MARKET DIGEST

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MONDAY, MAY 7 2018MAY 4, DJIA 24,262.51

UP 332.36

Good Morning. This is the Market Digest for Monday, May 7, 2018, with analysis of the financial markets and comments AristaNetworks Inc., AvalonBay Communities Inc., Prudential Financial Inc., SAP SE, United Rentals Inc., Newmont MiningCorp., Packaging Corp. of America, TJX Companies Inc. and U.S. Steel Corp.

IN THIS ISSUE:* Growth Stock: Arista Networks Inc.: Sharp selloff creates entry point; BUY to $280 (Jim Kelleher)

* Growth Stock: AvalonBay Communities Inc.: Reiterating BUY but lowering target to $185 (Jacob Kilstein)

* Growth Stock: Prudential Financial Inc.: Reaffirming BUY and $125 target (Jacob Kilstein)

* Growth Stock: SAP SE: Reaffirming BUY with $130 target (Joseph Bonner)

* Growth Stock: United Rentals Inc.: Looking for attractive entry point (Jim Kelleher and Angus Ferguson)

* Value Stock: Newmont Mining Corp.: Reiterating BUY and $43 target (David Coleman)

* Value Stock: Packaging Corp. of America: Maintaining BUY and $130 target (David Coleman)

* Value Stock: TJX Companies Inc.: Previewing fiscal 1Q19 earnings (Chris Graja)

* Value Stock: U.S. Steel Corp.: Reiterating BUY with revised target of $47 (David Coleman)

MARKET REVIEW:Stocks recovered from early declines on Friday to finish sharply higher. Market sentiment was helped by Warren Buffett

noting that Berkshire Hathaway had increased its stake in Apple by 75 million shares in 1Q. Apple, the most heavily weighted stockin the S&P 500, rose 3.9% on the day. The Nasdaq Composite finished up 1.7%, while the Dow Jones Industrial Average rose 1.4%and the S&P 500 added 1.3%. Meanwhile, earnings reports continued to surprise on the upside, with S&P 500 companies nowon track to show better than 25% growth in the first quarter. Friday’s strong performance helped the benchmarks rebound fromlosses going into Friday, although the Dow and S&P 500 still finished the week with minor declines of 0.2% each, while the Nasdaqposted a 1.3% rise. The major benchmarks remain mixed so far in 2018, with the Nasdaq rising 4.4%, but the Dow and S&P 500declining 1.9% and 0.4%, respectively.

On the economic front, Friday’s nonfarm payrolls report showed the U.S. economy added a below-consensus 164,000jobs in April. Job gains have averaged 208,000 over the past three months, but appear to be in a moderating trend. Meanwhile,a big headline was that the unemployment rate fell to 3.9%, its lowest level since a brief period in 2000 and, on a sustained basis,since the early 1970s. Closely watched for signs of inflation, average hourly earnings increased at a moderate 2.6% annual pacein April. Despite a labor market that is as tight as it has been in decades, as well as generous corporate tax cuts, wage growth remainsstubbornly slow. A better economy continues to attract discouraged workers from the last downturn back into the labor force,keeping the pool of workers rising and capping wage gains. The jobs report and its mixed data continue to signal a solid economicenvironment, but following a slew of large company bonuses in the immediate wake of tax cuts, we think sluggish wage growthcould be holding back consumer spending.

Yields on the 10-year Treasury finished about level with the prior week at 2.95%, but almost touched 3% again duringthe week. The Federal Reserve announced on Wednesday that it was holding interest rates steady. However, Fed officials continuedto highlight firmer inflation, with its preferred measure (the personal consumption expenditures index) showing a 2% rise in March.The Fed appears on track for another interest rate hike in June, following a 25 basis point increase in March. We think the equitymarket is performing as expected as investors adjust to more restrictive Fed policies after being strongly accommodative for nearlythe past decade through low interest rates and bond buying.

