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   March 10, 2010 @ 6:30 PM EST
TODAY'S COMMENTS
6:06pm Psychiatric Solutions Psychiatric Solutions just confirmed in an 8-K filing that the company is in talks to...
Rumor by Vicki Bryan
Psychiatric Solutions just confirmed in an 8-K filing that the company is in talks to be acquired. This story was first reported earlier today by The Wall Street Journal, which also noted that the potential acquirer is Bain Capital. Recall that Bain, as one of the shareholders of HCA, just received part of the huge and controversial $1.75 billion dividend payment distributed by the company in February (and funded with debt, as was the record breaking LBO of HCA in 2006). According to the WSJ story, PSYS has had discussions since last fall with other potential buyers like CCMP Capital Advisors, Kohlberg Kravis Roberts, and Blackstone, but nothing came of it. We can think of a number of problems with Psychiatric that troubled us enough to downgrade our opinion last year. Revenue growth has slowed, and pricing is weakening. Persistent and troubling problems with patient safety recur despite management's apparently vigorous intervention. Psychiatric continues to spend most of its cash on expansion and acquisitions, but revenue per licensed bed has been falling. Most of the cash used to repay debt in 2009 was generated from the sale of the troubled EAP business. Psychiatric has disappointed market expectations for revenue and profits over most of the past year, and management's outlook has become even more cautious for 2010. All of this explains why Psychiatric stock, which has averaged about $23.50 per share this year, is probably no bargain even though it is well off the $42 peak reached in 2007. That price equates to a multiple of nearly 8x trailing EBITDA, which is higher than average of 7x for larger hospital operators of similar credit quality (and none of Psychiatric's headline risk). Add the typical 25% premium to equity for a buyout, and the implied stock price approaches $30 per share--swelling to nearly 9x. That plus the implied increase in leverage would be hard to justify to potential investors in the new bonds that would be sold to pay for all of this, which implies more expensive interest costs (and lower cash flow) down the road and still no resolution of Psychiatric's myriad of operating problems. All of this throws the likelihood of a deal in jeopardy. Maintain "underperform."
11:35am Bon-Ton Stores This morning, Bon-Ton Stores reported results slightly ahead of our expectations. For the...
Earnings by Evan Mann, CFA
This morning, Bon-Ton Stores reported results slightly ahead of our expectations. For the fiscal fourth quarter ended January 30, sales were down 2.8% to $1.0 billion, primarily from a 2.4% decline in same store sales. The EBITDA margin widened 220 basis points to 13.5% due to a lower level of markdowns and ongoing cost savings. EBITDA increased 16% to $135.3 million from $116.7 million in the fourth quarter of fiscal 2008. For fiscal 2009, EBITDA was up 33% to $209.1 million with the ratio of total debt/EBITDA improving to 4.9x from 7.4x in fiscal 2008. We estimate that fiscal 2009 EBITDAR of $308 million covered interest plus rent 1.6x, up modestly from 1.3x in fiscal 2008. More importantly, rent adjusted leverage improved to a manageable 5.9x from 7.6x last year. Bon-Ton ended the fiscal year with $358 million available under its $675 million asset-based bank revolver, well above the $75 million minimum availability required by the retailer's secured credit agreements. Although no cash flow statement was provided, free cash flow (cash flow from operations less capital spending) was used to reduce year end debt by about $130 million to $1.0 billion. Management's fiscal 2010 EBITDA guidance of $225-240 million, up from $209.1 million in fiscal 2009, is driven by additional cost savings of $20-25 million and same store sales that are expected to be flat to up 2%.
11:10am Novartis AG Novartis Capital (guaranteed by Swiss pharmaceuticals giant Novartis) issued $5 billion in short-...
