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Week in Stocks: Sticking with a Struggling Homebuilder

Plus, Alcoa rebounds, Mills comes clean, and more.

Jeffrey Ptak, 01/15/2007

Morningstar's 100 stock analysts cover 1,800 companies. Their full analyst reports are available through Morningstar Principia Stocks Advanced and Morningstar Advisor Workstation Office Edition.

M/I Homes Releases Weak Order Numbers
On Thursday, homebuilder M/I Homes MHO released very weak fourth-quarter numbers. Orders were down 61% in the quarter, due in part to a cancellation rate that spiked to 63%--more than 20 percentage points higher than the third quarter. Though Morningstar analyst Eric Landry thinks the current rate of order deterioration is alarming, he expects it to drop substantially over the course of 2007, as there simply aren't that many buyers who bought during the heyday of the housing mania left to cancel. Landry believes the current backlog now primarily consists of buyers who have cut themselves a pretty good deal and therefore have less motivation to cancel. Even so, his model reflects a 32% revenue decline over the near term, and margins half of 2005 levels. All told, Landry is sticking with his fair value estimate, as his model already reflects a very difficult next few years for the company.

Alcoa Rebounds in Fourth Quarter
After a less-than-stellar third quarter marred by runaway costs and sinking aluminum prices, Alcoa AA bounced back nicely in the fourth quarter to end what was a record year in terms of sales and profitability. Strong demand in the aerospace and construction markets helped strengthen aluminum prices and re-energize Alcoa's downstream businesses. Simultaneously, the company received a boost from lower raw-material and energy costs. Management also presented its most bullish forecast yet for the overall aluminum market during the earnings conference call. Nevertheless, Morningstar analyst Scott Burns is maintaining a cautious stance regarding any changes in his operating forecast. Over the past few years, Alcoa has  made a habit of building investors' expectations up, only to disappoint later with operational issues. Still, Burns believes the long-term outlook for the industry is positive and expects earnings to continue growing at a rapid pace. As a result, he is maintaining his fair value estimate.

Mills Discloses Size of Restatement
On Tuesday, Mills MLS announced that its audit committee had completed an investigation into the company's accounting practices. In connection with the committee's findings, the firm is making various restatements of its fiscal 2005 financials, including a $350 million reduction of shareholders' equity. Though the committee found that many of the errors were more the product of shoddy internal controls than malfeasance, Morningstar analyst Akash Dave noted that the number of items to be restated is sizable and may affect future cash flows. Furthermore, Dave also observed that the possibility of bankruptcy still lurks given the liquidity crunch that Mills could face in servicing its $1 billion term loan from Goldman Sachs. However, the possibility of bankruptcy has always been present and part of Dave's thinking, but he still thinks that possibility is remote, as Mills continues to explore strategic alternatives that include individual asset sales, recapitalization, or an outright sale of the company. Dave also believes that Mills is making progress toward filing its financials, which it must do in order to consummate any strategic alternative. Until Dave has had the opportunity to see updated financials, he's leaving his fair value estimate unchanged. 

Apple Unveils Wireless Phone
Apple AAPL announced Tuesday that it will offer a feature-rich device, the iPhone, that allows users to play music, watch videos, access the Internet, send e-mail, take pictures, and make phone calls. The device, which will cost $499-$599 depending on memory size, will be sold through Apple and Cingular channels starting in June in the United States, with Europe and Asia to follow in successive quarters. Morningstar analyst Rod Bare expects Apple could sell 1.5 million phones in 2007 and about 9 million (an optimistic 20% of all expected high-end phone sales) in 2008. Bare's early estimates are based on unit sales trajectories and profitability assumptions from similar devices such as Palm's PALM Treo, Research in Motion's RIMM Blackberry, Motorola's MOT Q, and Sony Ericsson's SNE ERIC Walkman phone. Interested investors may want to look at those firms for additional insight into the relative attractiveness of the high-end phone marketplace. Although there's limited information so far on the economics of Apple's new product, Bare expects he'll raise his fair value estimate by a few dollars to reflect the positive impact this product family should have on Apple's financials.

Tough Pricing Hurts Advanced Micro Devices
Advanced Micro Devices AMD announced Thursday that December-quarter revenue will increase 3% from the September quarter, but it expects gross margins and operating income to decline as a result of significantly lower prices on its microprocessor products. Morningstar analyst Larry Cao has expected momentum to slow; AMD faces multiple challenges, such as integrating the ATI Technologies acquisition, upgrading its product lineup, increasing production at its new facilities, and the prospect of a price war with Intel INTC. Any misstep could inflict serious pain on the company, in Cao's opinion. This also informed Cao's cautious stance when AMD announced better-than-expected cost savings at its analyst day in December. The latest chatter suggests Intel will introduce new products at large discounts to the originally anticipated prices in the second quarter of this year. The announcement from AMD is the latest evidence that pricing can indeed cause trouble for both chipmakers, at least in the near term. This news has not changed Cao's outlook for AMD, however, and thus he's leaving his fair value estimate unchanged.

Sprint Nextel's Struggles Continue
Sprint Nextel S provided an update on its fourth-quarter performance and business trends last Monday, including projections for 2007 and 2008. It was of little surprise to Morningstar analyst Michael Hodel that the firm is still struggling with parts of the effort to integrate Sprint and Nextel and that management of the business, particularly on the old Nextel side, has been subpar. But the extent to which management expects these issues to hurt the company was substantially greater than Hodel had expected. Accordingly, he's slightly lowering his fair value estimate, though he continues to believe Sprint has the resources to turn its performance around over time. PAGEBREAK

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