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Stock Analyst Update

Week in Stocks: A Blue-Chip Tech Bargain Shows Progress

Plus, private equity giants go wild, Medtronic posts a strong quarter, and more.

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Dell's (DELL)  preliminary  third-quarter earnings significantly exceeded Wall Street's expectations. As Morningstar analyst Mark Lanyon had  earlier predicted, sales growth was again tepid, advancing only 3.4% from a year ago, though operating margins widened by 150 basis points. In Lanyon's opinion, this showing reflects Dell's calculated retreat from certain PC segments in favor of various higher-margin offerings that are emerging. Thus, while this shift damped growth, it drove improved operating profitability. More generally, Lanyon thinks that Dell is in the midst of an evolution away from a PC-centric business model toward a more balanced set of hardware, software, and service offerings to corporate customers. This, he believes, should allow Dell to move past its recent fundamental challenges (such as flagging customer service and reliance on the mature North American PC market) and confer more-respectable growth and operating profit performance than the company's current share price reflects. As such, Lanyon is maintaining his fair value estimate.
 Full Analyst Report: Dell

Blackstone Pays Through the Nose for Equity Office Properties Trust
On Monday, private-equity giant The Blackstone Group announced that it intends to purchase office property REIT Equity Office Properties Trust (EOP) for $48.50 per share in cash in what would be the largest take-private deal ever. The offer represents an 8.5% premium to the stock's Friday closing price and an even-steeper premium to Morningstar analyst Arthur Oduma's fair value estimate. Oduma thinks investors should take the money and run. Equity Office is the third public office real estate investment trust that Blackstone has bought in the recent past, the other two being Trizec and CarrAmerica. Given the size of the deal, which approximates $36 billion, Oduma doubts there will be many rival offers and, thus, expects the transaction to close as scheduled in early January 2007.
 Full Analyst Report: Equity Office Properties Trust

Medtronic Posts Strong Quarterly Results
Medtronic's (MDT) second-quarter performance yielded some signs that the implantable cardioverter defibrillator market is stabilizing and turning the corner after being rocked by widespread recalls at Guidant (now a part of Boston Scientific (BSX)) last summer. Following a 6% decline in  implantable cardioverter defibrillator sales during this year's fiscal first quarter, Medtronic eked out a 4% sales increase in the second quarter and has solidified its more than 50% share of the  implantable cardioverter defibrillator market. As long as Wang doesn't see more recalls issued, she anticipates that the market should regain its low-double-digit growth rate by the end of 2007. In the face of Medtronic's formidable salesforce, Wang believes that Boston faces an uphill battle to regain the market share it has lost in the aftermath of the recalls. Yet, while this is good news for Medtronic, Wang had already built this increase into her projections. As such, she's holding her fair value estimate steady.
 Full Analyst Report: Medtronic

Bank of America Scoops Up Wealth Manager U.S. Trust
Bank of America (BAC) said Monday that it plans to acquire U.S. Trust, a white-glove firm catering to the ultrawealthy, from Charles Schwab (SCHW) in a $3.3 billion cash deal. In Morningstar analyst Craig Woker's opinion, the deal looks to be quite pricey from Bank of America's perspective, as the deal value implies that the company is buying U.S. trust at a tax-inclusive price/earnings multiple in the range of 35-40, which is steep for a mature, relatively slow-growing business. Even assuming that Bank of America can significantly reduce costs--because of the significant level of corporate overhead that Schwab allocates to the business--Woker doubts that the purchase price is justifiable solely on the merits of U.S. Trust's earnings prospects. Nevertheless, Woker points out that the purchase, set to close on March 31, will have a minimal impact on Bank of America, and thus Woker envisions making no change to his fair value estimate. Conversely, Morningstar analyst Patrick O'Shaughnessy sees the deal as a much-needed move for Schwab. O'Shaughnessy contends that U.S. Trust had never been a good fit with Schwab's "average investor" mantra, and its slow growth and lagging profit margins made it a drag on Schwab's results. Not surprisingly given Woker's concern about the acquisition's price, O'Shaughnessy thinks it's a good deal for Schwab. Given management's previously stated willingness to explore acquisition opportunities, O'Shaughnessy thinks that Schwab will use the $2.5 billion in aftertax proceeds to fund future purchases. His fair value estimate is unchanged for now. 
 Full Analyst Report: Bank of America
 Full Analyst Report: Charles Schwab

More Restructuring for Alcoa
On Tuesday, Alcoa (AA) announced that it had signed an agreement to dump its underperforming soft alloy extrusion business into a joint venture with Orkla ASA's Sapa Group. The soft alloy business represents about 45% of the $4.6 billion in annual revenue generated by Alcoa's extrusion group. Morningstar analyst Scott Burns observes that the extrusion group has been the laggard of Alcoa's portfolio; operating margins have rarely surpassed 2% over the past several years. Burns thinks that the joint venture, which Sapa is slated to be run, should benefit from increased operating leverage by eliminating redundant capacity and increasing utilization at the most efficient plants. Burns has seen similar moves in other commodity businesses (especially chemicals) generate tremendous results for the contributing parties. Also, by letting Sapa manage the soft alloy business, Burns hopes that Alcoa can focus on improving the fortunes of its aerospace-related hard alloy extrusion segment. Although Burns likes the move, he's maintaining his fair value estimate because he'd already factored improvement in the extrusion business into his assumptions.
 Full Analyst Report: Alcoa