New Issue by Carol Levenson, CFA
Novartis Capital (guaranteed by Swiss pharmaceuticals giant Novartis) issued $5 billion in short- and intermediate-term debt yesterday to pre-fund part of its $28 billion commitment to purchase the next 52% of eyecare company Alcon. Prior to announcing this $50 billion acquisition, Novartis was a relative unknown in the U.S. corporate bond market. Nevertheless, its low business risk and high credit quality made for relatively easy sledding, and it raised the $5 billion at a weighted average interest cost of less than 3%. We have some qualms about this name, given management's lack of a track record in paying down acquisition debt of this magnitude, its willingness to "step down" markedly from its triple 'A' throne for this acquisition, and the uncertainty surrounding its rejected bid for the remaining minority interest in Alcon. Please see our upcoming full report.
TODAY'S REPORTS
Investment Grade
Kroger  Kroger Co. reported mixed results for its fourth quarter, capping a difficult year for the nation's largest conventional supermarket operator. But Kroger's...
March To Savings by B. Craig Hutson, CFA
Public Service Enterprise Group  On Monday, Public Service Enterprise Group held an analyst conference, originally scheduled for February 26. On March 2, Public...
Right Assets, Right Plan by Philip C. Adams, CFA
High Yield
Terex  Terex stock is up about 15% in the last week, perhaps due to speculation the the company could be acquired. We expect Terex to be an acquirer instead, using the cash...
Target Practice by Shelly Lombard
TUESDAY'S COMMENTS (3/9/2010)
4:25pm Amgen Inc. The company joined the bond issuance parade today, reportedly issuing $1 billion in two tranches. ...
New Issue by Carol Levenson, CFA
The company joined the bond issuance parade today, reportedly issuing $1 billion in two tranches. At year-end, Amgen had no short-term debt and $13.4 billion in cash (well in excess of its total debt), so it doesn't need to issue long-term debt. Hence the stated use of proceeds is "general corporate purposes" and the cash raised may even be used for share buybacks. These new issues will better balance the company's maturity schedule, however, which currently is heavily weighted towards the next couple of years. Although the company's business risk profile is weakened by its product concentration, it generates voluminous free cash flow and possesses excellent financial flexibility and sterling debt protection measures. We recently raised our credit score to "stable," but generally find that bonds trade rich. According to Bloomberg, the ten-year tranche was priced at T+80, which is not outrageously rich but offers little upside.
4:12pm Anheuser-Busch Inbev Moody's affirmed its 'Baa2' rating on Anheuser-Busch Inbev and raised its outlook to...
Ratings Action by B. Craig Hutson, CFA
Moody's affirmed its 'Baa2' rating on Anheuser-Busch Inbev and raised its outlook to positive from stable. The action follows ABI's strong performance in 2009 despite challenging operating conditions. For the full year, revenues and adjusted EBITDA rose 2.5% and 16.6%, respectively. ABI believes it gained market share in markets that represent 70% of its total volume. Moody's is pleased that ABI has made excellent progress in reducing its overall debt burden. The combination of a rights issue, robust free cash flow, asset sales, and refinancings have helped ABI to repair its balance sheet. Leverage declined to 3.7x from 4.7x, but it has a long way to go to reach ABI's target of 2x. We expect the brewer to use its free cash flow to repay its new $5 billion three-year term loan. We believe 2010, while still uncertain, will prove to be a better year than 2009. ABI will benefit from the World Cup this summer. ABI bonds have rallied significantly since being included on our Top Ten on September 8. We reiterated our outperform in a full report published yesterday.
2:21pm Sprint Nextel Corporation Sprint's shares are trading up sharply for the second consecutive day. The...
Market Movement by Dave Novosel, CFA
Sprint's shares are trading up sharply for the second consecutive day. The purported stimulus is comments from CFO Bob Brust regarding the company's debt structure and liquidity. He stated at an investor conference yesterday that Sprint intends to pay down the $5.2 billion of debt maturing in the next couple of years rather than refinancing it. Sprint has $750 coming due in the second quarter, $1.65 billion maturing in January of 2011, and $2.75 billion maturing in 2012. Sprint has indicated as much in the past so it did not strike us as newsworthy. Moreover, Sprint ended the year with almost $4 billion in cash and we expect free cash flow to easily exceed $2 billion this year. Therefore meeting its obligations should not be problematic. Mr. Brust admitted that the subscriber losses and high level of churn are troublesome, and vowed that the company was committed to improvements of both metrics. He also stated that stable revenue is possible. But given the mature postpaid market, the task could prove daunting.