Among our market indicators, our technical composite fell below zero but remains neutral with a flat-up trend. NYSEbreadth was down on fewer stocks above their 150-day moving average. Down volume exceeded up volume each day but Fridaylast week. CBOE trading measures saw heavy defensive put/call buying during mid-week, while the Nasdaq TRIN was hit by thelarge down volume. Our strategic composite was little changed, and remains neutral/positive with a flat trend. Market internalssaw relative strength in Technology and small-caps, but Industrials and Financials weakened, and defensive Utilities gained.

Independent Equity Research Since 1934ARGUS

A R G U S R E S E A R C H C O M P A N Y • 6 1 B R O A D W A Y • N E W Y O R K , N. Y. 1 0 0 0 6 • ( 2 1 2 ) 4 2 5 - 7 5 0 0LONDON SALES & MARKETING OFFICE TEL 011-44-207-256-8383 / FAX 011-44-207-256-8363

®

2017 - DJIA: 24,719.22

1934 - DJIA: 104.04

MARKET DIGEST

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External indicators were hurt by lower international bonds and soft emerging market stocks, offset by strong Australian versusJapanese stocks and relative strength in emerging versus developed market currencies. Our conclusion: while stocks have revisitedthe bottom of a three-month pennant, or triangular pattern, technical indicators are making successively higher lows, whichindicates an upside breakout is now more likely.

In this week’s light economic calendar, the producer price index – final demand for April will be released on Tuesday.Thursday brings the consumer price index and the treasury budget for April. On Friday, consumer sentiment for March and import/export prices for April will be released.

Last week, Argus analysts downgraded Hershey Company (HSY) to HOLD from BUY. The average stock in the Argusuniverse declined 0.7% last week. The largest percentage gainers were NutriSystem (NTRI; HOLD; +17.2%), Chicago Bridge& Iron (CBI; HOLD; +14.9%), and Apple Inc. (AAPL; BUY; 13.3%), while the largest percentage decliners were Snap Inc.(SNAP; HOLD; -24.2%), Arconic Inc. (ARNC; BUY; -23.3%) and Cardinal Health (CAH; BUY; -19.5%). (Stephen Biggar)

ARISTA NETWORKS INC. (NYSE: ANET, $245.05) ............................................................... BUY

ANET: Sharp selloff creates entry point; BUY to $280* Arista fell 7%, or $20, following results that crushed 1Q18 consensus expectations, based on guidance that merely

matched the pre-reporting consensus for 2Q18.

* Arista appears to be winning its long-running legal battle with Cisco. CEO Jayshree Ullal stated that with most legalmatters now behind, Arista expects to “return to normal” in the second half of 2018.

* Arista, which now has more than 5,000 customers, is enjoying worldwide success while also selling to leaders inmultiple verticals, including Cloud titans, Cloud specialty service providers, tier one telcos, enterprises and other.

* We regard any weakness as an opportunity to establish or add to positions in what we regard as a premierinvestment idea and a long-term holding in the cloud network space.

ANALYSISINVESTMENT THESISBUY-rated Arista Networks Inc. (NYSE: ANET) fell 7%, or $20, following publication of 1Q18 results that crushed

consensus but guidance that merely matched the pre-reporting consensus for 2Q18. With spending by cloud service providerscontinuing to grow, some investors may have reasoned that ANET was losing share. We believe that most investors were happyto take money off the table after one-year appreciation of 70%-plus, even including the selloff.

Arista, which has promoted leaf-spine architecture as an advance over legacy switching & routing technology, is nowpromoting its universal leaf-spine architecture, which brings further efficiency and power to networking. Late in 1Q18, Aristaintroduced new data center fixed-leaf models based on Broadcom Trident and Tomahawk silicon.

In its long-running IP battle with Cisco, Arista has been able to keep its products available to customers by winning smallvictories in court, successfully developing workarounds, and on-shoring the manufacturing of products that the InternationalTrade Commission (ITC) banned from import. Based on the recent ITC suspension of enforcement of remedial actions, along withactual or pending patent expirations, the Cisco case against Arista appears to be running out of steam. CEO Jayshree Ullal statedthat with most legal matters now behind, Arista expects to “return to normal” in the second half of 2018.

