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Week in Stocks: Sticking with a Cheap Natural-Gas Pick

Plus, Comverse's accounting woes deepen, Expedia meets expectations, and more.

Jeffrey Ptak, 11/20/2006

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.

Given what Morningstar analyst Justin Perucki has heard from other players in the natural-gas industry over the past few weeks, he didn't have high expectations for Compton Petroleum's CMZ third-quarter results. High labor, equipment, and supply costs have waylaid Canadian producers, specifically those in western Canada with projects in the oil sands going full-tilt. That trend, coupled with weaker natural-gas prices, has crimped profits. In response, some firms have curtailed their natural-gas drilling programs in the region and redeployed capital elsewhere. However, Compton doesn't enjoy this luxury given its highly concentrated portfolio, explaining why it has borne the full brunt of the profit crunch. Nevertheless, Perucki sees a silver lining: As other firms scale back activity, it'll likely place upward pressure on natural-gas prices while reduced demand for services should deflate costs. In short, Perucki thinks Compton's long-run fundamentals remain intact and, thus, is sticking with his fair value estimate.

Comverse Technology's Accounting Woes Deepen
Just as Comverse Technology CMVT appeared to be turning the corner and putting its stock-option accounting saga behind it, the company announced Tuesday that it had uncovered additional accounting errors relating to recognition of revenue from certain contracts and in recording certain deferred tax accounts. The company also apparently misclassified certain expenses in earlier periods. Given the additional six to 12 months that it will probably take to restate results, this revelation significantly increases the possibility that Comverse's shares could face de-listing. While this latest twist is likely to have many investors throwing in the towel, Morningstar analyst John Slacks thinks Comverse's sizable cash cushion (equivalent to nearly $9 per share) and the growth prospects for its messaging business--which is buoyed by strong carrier demand and the impending launch of its unified messaging platform--provide a measure of safety for investors who can stomach what will probably be a bumpy ride. Thus, he's maintaining his fair value estimate

Expedia's Third-Quarter Results Track Our Estimates
Expedia EXPE reported third-quarter results Nov. 9. Total gross bookings grew 8% over the same quarter last year, but overall sales grew only 5% due to lower revenue margins (net revenue as a percentage of gross bookings). Most of the revenue margin weakness stemmed from lower payments from the company's domestic air and hotel suppliers, as a relatively strong economy helped airlines and hotels fill seats and rooms without much help from online agents like Expedia. By contrast, overseas growth remained robust thanks to a 29% jump in gross bookings and revenue margin expansion. While Morningstar analyst Sumit Desai thinks revenue margins may remain under pressure for some time, he contends that Expedia's business is countercyclical--airlines and hotels will reduce payments amid a strong economy when they can fill seats and rooms without much help from online agents like Expedia, but payment trends are likely to improve during downturns. And though Expedia's operating income before amortization slid 2% from the prior year, Desai observes that much of the decline was attributable to higher marketing expenditures, which he believes will help reverse the company's weak airfare results and translate to improved future profit growth. All told, despite the company's struggles in some markets, Desai sees clearer skies ahead and, thus, is maintaining his fair value estimate.

Newfield's Woodford Shale Steps Up
Newfield Exploration's NFX Woodford Shale natural-gas field continues to impress, with better-than-expected results and remains a key component of the company's growth in 2007 and beyond. Morningstar analyst Catharina Milostan came away with high hopes after touring the Woodford Shale in May 2006 and hasn't been disappointed, as production tests continue to surprise on the upside. Recent results reveal that Newfield's efforts to use each new well as an opportunity to test drilling or fracturing methodologies is paying off. The last eight horizontal wells tested with more fracturing stages netted average initial gross production of nearly 6 million cubic feet of natural gas per day (mmcf/d). To put this in perspective, just a month ago average initial production from 10 Woodford Shale wells was at just 3.3 mmcf/d. Typically, Milostan is impressed with initial production rates from gas shale wells in the 3-5 mmcf/d range. Of Newfield's most recent eight wells, two wells had peak initial production of over 10 mmcf/d, and one averaged 6 mmcf/d in the first month of production. While not all of Newfield's most recent wells had such strong results, it indicates that the firm is making great headway in determining optimal production techniques. Milostan looks for Woodford Shale production to be a major component of Newfield's growth in 2007. PAGEBREAK

Lee Enterprises Posts Mixed Quarter
Lee Enterprises LEE posted its fiscal fourth-quarter results Nov. 9. Total revenues for the quarter climbed a slight 0.2% over the same period last year (0.5% on a same-property basis thanks to slight upticks in advertising and circulation revenues, bucking the industry trend). However, total costs came in higher than Morningstar analyst James Walden expected, particularly other cash operating expenses. Walden notes that this, too, stood in contrast with Lee's peers, many of which have been in cost-cutting mode. Yet, all told, the mixed results don't have a material impact on Walden's fair value estimate, which he's leaving unchanged.

SEC Steps Up Probe of Dell's Accounting Practices
Dell DELL is delaying the release of third-quarter results until the end of November and announced that the SEC has upgraded its previously informal investigation of the firm's accounting practices to a formal probe. Morningstar analyst Mark Lanyon deems the formal probe the more serious of the two announcements, yet reiterates his previous stance on the issue: He still has no decent take on the size and the scope of any potential restatement and therefore will wait for the company to provide a full account of its findings. Lanyon notes that despite the fact that details haven't been forthcoming, many factors cast doubt on the notion that Dell will become the next Enron or Worldcom. For instance, Dell is thoroughly monitored by third-party industry watchers, and its business throws off gobs of cash, mitigating the risk that the company is booking phantom profits. Therefore, in the absence of quality information and seeing as he's already lowered Dell's Stewardship Grade in response to the accounting investigation, Lanyon is not contemplating a revision to his fair value estimate.

FDA Postpones Approval of Promising Novartis Diabetes Treatment
Novartis NVS announced Monday that the FDA will take three additional months to review the company's promising Type 2 diabetes treatment, Galvus. In particular, the FDA will review additional clinical studies submitted by Novartis. Those studies aim to demonstrate that Galvus does not cause certain skin issues in humans that have been observed in primates. While this delay gives Merck's MRK Januvia more time to gain ground as the only DPP-IV inhibitor on the market, Morningstar analyst Heather Brilliant still expects Galvus to receive regulatory approval next year. Thus, while Brilliant sees this as a disappointing development, the delay doesn't shake her conviction that Galvus will give Januvia a run for its money once it reaches the market. As such, she's leaving her fair value estimate unchanged. 

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