TSC Ratings' Updates: Southwest

AK Steel, Hanesbrands, Quest Diagnostics, Southwest Airlines and Western Digital are downgraded.
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The following ratings changes were generated on Friday, Oct. 17.

We've downgraded

AK Steel Holding

(AKS) - Get Report

from buy to hold. Strengths include its revenue growth, largely solid financial position with reasonable debt levels by most measures and notable return on equity. Weaknesses include poor profit margins, weak operating cash flow and a generally disappointing performance in the stock itself.

Revenue grew by 19.6% since the same quarter one year ago, trailing significantly the industry average of 72.2% but still boosting EPS. The 0.51 debt-to-equity ratio is low and below the industry average, implying successful management of debt levels. The company also maintains an adequate quick ratio of 1.06, which illustrates the ability to avoid short-term cash problems.

AK Steel's gross profit margin of 15.4% has decreased from the same quarter last year and is rather low. Its net profit margin of 6.5% significantly trails the industry average. Net operating cash flow has decreased to $161.20 million, or 36.70%. In addition, when comparing the cash generation rate with the industry average, the firm's growth is significantly lower.

We've downgraded

Quest Diagnostics

(DGX) - Get Report

, which provides diagnostic testing, information and services that enable physicians and other healthcare professionals to make decisions to improve health, from buy to hold. Strengths include the company's revenue growth, higher earnings, higher cash levels, sound leverage, and key business initiatives. Weaknesses include declining operating margin and diminishing returns. In addition, frequent changes in laws and regulations in the U.S. may negatively impact the company's future performance.

Quest Diagnostics' net second-quarter sales advanced 12%, with the acquisitionAmeriPath adding about 8.1% to the growth. Revenue increased to $1.84 billion from $1.64 billion a year ago. Revenue from clinical testing rose 12.4% to $1.68 billion, while revenue from other operating segments climbed 8.3% to $161.41 million. Revenue per requisition increased 7.1%, and clinical testing volume, measured by the number of requisitions, rose 4.9%. Cash and cash equivalents jumped to $143.40 million from $122.30 million in the comparable quarter of last year. The debt-to-equity ratio improved to 0.89 from 1.23 as total debtdeclined and shareholders' equity increased 15% to $3.67 billion.

Selling, general and administrative expenses advanced 10.9% to $438.04 million from $395.11 million a year ago. Amortization expenses surged 85.3%. Operating margindeclined to 16.67% from 16.78%. Returns declined despite an increase in net income. Return on equity narrowed 114 basis points to 16.56% from 17.70%. Return on assets contracted 197 basis points to 4.59% from 6.56%.

Quest entered the Indian insurance sector by becoming the sole provider of health assessment services for Birla Sun Life Insurance. The Indian premium market is expected to more than double to $80 billion to $100 billion by 2012. The company raised its estimate for fiscal-year 2008 EPS from continuing operations to be in the range of $3.10 to $3.20 on revenue growth of about 9%.

We've downgraded

Hanesbrands

(HBI) - Get Report

from hold to sell, driven byits generally weak debt management, weak operating cash flow and generally disappointing historical performance in the stock itself.

The debt-to-equity ratio is very high at 6.08 and currently higher than the industry average, implying very poor management of debt levels within the company. Hanesbrand maintains a poor quick ratio of 0.88, which illustrates the inability to avoid short-term cash problems.Net operating cash flow has significantly decreased to -$30.48 million, or 129.83%, when compared with the same quarter last year. In addition, the firm's growth rate is much lower than the industry average.

Since the same quarter one year prior, revenue slightly dropped by 4.4%, but EPS increased nonetheless. Hanesbrands' 38.4% gross profit margin is strong and has increased from the same quarter last year. Its net profit margin of 5.3%, however, trails the industry average. Shares are down 44.3% on the year, underperforming the S&P 500. This decline could help make the stock attractive down the road, but we believe that it is too soon to buy.

We've downgraded

Southwest Airlines

(LUV) - Get Report

from buy to hold. Strengths include its revenue growth, largely solid financial position with reasonable debtlevels by most measures and reasonable valuation levels. Weaknesses include deteriorating net income, poor profit margins and weak operating cash flow.

Revenue rose by 11.7% since the same quarter last year, outpacing the industry average of 4.2%, but EPS declined. The current debt-to-equity ratio, 0.38, is low and is below the industry average, implying successful management of debt levels. The 0.68 quick ratio, however, displays a potential problem in covering short-term cash needs.

Net operating cash flow has significantly decreased to -$2,276.00 million, or 1577.92%, compared with the same quarter last year. In addition, the firm's growth rate is much lower than the industry average. Net income has decreased by 174.7%, from $162 million to -$121 million, significantly underperforming when the S&P 500 and the airlines industry. The net income hassignificantly decreased by 174.7% when compared to the same quarter one year ago, falling from

We've downgraded hard drive developer

Western Digital

(WDC) - Get Report

from buy to hold. Strengths include its robust revenue growth, largely solid financial position with reasonable debt levels by most measures and increase in net income. Weaknesses include poor profit margins and a decline in the stock price during the past year.