For 1Q18, revenue of $473 million increased 43% while non-GAAP EPS of $1.66 increased 79%. The company isenjoying worldwide success while also selling to leaders in multiple verticals, including Cloud titans, Cloud specialty serviceproviders, tier one telcos, enterprises and other. Arista now has more than 5,000 customers.

ANET shares fell even harder, by 17%, or $55, following February publication of 4Q17 results and guidance. Thedisconnect between near-term stock performance and operating outlook was reflected by analysts rising their sales and EPSforecasts across the board even as ANET was selling off. We regard any such weakness as an opportunity to establish or add topositions in what we regard as a premier investment idea and a long-term holding in the cloud network space. We are reiteratingour BUY rating to a 12-month target price of $280.

RECENT DEVELOPMENTSAfter two sharp earnings-related selloffs in February and May, ANET is up 3% in 2018 versus 15% for it cloud and

internet peer group. ANET shares advanced 143% in 2017, compared to a 39% gain for a peer group of cloud and internet servicecompanies. ANET increased 24% in 2016, compared with a 9% gain for the communications-equipment peer group. ANET sharesadvanced 28% in 2015, versus a 6% decline for Argus-covered peers. ANET shares began trading at $43 following their IPO onJune 6, 2014.

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For 1Q18, Arista reported revenue of $473 million, which was up 41% year-over-year and 1% sequentially; above thehigh end of the $450-$468 million guidance range; and above the $464 million consensus forecast. Non-GAAP earnings of $1.66per diluted share rose 79% annually and declined $0.05 from 4Q17, on a sequentially higher non-GAAP tax rate. Non-GAAP EPStopped the consensus of $1.51 by $0.15. While management does not furnish explicit non-GAAP EPS guidance, line-itemguidance had pointed toward an estimate in the $1.50 range.

At the heart of Arista’s cloud-based network solutions is a leaf/spine architecture that is inherently more efficient.Traditional legacy networks hand off traffic from the optical layer to successive layers for core switching, distribution and access.Arista’s cloud-based network solution goes directly from routing to leaf and spine, cutting out a layer.

Additionally, the spanning tree protocol (STP) at the heart of legacy networks by nature deactivates backup links,resulting in almost half of all ports in large environments going unused. Leaf-spine networks, with only two tiers, are inherentlyflatter and use equal cost multi-pathing, which keeps all paths active and utilizes all ports. This leads to a more efficient, cost-effective and agile network.

Arista has evolved its cloud-based network further with its Universal leaf-spine architecture. This is an even flatterapproach in which routing is not separate but integrated into the universal spine and leaf. This architecture is attractive and cost-effective particularly in the most data-intensive environments such as DCI (data center interconnect).

Arista’s Any Cloud software platform is based on the company’s virtual EOS router, CloudVision analytics engine andCloud Tracer for consistency and visibility metrics. The CEO stated that Arista is “truly enabling hybrid cloud networking” withleading partnership offerings designed to support any public or hybrid cloud environment. Major partners for Any Cloud includeAWS, Microsoft Azure Stack, Google GCP, Oracle Cloud and Equinix Exchange. During 1Q18, Arista demonstrated support fordisaggregated eOS for Facebook with Wedge 100.

Late in 1Q18, Arista introduced new 25 Gbps and 100 Gbps platforms for switching and routing. The Arista 7050C3 and7260X3 series are fixed form-factor leaf and spine platforms based on the Broadcom Trident 3 and Tomahawk 2 data centerswitching silicon. Like all Arista products, the new platforms run single eOS (extensible operating system) software and offersArista CloudVision; these features enable automation and enhanced visibility.

One promising market, particularly with Cloud Titans, is AI. Arista has teamed with flash storage systems vendor Pureand GPU company NVidia. The CEO characterized this work as still in the experimental stage but “exciting.”

