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A select group of market segments and companies are poised to improve results in the coming months, analysts say.

Analyst: Ronald A. Tadross, CFAFirm: Banc of America Securities [email protected]

Area of coverage: Autos and auto parts

Sector outlook: We expect auto sales to increase to 16.5 million units from [the original projection of] 16.2 million in 2007. North American auto production is expected to total 15 million units in 2007 and 15.2 million in 2008. We estimate Big Three production at 9.2 million in 2008, down from the 9.6 million expected in 2007.

Sales mix could continue to pressure the Big Three and their suppliers. We see a significant increase in the mix of four-cylinder engines in the 2007 model year vehicles. This trend could continue for three to four years after gas prices have peaked, as was seen in the 1970s.

To end with the good news, commodity cost increases continue to moderate and even showed the first meaningful year-over-year decline since late 2001.

We estimate that higher commodity costs might have hurt automaker and supplier margins by 1-2 percentage points over the last two years. While we are modeling commodity costs flat from 2007, we could see some benefits if recent trends continue, but wouldn’t pay for it now.

About Toyota Motor Corporation (TM): We are raising our respective fiscal year 2008, fiscal year 2009 and fiscal year 2010 earnings per share (EPS) estimates for Toyota to $9.40, $10.10 and $11.00 respectively from $9.15, $9.80 and $10.80. The earnings estimate increase primarily reflects a weaker yen and higher equity income from unconsolidated subsidiaries and first quarter 2007 results that beat expectations.

We are now modeling 117 yen-to-U.S. dollar rate compared to 115 yen-to-U.S. dollar before. Higher equity income from Chinese joint ventures, which tripled in the first quarter of fiscal year 2008 from a year ago, and strong results at keiretsu suppliers seem sustainable.


Analyst: John W. RansomFirm:. Raymond James & Associates, Inc.800-237-5643

Area of coverage: Drug stores

Sector outlook: Same-store sales for August increased 3.7 percent on average; the consensus called for a 4 percent increase … [W]e remind investors that the deceleration at the pharmacy is largely expected, given the hurdles associated with lapping the Medicare Part D rollout and the high utilization of lower-priced generic drugs.

That said, front-end sales have improved in recent months as retailers gain better traction on various internal initiatives. August front-end sales were particularly strong at CVS/Caremark Corp. and Walgreen, as both likely benefited from a strong back-to-school season. Walgreen reported the leading results for the group, with better-than-expected same-store sales growth of 6.5 percent (consensus was 6.1 percent), as a soft prescription comp of 6.5 percent (consensus was 6.8 percent) was offset by strong front-end sales growth of 6.6 percent (consensus was 5.2 percent).

About CVS/Caremark Corp. (CVS): CVS/Caremark outperformed expectations on all fronts (as the newly combined entity reported its first full quarter results), with strong top-line growth and margin improvements at both the retail pharmacy and the pharmacy benefit managers (PBM) segments. Furthermore, management’s commentary during the quarterly earnings conference call was bullish, and although near-term financial targets were unchanged, the opportunity for more upside improvements appears more likely as the Caremark integration is tracking ahead of schedule. We expect the company to exceed its current synergy forecasts while broader pharmaceutical channel tailwinds are likely to help sustain its recent operating momentum.

For the quarter, CVS/Caremark reported earnings per share (EPS) of $0.47; however, excluding some $22 million in integration expenses, normalized EPS was $0.48. These results were ahead of consensus and Raymond James & Associates’ forecasts of $0.46 and $0.45 respectively. Furthermore, we point out that results included some $45 million in higher-than-expected amortization expense (related to intangible assets at Caremark, largely client relationships that will be sustained going forward), which pressured earnings by $0.02.

CVS opened 37 new stores (including one specialty pharmacy store), closed 15 stores and relocated 30 others. Aggregate retail store count as of June 30, 2007, stood at 6,230 (including 53 specialty pharmacies) vs. 6,205 in the year-ago period.


Food Sector outlook: With fears of an economic slowdown growing, the food sector remains one of those areas where the impact could be muted. A number of brand names continue to show healthy domestic performance.

Analyst: David Driscoll, CFAFirm: [email protected]

Area of coverage: Food

About Kellogg Co. (K): Our bullish thesis on Kellogg based on its strong pricing trends is being realized as the firm produced second quarter 2007 earnings per share of 75 cents versus consensus estimates of 70 cents. The quarter featured a continuation of the company’s strong organic sales trends, although it was Kellogg’s margin improvements which stood out as gross margins expanded 113 basis points year over year. This came despite higher input costs as pricing across the portfolio was up 4.2 percent.

Kellogg raised its 2007 expectations for input inflation by 6 cents per share from its prior guidance to a new range of 26-30 cents per share. Management also plans to spend more on its brand-building initiatives versus its original expectations. Nonetheless, we believe our above-consensus 2007 estimate of $2.79 (3 cents over consensus) is achievable as it implies 5.5 percent growth in Kellogg’s base operations in the second half, which we view as achievable given Kellogg’s strong pricing trends.

We believe that Kellogg’s ability to grow earnings at a solid double-digit rate in 2007 despite an onerous cost environment is a testament to the strength embedded within the firm’s brands and serves as an indication that Kellogg continues to successfully execute its business model. We continue to see very good value in the Kellogg shares at current valuation levels.


Analyst: David PalmerFirm: UBS Securities LLC212-713 [email protected]

Area of coverage: Food

About Kraft Foods Inc. (KFT): New Chief Financial Officer Tim McLevish joins Kraft after serving as Ingersoll-Rand’s CFO since May 2002. While former CFO James Dollive is respected, we believe McLevish’s hire is a positive for Kraft.

During McLevish’s tenure at Ingersoll-Rand, its stock rose by a 15 percent CAGR — a period which included the sale of several large businesses. McLevish’s experience (along with his aggressive style and financial acumen) could make him the right CFO for Kraft now and a good complement to CEO Irene Rosenfeld’s marketing and operations background.

McLevish’s appointment may foreshadow further selling of Kraft businesses in our opinion. During his time at Ingersoll-Rand, IR sold its Bobcat and Road Development units (UBS estimates about 20 percent and 8 percent of total revenues, respectively) for prices above expectations.

New sales structures, compensation incentives, and a decentralized organization structure can help Kraft harness the benefits of scale, manage complexity, and enable accretive acquisitions.


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