Revenue rose by 45.8%, but EPS in the most recent quarter were stagnant. The company's debt-to-equity ratio of 0.19 is very low but is currently higher than the industry average. It also maintains an adequate quick ratio of 1.35, which illustrates the ability to avoid short-term cash problems. During the past fiscal year, Western Digital increased its bottom line by earning $3.83 vs. $2.50 in the prior year. For the next year, the market expects a contraction of 12% in earnings, to $3.37. Gross profit margin of 27%, while an increase over last year, is lower than desirable. Net profit margin of 10.7% is significantly lower than the same period last year.

Shares have plunged 37.25% on the year, apparently dragged down in part by the decline we have seen in the S&P 500. In one sense, the decline is a positive for future investors, making it cheaper (in proportion to its earnings over the past year) than most other stocks in its industry. But due to other concerns, we feel the stock is still not a good buy right now.

Other ratings changes include

Vale

(RIO) - Get Report

, downgraded from buy to hold, and

Cubist Pharmaceuticals

(CBST)

, upgraded from hold to buy.

All ratings changes generated on Oct. 17 are listed below.

Ticker

Company

Current

Change

Previous

AAP

Advance Auto Parts

HOLD

Downgrade

BUY

AKS

AK Steel Holding

HOLD

Downgrade

BUY

BAP

CrediCorp

HOLD

Downgrade

BUY

BITS

Bitstream

HOLD

Downgrade

BUY

BKMU

Bank Mutual

HOLD

Downgrade

BUY

CBC

Capitol Bancorp

SELL

Downgrade

HOLD

CBST

Cubist Pharmaceuticals

BUY

Upgrade

HOLD

CPNO

Copano Energy

HOLD

Downgrade

BUY

CTV

CommScope

HOLD

Downgrade

BUY

DGX

Quest Diagnostics

HOLD

Downgrade

BUY

FNF

Fidelity National Financial

SELL

Downgrade

HOLD

FTR

Frontier Communications

HOLD

Downgrade

BUY

GDP

Goodrich Petroleum

SELL

Downgrade

HOLD

GFLBB

Great Florida Bank

SELL

Initiated

HARL

Harleysville Savings Financial

HOLD

Upgrade

SELL

HBI

Hanesbrands

SELL

Downgrade

HOLD

HCC

HCC Insurance Holdings

HOLD

Downgrade

BUY

HNBC

Harleysville National

HOLD

Downgrade

BUY

HOS

Hornbeck Offshore Services

HOLD

Downgrade

BUY

IX

Orix

SELL

Downgrade

HOLD

KMP

Kinder Morgan Energy

HOLD

Downgrade

BUY

LPNT

Lifepoint Hospitals

HOLD

Downgrade

BUY

LUV

Southwest Airlines

HOLD

Downgrade

BUY

LZ

Lubrizol

HOLD

Downgrade

BUY

MAYS

J.W. Mays

SELL

Downgrade

HOLD

MCHP

Microchip Technology

HOLD

Downgrade

BUY

MSW

Mission West Properties

SELL

Downgrade

HOLD

NM

Navios Maritime Holdings

HOLD

Downgrade

BUY

NRT

North European Oil Royalty Trust

HOLD

Downgrade

BUY

PAS

PepsiAmericas

HOLD

Downgrade

BUY

PESI

Perma-Fix Environmental Services

SELL

Downgrade

HOLD

RECN

Resources Connection

HOLD

Downgrade

BUY

RIO

Companhia Vale do Rio Doce

HOLD

Downgrade

BUY

SHOR

Shoretel

HOLD

Upgrade

SELL

SI

Siemens

HOLD

Downgrade

BUY

STN

Stantec

HOLD

Downgrade

BUY

TRV

Travelers

HOLD

Downgrade

BUY

UACL

Universal Truckload Services

HOLD

Downgrade

BUY

VSR

Versar

HOLD

Downgrade

BUY

VVUS

Vivus

HOLD

Downgrade

BUY

WBD

Wimm-Bill-Dann Foods

HOLD

Downgrade

BUY

WDC

Western Digital

HOLD

Downgrade

BUY

Each business day, TheStreet.com Ratings updates its ratings on the stocks it covers. The proprietary ratings model projects a stock's total return potential over a 12-month period, including both price appreciation and dividends. Buy, hold or sell ratings designate how the Ratings group expects these stocks to perform against a general benchmark of the equities market and interest rates. While the ratings model is quantitative, it uses both subjective and objective elements. For instance, subjective elements include expected equities market returns, future interest rates, implied industry outlook and company earnings forecasts. Objective elements include volatility of past operating revenue, financial strength and company cash flows. However, the rating does not incorporate all of the factors that can alter a stock's performance. For example, it doesn't always factor in recent corporate or industry events that could affect the stock price, nor does it include recent technology developments and competitive dynamics that may affect the company. For those reasons, we believe a rating alone cannot tell the whole story, and that it should be part of an investor's overall research.

This article was written by a staff member of TheStreet.com Ratings.