CEO Jayshree Ullal stated that Arista has moved “well beyond the overhead and delays of customer certification thatwe had been experiencing during the past three quarters.” On 4/6/18, the ITC suspended enforcement of the remedial orders itoriginally issued in the so-called 945 investigation related to Cisco’s ‘668 patent. This suspension of enforcement will allow Aristato continue selling its redesigned patents because the ‘668 patent is invalid.

The ‘668 patent has been one of two patents still at issue in the 945 investigation. The second of the two Cisco patents,‘577, expires on 6/30/18. On 3/23/18, the administrative law judge issued a recommended determination that Arista’s redesignedproducts do not infringe the ‘577 patent.

Recapping all that has gone on since this litigation began in December 2014, Arista claims to have won favorabledecisions in 12 of 14 asserted patents. Of its original 6-patent case under 945, Cisco is “left battling to enforce two invalid patents.”Cisco’s multi-patent legal onslaught is understandable, based on research from Crehan that shows Arista gaining data-centermarket share, in ports and in dollars, at the expense of Cisco.

Based on the recent ITC suspension of enforcement of remedial actions, along with actual or pending patent expirations,the Cisco case against Arista appears to be running out of steam. CEO Jayshree Ullal stated that with most legal matters nowbehind, Arista expects to “return to normal” in the second half of 2018.

In February, the ANET shares sold off following 4Q17 results release when Arista stated that it faced some project-oriented delays as it worked through certification issues with clients. This included some of Cloud Titan customers. The CEOstated that with legal issues now receding and with certification issues largely behind, Arista expects the issue of delayedcertifications to be very minimal in 2Q18 and “virtually non-existent in the second half.

For 2Q18, Arista guided for revenue of $500-$514 million; non-GAAP gross margin of 62%-64%; and non-GAAPoperating margin of 32%-34%. For the remainder of 2018, on the bigger sales base the company expects to grow revenue at abouta 20% annual pace. Even though 2Q18 guidance was above expectations, some investors concluded that cloud ISPs are growingfaster than the company. Arista executives pointed out that networking is a small part of cloud spending and is lumpy. Additionally,visibility on spending is limited more than one or two quarters out. We note that Arista has been consistently and at timesexcessively conservative when it comes to forward guidance.

We regard any such weakness as an opportunity to establish or add to positions in what we regard as the premierinvestment idea and a long-term holding in the cloud network space.

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EARNINGS & GROWTH ANALYSISFor 1Q18, Arista reported revenue of $473 million, which was up 41% year-over-year and 1% sequentially; above the

high end of the $450-$468 million guidance range; and above the $464 million consensus forecast. Non-GAAP earnings of $1.66per diluted share rose 79% annually and declined $0.05 from 4Q17, on a sequentially higher non-GAAP tax rate.

The non-GAAP gross margin was 64.4% for 1Q18, down from 65.9% in 4Q17 and up from 64.2% a year earlier. Aristais incurring costs to in-source some production while developing workarounds for infringing products. The non-GAAP operatingmargin narrowed to 35.4% in 1Q18 from 36.1% in 4Q17, but was up from 30.2% a year earlier.

Non-GAAP EPS topped the consensus of $1.51 by $0.15. While management does not furnish explicit non-GAAP EPSguidance, line-item guidance had pointed toward an estimate in the $1.50 range.

For 2017, revenue of $1.65 billion was up 46% from $1.13 billion for 2016. Arista generated non-GAAP earnings of$5.60 per diluted share, up 70% from $3.50 in 2016.

For 2Q18, Arista guided for revenue of $500-$514 million; non-GAAP gross margin of 62%-64%; and non-GAAPoperating margin of 32%-34%. Based on that guidance, we are modeling non-GAAP 2Q18 EPS of $1.70.