Newspapers Align with Yahoo
Several newspaper groups, including Belo (BLC), Cox Newspapers, Hearst, Journal Register (JRC), Lee Enterprises (LEE), MediaNews, and E.W. Scripps (SSP), have signed a deal with Yahoo (YHOO) that will allow them to sell ads on Yahoo's HotJobs site, providing additional exposure for their local and regional job listings. The agreement also calls for the newspapers and Yahoo to potentially share content and search capabilities. Morningstar analyst Jim Walden thinks this is an intriguing alliance, providing newspapers with more scope and attractive technology features for their own Web sites. In Walden's opinion, this deal further highlights a rather meaningful shift in strategy for newspaper publishers: teaming up with a dominant Internet player. It comes just after several publishers  inked a deal allowing them to sell ads through Google's (GOOG) site.
 Full Analyst Report: Belo
 Full Analyst Report: E.W. Scripps
 Full Analyst Report: Journal Register
 Full Analyst Report: Lee Enterprises
 Full Analyst Report: Yahoo

Sanmina-SCI Posts Atrocious Results
Sanmina-SCI (SANM) reported fiscal 2006 results that capped off an atrocious year. Revenue decreased by 6.6% from 2005, primarily because of weak computer demand from Sanmina's largest customer, Lenovo (LNVGY). Profitability and revenue should recover from operational improvements in the company's printed circuit board segment, increasing revenue from core electronics manufacturing services (which earn gross margins around 8%, near the top of the industry), and the transition away from the unprofitable original design manufacturing segment. Nevertheless, Morningstar analyst Andrew Golomb remains skeptical about management's ability to convert opportunities into shareholder value. Operational problems, accounting headaches (not the least of which are the company's soon-to-be-restated financial statements, which remain in arrears), and an evolving business strategy cast much uncertainty on Sanmina's future. If additional restructuring charges or operational missteps occur, Golomb will probably lower his fair value estimate, but because he had forecast dismal results, he's maintaining his fair value estimate for now. 
 Full Analyst Report: Sanmina-SCI

ADC Telecommunications Should See Improvement in 2007
ADC Telecommunications (ADCT) is slated to report fiscal fourth-quarter results on Dec. 12. Although Morningstar analyst John Slack isn't expecting any major surprises in the quarter given  management's cautious guidance last quarter, he said he believes that the company is well positioned heading into fiscal 2007. The second half of 2006 saw a spending pause due to carrier consolidation and Verizon's (VZ) efficiency gains with its fiber deployments, which required fewer equipment cabinets to serve the same number of homes passed. However, looking forward to 2007, Slack said ADC stands to benefit as carriers shift from building infrastructure to connecting homes. In Slack's view, we are still in the early stages of a multiyear initiative by carriers to upgrade their access networks, and these infrastructure upgrades should drive sales growth at ADC for the next year or two. However, the lumpy nature of large infrastructure projects means that ADC has limited quarter-to-quarter visibility. Slack is leaving his fair value estimate unchanged.
 Full Analyst Report: ADC Telecommunications

Roundup of This Week's Feature Commentary
As readers might recall from our last piece on corporate governance, the actions of a company's management team, as well as its board of directors, can have a significant impact on investor returns. While it's usually calamities like Enron and WorldCom that grab the headlines, more-commonplace missteps like poor decisions in the executive suite (or rubber-stamp oversight by supposedly independent directors) can erode shareholder value in the long term. In this piece, Morningstar analyst Greggory Warren reviews how options-backdating hurts investors, explains what it takes to score an "F" for management compensation under Morningstar's Stewardship Grade methodology, and offers some takeaways for the duly governance-minded long-term investors among us.
Why Some Corporate Boards Fail Investors

Hotel investors needed steely resolve to brave the lodging industry's ups and downs over the last five years. From 2000 to 2003 occupancy plummeted by more than 4 percentage points while nightly rates fell 2.5% over the same period. Since then, hotels have rebounded: Occupancy and rate levels are quickly approaching the industry's mid-1990s peak. Stock performance has mimicked these travel trends; bellwether Marriott International  (MAR) lost 40% of its value from August 2001 to February 2003, but has since appreciated by more than 200%. In this piece, Morningstar analyst Jeremy Glaser recounts the toll that 9/11 took on hotel stocks and describes the factors that have driven the subsequent recovery in room rates and occupancy. In addition, Glaser explains why he thinks growing demand and a limited supply of new rooms should keep the hotel industry healthy in the years to come and reviews the ways investors can take advantage of the rosy scenario that has taken hold.
Hotel Stocks We Like

SLM (SLM), better known as Sallie Mae, is the dominant player in the attractive student loan market. That attractiveness has bred competition. However, we believe Sallie boasts a wide moat that should protect its profits over the long haul. In this video report, Morningstar director of stock analysis, Pat Dorsey, explains how recent  subsidy-reduction fears have created a great buying opportunity for this wide moat firm.
Video Report: SLM

With market gains exceeding the pace at which companies are compounding their underlying economic value,  we're seeing fewer bargains. In short, the pool of five-star stocks has gotten appreciably shallower since last summer. Nevertheless, as Morningstar director of stock analysis Pat Dorsey points out in the following video report, values can still be had. In particular, Dorsey highlights a number of high-quality, wide-moat companies that happen to be selling at what we consider bargain-basement prices.
Video Report: High-Quality, Wide-Moat Stocks for Any Outcome

This Week's 10 Most Popular Stock Analyses
 Hansen Natural (HANS)
 Thomson ADR (TMS)
 Accenture (ACN)
 Apollo Group (APOL)
 Sanmina-SCI (SANM)
 Cheniere Energy (LNG)
 Computer Sciences (CSC)
 Dell (DELL) 
 Genentech (DNA)
 Compton Petroleum (CMZ)

Jeffrey Ptak does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.