became a big player in the for-profit higher- education. Its initial growth came via acquisitions, but it has added campus openings to its mix. Based on for-profit's rising share, COCO's focus on attractive markets such as health care, and greater knowledge needs in the workforce, COCO should experience an extended growth period. We see $1.30 in EPS in fiscal year 2003 (ending June) and $1.65 in fiscal year 2004. The stock is trading above the market at 28 times our fiscal year 2003 estimate, but it is undervalued based on our call for 25% or more EPS growth in the next few years.

McDonald's (MCD ): Maintains 3 STARS (hold)

Analyst: Dennis Milton

McDonald's lowered its December quarter earnings per share estimate by eight cents, to 26 cents, because of disappointing sales and higher advertising and technology spending. Same-store sales in the U.S. dropped 1.3% in October and November, despite efforts to drive traffic through heavy discounting. Also, a previously announced restructuring plan is now expected to cost 31 cents per share -- more than expected. According to S&P's cash-flow model, McDonald's shares are at a 25% discount to their intrinsic value. However, S&P would not add to positions in the absence of improving sales trends.

GlaxoSmithKline (GSK ): Maintains 3 STARS (hold)

Analyst: Herman Saftlas

GlaxoSmithKline is still working with the FDA to resolve safety issues on Advair, an inhaled corticosteroid for Chronic Obstructive Pulmonary Disorder, often referred to as smoker's lung. The FDA meeting is planned for early 2003. With increasing off-label use for this disorder, S&P sees Advair sales rising 30% to $1.8 billion in 2003. S&P has raised its 2003 estimate by five cents, to $2.60, aided by at least six new drugs next year. However, Glaxo still faces a generic challenge to Paxil and other drugs. Its shares are valued at a 20% discount to the big-pharma price-earnings multiple.

FEI Company (FEIC ) and Veeco Instruments (VECO ): Maintains 2 STARS (avoid)

Analysts: Ari Bensinger, Richard Tortoriello

The companies say that they will not be able to complete their pending merger by the Dec. 31 deadline. Under the terms of their agreement, if the merger is not consummated by Dec. 31, either party has the right to terminate. With the original $1 billion stock-swap deal in July now valued at slightly over $500 million, FEI may not agree to extend the deadline. With weak operating momentum and major uncertainties hanging over FEI and Veeco, S&P would continue to avoid both chip equipment stocks.

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