For the remainder of 2018, on the bigger sales base, the company expects to grow revenue at about a 20% annual pace.We are once again raising our EPS outlook for Arista. We are boosting our 2018 non-GAAP forecast to $7.02 per diluted

share from $6.37. We are also raising our preliminary 2019 non-GAAP EPS projection to $7.77 per diluted share, from an initial$7.25. Our five-year EPS growth rate for ANET is 16%.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on Arista is High, raised from Medium-High late in 2017. The company’s rich sales growth,

which is increasingly software-driven, throws off substantial cash. Debt is less than 5% of cash, which is growing rapidly.Cash was $1.74 billion at 1Q18. Cash was $1.54 billion at the end of 2017, up from $868 million at the end of 2016. Cash

for pre-public Arista was $687 million at year-end 2015 and $240 million at year-end 2014.Total debt was $64 million at 1Q18. Total debt was $54 million at the end of 2017, down slightly from $55 million at

year-end 2016. Debt for pre-public Arista was $41 million at the end of 2015 and $43 million at the end of 2014.At 1Q18, the debt/total capital ratio was 3.3% in a declining trend from 3.4% at year-end 2017. As of the end of 2016,

the debt/total capital ratio was 4.6%, well below the communications equipment industry average of 17.6%.The company has never paid a dividend, and we do not expect it to implement one over the next two years. Arista is not

actively repurchasing its shares.MANAGEMENT & RISKSJayshree Ullal has served as president and CEO of Arista since October 2008, and was previously senior vice president

of data center, switching and services at Cisco. Ita Brennan is CFO. The company recently named Manny Rivelo as its chief salesofficer. Anshul Sadana is chief customer officer.

Andreas Bechtolsheim, an Arista founder, has served as the company’s chairman since 2004 and as its chief developmentofficer since 2008. Mr. Bechtolsheim was previously the co-founder of Sun Microsystems, a maker of computers and computersoftware, which was acquired by Oracle in 2010. He also co-founded Granite Systems, a producer of Gigabit Ethernet switches,which was purchased by Cisco in 1996, and served in various executive positions at Cisco following the buyout.

Arista is involved in patent litigation with Cisco Systems. In February 2016, the International Trade Commission foundthat Arista infringed on three Cisco patents for Ethernet switches; that ruling was reaffirmed in August. In November 2016, theU.S. Customs and Border Protection (CBP) arm within Homeland Security allowed the importation of products employing a“workaround” technology. In January 2017, the ITC revoked the CBP ruling.

The back-and-forth nature of these rulings suggests that the final outcome is inherently unpredictable. Arista has alsosought to supersede any trade impositions by on-shoring the manufacturing of its products to U.S.-based facilities.

Arista investors face customer concentration risk, as several large customers account for a significant portion of thecompany’s revenue, as well as risks from intense competition and changes in technology that could reduce demand for thecompany’s products. Arista may also be hurt by supply shortages and adverse currency movements.

COMPANY DESCRIPTIONArista Networks is a leading supplier of cloud networking solutions for internet companies, cloud service providers, and

next-generation data centers. It generates the largest portion of its revenue from switching products that incorporate its ExtensibleOperating System (EOS) software.

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INDUSTRYOur rating on the Technology sector is Over-Weight, as we see value in Tech stocks following the recent selloff.Over the long term, we expect the Tech sector to benefit from pervasive digitization across the economy, greater

acceptance of transformative technologies, and the development of the Internet of Things (IoT). Healthy company and sectorfundamentals are also positive. For individual companies, these include high cash levels, low debt, and broad internationalbusiness exposure.

The sector is outperforming the S&P 500 thus far in 2018, with a gain of 3.2%. It also outperformed in 2017, with a gainof 36.9%, and in 2016, with a gain of 12.0%.

Fundamentals for the Technology sector look reasonably balanced. By our calculations, the P/E ratio on projected 2018earnings is 17.8, above the market multiple of 16.7. Earnings are expected to grow 24.3% after rising 33.2% in 2017. Earningsrose in the low single digits in 2015-2016. The sector’s debt ratios are below the market average, as is the average dividend yieldof 0.8%.

VALUATIONFollowing the recent selloff, ANET shares trade at 35.2-times our 2018 non-GAAP EPS estimate and at 31.8-times our

2019 forecast, for an average two-year forward P/E of 33.5. From 2015 through 2017, the shares averaged a P/E of 28.2. On a two-year-forward basis, ANET trades at a relative P/E of 2.0, above its historical relative P/E of 1.6. We note that EPS is growing muchfaster now than in that earlier period based on ability to leverage volumes and better utilize overhead.

