S&P Keeps Buy on Verizon

Northwest Airlines and Lexmark get downgraded, Gemstar-TV Guide stays at a sell ranking, and more

Verizon Communications (VZ ): Maintains 4 STARS (buy)

Analyst: Todd Rosenbluth

(Update) Following Verizon's call to discuss second-quarter results that were 2 cents below our estimate, we remain confident that wireless growth will be the driver of revenues and that cost cutting will remain a key focus. We are lowering our 2005 and 2006 EPS estimates by 2 cents and 20 cents, respectively, to $2.56 and $2.74, largely on expected broadband pricing changes and Verizon's fiber buildout. Even with sizable cable competition and the expected integration of its pending wireline merger, we believe that Verizon has the strongest fundamentals of the Bells. We continue to view the shares as undervalued.

Gemstar-TV Guide (GMST ): Reiterates 2 STARS (sell)

Analyst: Gary McDaniel

We believe the $110 million overhaul of the flagship magazine will significantly increase costs while reducing revenues. The magazine will be targeted at a younger demographic, but we believe this target audience is more likely to rely on online listing and news sites and interactive program guides from their cable providers. We believe that printed TV listings is a declining product and unlikely to show future growth; we would prefer the magazine be run for cash. Additionally, Gemstar-TV Guide is again exploring a sale of SkyMall, the only contributor to profitability in its publishing segment.

Northwest Airlines (NWAC ): Downgrading to 2 STARS (sell) from 3 STARS (hold)

Analyst: James Corridore

Second-quarter operating loss of $3.21, vs. 90 cents loss, is about in line with our $3.23 loss estimate. We saw no major surprises in the earnings report. But, we are worried about Northwest's inability to get labor cost cuts; the company admits it faces Chapter 11 filing if it is unable to get labor concessions and pension plan changes. It also faces a potential mechanics strike that could force a cutback in service. While there is possible upside if Northwest ultimately gets its cost cuts, we think the risks are too high. We are lowering our 12-month target price to $3 from $7.

Lexmark International (LXK ): Downgrading to 3 STARS (hold) from 4 STARS (buy)

Analyst: Megan Graham-Hackett

Second-quarter earnings per share of $1.06 before special items, vs. $1.02, is in line with our estimate, but about 2 cents is from a lower share count. The surprise in the second quarter was the revenue shortfall, up just 3% vs. our 8% forecast, as weakness in Europe led to aggressive pricing and slower supplies growth. We are lowering our 2005 EPS estimate to $4.31 from $4.58. While we view Lexmark's continued investments to expand its product line as helping future revenue growth, we see near-term pressure on EPS gains. We are lowering our discounted cash flow-based target price to $72 from $80 on 15-year free cash flow growth of 9% vs. our prior 10%.

Gilead Sciences (GILD ): Upgrading to 5 STARS (strong buy) from 4 STARS (buy)

Analyst: Frank DiLorenzo, CFA

Based on Gilead's solid second-quarter and our forecast of brisk growth in its HIV treatment franchise, we see an enhanced opportunity following the recent share pullback. We continue to project anti-HIV franchise sales of $1.33 billion. The company is also generating significant cash, with second-quarter operating cash flow exceeding $291 million. We are raising our 2006 EPS estimate to $1.67 from $1.64. With our EPS growth rate projection of 24.4% through 2008, Gilead's p-e-to-growth of 1.1 compares favorably to the peer average of 1.4. Assuming the shares trade to a PEG of 1.5, our 12-month target price remains $57.

Martha Stewart Living (MSO ): Reiterates 1 STAR (strong sell)

Analyst: Gary McDaniel

MSO and Discovery Communications announces TLC will air the new "Martha" show and MSO will develop an original reality series to air on one of Discovery's networks. The syndication of "Martha" to cable was widely anticipated, but the new reality show was not. We believe this show is a better fit with MSO's brand than the Apprentice spin-off and may drive additional magazine and merchandise sales. However, our model already assumes that an additional new series would launch in 2006; thus, we are maintaining our estimates of a loss of 74 cents per share in 2005 and EPS of 1 cent in 2006.

Medco Health (MHS ): Upgrading to 4 STARS (buy) from 3 STARS (hold)

Analyst: Phillip Seligman

Second-quarter earnings per share of 48 cents, vs. 46 cents, is in line with our est. We are encouraged by client wins outweighing losses and higher cash flow. We think the planned Accredo acquisition will boost Medco's competitive strength; the deal is expected to close in August pending needed approvals. We expect EBITDA/adjusted script, which fell 2.6%, to rise on mail-order penetration. We expect 2006 EPS to be aided by the Medicare drug program, absence of program start-up costs, and lap of client loss. We are raising our target price by $3 to $56, or 20 times our 2006 $2.80 cash EPS estimate, in line with peers.

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