S&P Cuts Darden Restraurants to Hold

Darden Restaurants (DRI ): Downgrades to 3 STARS (hold) from 4 STARS (accumulate)

Analyst: Dennis Milton

Darden shares have rebounded nearly 30% from their March low, and now trade at 15 times S&P's fiscal 2004 (May) earnings per share estimate of $1.45, a slight discount to peers. S&P believes this valuation adequately reflects the company's growth prospects. S&P's cash flow model, which assumes earnings growth at an 11%-12% rate over the next five years, and gradually declining growth rates thereafter, intrinsically values shares at $22. S&P would not add shares at this valuation, but recommends investors hold their current positions.

Children's Place (PLCE ): Upgrades to 2 STARS (avoid) from 1 STAR (sell)

Analyst: Mark Basham

The retailer's second-quarter loss of 35 cents vs. a 38-cent loss is worse than S&P's 28-cent projected loss, reflecting a gross margin S&P found disappointing. But S&P thinks this stemmed from clearing more summer seasonal inventory by July. S&P is raising the fiscal 2004 (Jan.) earnings per share estimate to 47 cents, from 45 cents, on the belief that the merchandise mix going into the third quarter is much cleaner and should produce better margins. S&P is raising the free cash flow projections, since Children's Place will continue a less risky 50-per-year new-store pace in fiscal 2005. Based on S&P's revised discounted cash flow model, S&P is raising the 12-month target price to $17 from $13.50.

Merck (MRK ): Maintains 3 STARS (hold)

Analyst: Herman Saftlas

Merck received $2 billion from the Medco pharmacy-benefits management unit, related to a planned spinoff (effective Aug. 19) of the unit to Merck shareholders at 0.1206 Medco share per Merck share. The divestiture will cut Merck's ongoing revenues by over 50%, but should have only a minimal impact on profits, with benefits management margins significantly below core pharmaceutical margins. Factoring in the absence of Medco, along with new competition for cholestorol drug Zocor, S&P is lowering the 2004 earnings per share estimate by 5 cents, to $3.70. At 14 times S&P's 2004 estimate, well below peers, and yielding 2.8%, S&P continues to recommend investors hold Merck.

MetLife (MET ): Maintains 4 STARS (accumulate)

Analyst: Catherine Seifert

MetLife disclosed in its 10Q (released last night) that the U.S. Securities and Exchange Commission is investigating its mutual fund subsidiary after glitches in the unit's asset allocation software led to investor losses. S&P is maintaining the 2003 earnings per share estimate of $2.90, since the $3 million to $11 million in pretax charges that MetLife expects to pay will not materially impact these results. S&P is wary that more issues may be uncovered and would not be surprised if MetLife was forced to outsource these functions. But S&P's thesis that MetLife is an undervalued franchise remains intact, assuming these issues are contained.

Flextronics International (FLEX ): Maintains 5 STARS (buy)

Analyst: Richard Stice

Flextronics agreed to acquire Microcell Group, an original design manufacturer of mobile communication devices, for $80 million cash plus the assumption of $120 million of net liabilities. The transaction, set to close in October, is expected to have a neutral to slightly positive impact on Flextronic's fiscal 2004 (March) results. S&P views the planned deal as positive, since it should broaden Flextronics's overall capabilities and expand margin performance. S&P's 12-month target price of $15 equates Flextronic's p-e-to-growth ratio with S&P's information-technology sector category and combines it with S&P's discounted cash flow analysis.

American Eagle Outfitters (AEOS ): Maintains 3 STARS (hold)

Analyst: Yogeesh Wagle

American Eagle posted July-quarter earnings per share of 11 cents vs. 14 cents, in line with S&P's estimate. Despite controlled expenses, operating margin narrowed 130 basis points on the impact of a 5.5% same-store sales decline and lower merchandise margin. S&P thinks American Eagle will have a modestly successful back-to-school season as it enhances its brand focus, launches more value-priced products, and adds more activewear. At 12 times S&P's $1.42 fiscal 2005 (Jan.) earnings per share estimate, American Eagle is below peers and the S&P MidCap 400. But S&P sees only slight upside; S&P thinks American Eagle faces faster-growing and trendier peers in the crowded teen retail space.

Enzon Pharmaceuticals (ENZN ): Upgrades to 4 STARS (accumulate) from 3 STARS (hold)

Analyst: Frank DiLorenzo

June-quarter earnings per share of 26 cents was a penny above S&P's estimate. Royalties on PEG-Intron of $20 million were $2 million above S&P's view and Abelcet sales of $17.5 million were $2.5 million above. Enzon could start pivotal trials of PEG-Camptothecin in gastric and gastroesophageal cancers, and ATG-Fresenius S for transplant rejection in the second half of fiscal 2004 (June). Enzon sees flat royalties for the next two quarters, and a pickup in later quarters. S&P estimates GAAP fiscal 2003 earnings per share of 70 cents and sees 80 cents earnings per share in fiscal 2004. S&P sees limited growth prospects into next year and suggests biotech investors focus on higher-growth stocks.

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