Compared with a diverse peer group that includes equipment vendors as well as cloud service providers, ANET tradesat modest premiums that we believe are well-deserved, given ANET’s disruptive business model.

Our more forward-looking discounted free cash flow model values ANET in the $400 range, in a rapidly rising trend.Our blended fair value estimate for ANET of $330 is also in a rapidly rising trend. Appreciation to our target price of $280 impliesa potential risk-adjusted total return of 13% from current levels, in excess of our forecast market return and thus consistent witha BUY rating.

On May 4, BUY-rated ANET closed at $245.05, down $22.80. (Jim Kelleher, CFA, 5/4/18)

AVALONBAY COMMUNITIES INC. (NYSE: AVB, $164.35) ................................................... BUY

AVB: Reiterating BUY but lowering target to $185* We believe that AvalonBay has strong opportunities in the high-end apartment market, which has high barriers to

entry. At the same time, it faces risks from apartment oversupply in New York and San Francisco.

* On April 25, AVB reported 1Q18 revenue of $561 million, up 7% from 1Q17. Revenue topped our estimate of $554million and the consensus forecast of $557 million. Core FFO rose 5% to $2.18 per share, below our estimate andthe consensus forecast of $2.19.

* We are lowering our 2018 core FFO estimate to $8.97 from $9.02 per share based on the 1Q miss and ourexpectations for higher depreciation, smaller gains on property sales, and headwinds from oversupply in New Yorkthis year. We are also lowering our 2019 FFO estimate to $9.35 from $9.42 per share.

* AVB shares appear favorably valued at 18.4-times our 2018 core FFO estimate, near the low end of the five-yearhistorical range of 17.4-30.1 and close to the apartment and office REIT peer median of 18.2.

ANALYSISINVESTMENT THESISWe are maintaining our BUY rating on AvalonBay Communities Inc. (NYSE: AVB), a REIT that develops, owns, and

operates upscale apartment communities; however, we are lowering our target price by $5 to $185 based on the 1Q FFO miss andour concerns about near-term oversupply in New York and San Francisco.

We believe that AvalonBay has strong opportunities in the high-end apartment market, which has high barriers to entry.The company’s communities are located in metropolitan areas that have benefited from rising employment and high wages, andthat have become increasingly attractive to young professionals. Many in this group are also delaying marriage and children untiltheir 30s and thus have less immediate need for large single-family homes. To offset the challenges of oversupply in San Franciscoand New York, Avalon also owns apartment communities in the surrounding suburbs. Other positives are the company’sexperienced management team and access to low-cost capital.

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AVB shares have declined 16% over the last year, and we believe that the pullback provides a favorable entry point. Inour view, the impact of higher interest rates and oversupply in certain regions has already been priced into the stock. On price/AFFO, the shares trade at 18.4-times our 2018 core FFO estimate, near the low end of the five-year historical range of 17.4-30.1and close to the apartment and office REIT peer median of 18.2. The above-average dividend yield of 3.6% may be attractive toincome-oriented investors, though REIT stocks in general may lag in a rising interest rate environment. Our revised $185 pricetarget implies a 2018 price/AFFO ratio of 20.7, which we feel is appropriate given the company’s above-average growth prospects.

RECENT DEVELOPMENTSAVB shares have outperformed over the last three months, rising 0.2% compared to a loss of 3.5% for the S&P 500. They

have underperformed over the last year, however, with a loss of 14.0% compared to an increase of 11.5% for the index. The betaon AVB is 0.73, slightly below the peer mean of 0.79.

On April 25, AVB reported 1Q18 revenue of $561 million, up 7% from 1Q17. Revenue topped our estimate of $554million and the consensus forecast of $557 million. Core FFO rose 5% to $ $2.18 per share, below our estimate and the consensusforecast of $2.19. The increase reflected an increase in NOI from new and existing communities, partly offset by capital marketsactivity. NOI in the same-store portfolio rose 1.2% from the prior year to $295 million. This was down from the 3.9% growthachieved in 1Q17. Occupancy of 96.2% was down 10 basis points from the prior-year quarter.