1:45pm U.S. Concrete U.S. Concrete stock may be delisted soon unless the price recovers consistently above $1 per...
News by Vicki Bryan
U.S. Concrete stock may be delisted soon unless the price recovers consistently above $1 per share. The company announced this morning that the Nasdaq has served notice following 30 consecutive days when the stock closed below $1. Actually, the stock has closed below $1 since late January, and it's not clear that it will ever recover. As we noted in a comment on 2/23 and a report on 2/25, the company is not likely to survive without a major restructuring. It recently hired financial and legal advisors and it has announced plans to "address" its bond debt. RMIX's banks have cut their exposure by reducing the loan commitment and we expect them to block the bond interest payment on April 1. Bankruptcy is an unsavory option for the bonds, since we don't believe RMIX's asset value supports the current pricing in the mid-50s, so bondholders are likely to face a tough negotiation with little leverage. The stock has been worthless for some time, so chances are high that it will be delisted when the 180-day grace period expires.
12:34pm Smithfield Foods There was encouraging news yesterday that should benefit Smithfield Foods. The U.S...
News by Vicki Bryan
There was encouraging news yesterday that should benefit Smithfield Foods. The U.S. Department of Agriculture reported that Russia has decided to resume imports of U.S. pork and pork products. Russia, which reportedly buys 6% of pork production in the U.S., had banned U.S. pork imports for several months, with most of the plants on its restricted list belonging to market leader Smithfield. The news is timely, coming on the heels of recent industry data which indicates that the breeding hog population in the U.S. and Canada is down. Hog spot and futures prices are firming. Smithfield likely will elaborate further on the positive impact when it reports earnings on Thursday for its fiscal third period ended in January. We have projected a moderation in the downward trends versus the previous two quarters, with revenue down just 5% in the third quarter to $3.2 billion, along with improving profitability with EBITDA margin increasing to 4%-6%. We will discuss third quarter results in an upcoming report.
11:20am Limited Brands Yesterday, Limited Brands announced that it has paid off the remaining $200 million of its term...
News by Evan Mann, CFA
Yesterday, Limited Brands announced that it has paid off the remaining $200 million of its term loan and amended its bank credit agreement. The size of the bank revolver was reduced to $927 million from $1.0 billion. While $127 million of this facility will continue to mature in August 2012, $800 million of the commitment was extended until August 2014. More importantly for Limited Brands, the company was able to loosen the restricted payments covenant. There are no longer any restrictions as long as the trailing four quarter ratio of consolidated debt to EBITDA is less than 3x. For the fiscal year ended January 30, leverage was 2.2x and the retailer had $1.8 billion of cash on hand. As articulated previously, we believe loosening the restricted payments covenant is a prelude to the resumption of common share repurchases or other shareholder friendly actions.
11:03am Merck As was expected (see our comment dated 7/30/09), this morning Merck and Sanofi-Aventis announced they were...
Asset Sale by Carol Levenson, CFA
As was expected (see our comment dated 7/30/09), this morning Merck and Sanofi-Aventis announced they were combining their animal health businesses in a joint venture with 50/50 ownership by the two companies. As per the July agreement, Merck will get an additional $750 million payment and also $250 million in "true-up" compensation reflecting the value of the assets it is contributing to the joint venture (essentially the Schering-Plough animal health business). The deal is subject to antitrust approval, which may prove tricky as antitrust objections raised by the Schering-Plough acquisition caused Merck to sell half of its animal health business to Sanofi-Aventis in the first place. Animal health (as we can personally attest) is a huge and growing market and the joint venture, with its geographic and product diversity selling to a customer base of farmers, veterinarians, and "companion animal" owners, should be a strong entrant. Assuming it is approved by the regulators, this is a modest positive for Merck, not only for the cash payment but also by enabling it to continue to participate with scale in this market.