During the first quarter, AVB acquired two land parcels for future development at a cost of $57 million. The companyplans to begin construction of apartment communities on this land in 2018.

In 1Q18, the company did not sell any properties.During the first quarter, AVB completed the development of three communities with 770 apartments. The total cost of

construction was $287 million. As of March 31, the company had 18 communities under development at a total cost of $2.6 billion.Along with the 1Q18 results, the company provided 2Q18 core FFO guidance of $2.16-$2.22 per share. The midpoint

of $2.19 was below our estimate of $2.23 and the consensus forecast of $2.21. Management projects full-year 2018 core FFO of$8.73-$9.13 per share, implying 6% growth from 2017. Management also sees same-store NOI growth of 1.25%-2.75% as newinvestment activity stabilizes. The company plans to begin $0.8-$1.0 billion and complete $700-$750 million of new developmentprojects this year.

EARNINGS & GROWTH ANALYSISWe are lowering our 2018 core FFO estimate to $8.97 from $9.02 per share based on the 1Q miss and our expectations

for higher depreciation, smaller gains on property sales, and headwinds from oversupply in New York this year. We are alsolowering our 2019 FFO estimate to $9.35 from $9.42 per share.

AVB organizes its portfolio into three operating segments: Established Communities, Other Stabilized Communities,and Development/Redevelopment Communities. First-quarter operating performance by business segment is summarized below.

— Established Communities, also known as Same Store Communities, includes 190 communities with about 56,000apartments. Segment revenue rose 2% to $418 million, which accounted for 75% of 1Q rental revenue. NOI for EstablishedCommunities rose 1.2% from the prior-year period to $295 million, while occupancy declined 10 basis points to 96.2%.

— Other Stabilized Communities have stabilized occupancy from the beginning of the calendar year, rather than fromthe beginning of the prior-year period as is the case for the Established Communities. The portfolio consists of 43 communitieswith about 10,000 apartments. Revenue declined 4% to $71 million, and accounted for 13% of 1Q rental revenue. NOI rose to$47 million from $35 million in 1Q17.

— Development/Redevelopment Communities are those that are under construction and have not yet received acertificate of occupancy. The portfolio consists of 30 communities with about 14,000 apartments. Revenue rose 21% to $82million, and accounted for 12% of 1Q rental revenue. NOI fell to $44 million from $52 million a year earlier.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on AVB is Medium-High, the second-highest rank on our five-point scale. The company

has a credit rating of A- from S&P and A3 from Moody’s.As of March 31, debt totaled $7.7 billion, up from $7.1 billion at the end of 1Q17. Cash and cash equivalents rose to $137

million from $122 million a year earlier. As of March 31, the company had no borrowings on its $1.5 billion credit facility. Thenet debt/core EBITDA ratio was 5.1, below the peer median of 6.5. The total debt/total capital ratio was 42% at the end of thequarter, below the peer median of 47%. EBITDA covered interest expense by a factor of 5.8, above the peer median of 4.2.

AVB pays a quarterly dividend of $1.47 per share, or $5.88 annually, for a yield of about 3.6%, above the 3.3% peermedian. Over the past five years, the company has raised the dividend at a CAGR of 7%. Our 2018 dividend estimate is $5.88and our 2019 estimate is $6.03.

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MANAGEMENT & RISKSTimothy Naughton, 56, has served as CEO since January 2012 and has been with the company since 1989. He also serves

as AVB’s chairman and is a director of Welltower, a healthcare REIT, and of Park Hotels & Resorts, a hotel REIT. He is thechairman of NAREIT, a REIT industry association.

AVB faces risks associated with local economic conditions, including the state of the job market, and supply and demandfor high-end housing. The company may also have to abandon development projects that are not economically viable. Anotherrisk is the lack of sole decision-making authority in joint venture operations. AVB also faces risks from regulation, including rentcontrol laws.