9:44am Toyota Motor Corporation Toyota went to great pains yesterday to discredit an SIU professor and ABC News...
News by B. Craig Hutson, CFA
Toyota went to great pains yesterday to discredit an SIU professor and ABC News over a report that alleged that SUA in Toyota vehicles could be caused by electronic problems. Toyota has repeatedly maintained that electronics are not a cause of SUA and that it has identified the proper fixes for its vehicles. Toyota's arguments yesterday appeared to provide solid evidence that Professor Gilbert's actions were inconsistent with real world driving conditions. Professor Gilbert is expected to meet with Toyota and Exponent, its independent engineering firm, to discuss the results in the next several weeks. We wish that Toyota would put as much effort into finding the root cause of SUA in its vehicles as it did into discrediting Professor Gilbert. Just yesterday there was another highly publicized case of a runaway Prius on a California highway. The Prius in question was not subject to any of the recent recalls. Toyota has acknowledged the case and dispatched a team of engineers that will likely conclude that there was no problem with the electronics system. An admission of a problem with the electronics system, or a software issue, etc. will prove to be a much bigger hit to Toyota's brand image than anything it has suffered so far. We are still in the early stages of how this entire saga will play out for the world's largest automaker.
TUESDAY'S REPORTS (3/9/2010)
Investment Grade
MetLife  The early line on the MetLife-ALICO transaction from equity investors is that the deal will be a win-win combination. Bondholders have taken a slightly more cautious...
Global Reach by Kathleen Shanley, CFA
Walt Disney  A couple of Oscars and an impressive opening weekend for its new release, Alice in Wonderland, was overshadowed by the spat with Cablevision regarding...
An Oscar For Retransmission by Dave Novosel, CFA
Masco  Masco got a boost from the rating agencies just in time for its first new issue in three years. But the outlook for housing starts and home improvement spending is...
Bond-Aid by Carol Levenson, CFA
High Yield
Teekay Corporation  The cyclical low point for tanker spot market rates may be in the rear view mirror. Last week, Teekay Corporation reported fourth quarter EBITDA in...
Spot Rates In The Tank  by Evan Mann, CFA
Wendy's/Arby's Group  Stock in Wendy's/Arby's Group took a dive last Thursday after the company announced fourth quarter results that missed market estimates for...
Forewarned is Forearmed by Vicki Bryan
Target 3/2 
Nordstrom 2/26 
Simon Prop 2/26 
GMAC 2/26 
Huntsman 2/23 
Toyota Motor 2/23 
Penney 2/22 
Duane Reade 2/17 
Marriott 2/16 
Jones Apparel 2/12 
Nalco 2/12 
Corrections 2/10 
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Rigorous Analysis
Coverage of Key Securities
Every report is one page, and concludes with an actionable investment recommendation.
Mar 9, 2010 | Marketwatch
KS on "AIG Wraps Up Deal With MetLife" Quote- But KS said now that AIG has dealt away its biggest chips with the Alico and AIA sales, she doesn't expect any comparably scaled deals in the future...
Mar 9, 2010 | Bloomberg
KS on "GMAC Finance Chief Hull Will Join Providence Equity" Quote-Under normal circumstances, it wouldn't be surprising to see a shake-up in the executive ranks when a new CEO comes in."
Mar 8, 2010 | Forbes.com
KS on "AIG Wraps Up Deal With MetLife" Quote - "ILFC's debt burden has been a deterrent to potential buyers."
Mar 5, 2010 | Medill Report
DN on "R.R. Donnelley's new acquisition is a good fit, but analysts are still concerned" Quote- "The biggest problem is that it's a fragmented industry, with tons of smaller competitors. As large as Donnelley is, their market share is small...
Mar 5, 2010 | Bloomberg
KS on "U.S. Corporate Credit Risk Index Falls to Lowest in Six Weeks" Quote - "A company filing this week with the U.S. Securities and Exchange Commission shows it "still faces significant challenges in working out its portfolio of troubled assets..."
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