REITs in general face interest rate risk, which may be exacerbated if acquisitions are funded with floating-rate debt, orif existing debt matures and credit conditions are tight. The high 3.6% yield may cause the stock to act more like a bond if interestrates rise, as they are expected to over the next two years. As such, the stock could fall along with bond prices.

COMPANY DESCRIPTIONAvalonBay, Inc. is a real estate investment trust that develops, owns, and operates apartment communities. The company

focuses on luxury buildings in upscale markets with high job growth and quality of life, such as New York, Los Angeles, andBoston. AvalonBay owns 288 communities with about 84,000 apartments. The company was founded in 1978 and reincorporatedin 1995, when it began to focus on apartment communities. AVB shares are a component of the S&P 500.

VALUATIONAVB shares have traded between $153 and $200 over the last 52 weeks, and are currently below the midpoint of this

range. On price/core FFO, the shares trade at 18.4-times our 2018 core FFO estimate, near the low end of the five-year historicalrange of 17.4-30.1 and close to the apartment and office REIT peer median of 18.2. The above-average dividend yield of 3.6%may be attractive to income-oriented investors; however, we are concerned that REIT stocks in general may lag in a rising interestrate environment. Our revised $185 price target implies a 2018 price/AFFO ratio of 20.7, which we feel is appropriate given thecompany’s above-average growth prospects.

On May 4, BUY-rated AVB closed at $164.35, up $1.50. (Jacob Kilstein, CFA, 5/4/18)

PRUDENTIAL FINANCIAL INC. (NYSE: PRU, $100.66) ......................................................... BUY

PRU: Reaffirming BUY and $125 target* On May 2, Prudential posted 1Q18 after-tax adjusted operating EPS of $3.08, up from $2.79 a year earlier. The

result topped our estimate of $3.00 and the consensus estimate of $2.98, as the annuities and asset managementbusinesses benefited from higher market values.

* We are raising our 2018 EPS estimate to $12.18 from $12.03, based on the strong 1Q EPS, continued businessgrowth, and a 21% tax rate, below the 22% we had expected. We are also raising our 2019 estimate to $12.78 from$12.70.

* Prudential and other insurers should benefit from a recent court decision striking down the U.S. Department ofLabor’s Fiduciary Rule, which had been intended to protect consumers seeking financial advice and purchasinginvestment products.

* PRU shares trade at a discount to peers and appear attractive given the company’s above-peer-median dividendyield and ROE. Our target price of $125 implies a multiple of 10.3-times projected 2018 earnings, above the peermedian of 9.5.

ANALYSISINVESTMENT THESISOur rating on Prudential Financial Inc. (NYSE: PRU) is BUY with a target price of $125. The stock has performed well

since the November 2016 election on expectations that the Trump administration will lower corporate taxes and reduce financialregulations, which may help to eliminate Prudential’s SIFI designation. In addition, prospects for economic stimulus have pushedTreasury yields higher and should lead to increased returns on PRU’s $903 billion bond portfolio. The company’s emphasis onfaster-growing international life insurance markets also positions it to deliver industry-leading returns. Prudential’s balance sheetis clean, and management consistently returns capital to shareholders through dividend hikes and share buybacks. The shares tradeat a discount to peers and appear attractive given the company’s above-peer-median dividend yield and ROE. We think the currentstock price near $99 provides a favorable entry point.

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RECENT DEVELOPMENTSPRU shares have underperformed the broad market over the last quarter, declining 16% compared to a 5% loss for the

S&P 500. They have also underperformed over the past year, declining 9% while the S&P has risen 10%. The beta on PRU sharesis 1.29, versus 1.17 for peers.

On May 2, Prudential posted 1Q18 after-tax adjusted operating EPS of $3.08, up from $2.79 a year earlier. The resulttopped our estimate of $3.00 and the consensus estimate of $2.98, as the annuities and asset management businesses benefitedfrom higher market values. After-tax adjusted operating income rose 3% to $1.7 billion, helped by higher annuity and assetmanagement fees, growth across the company’s businesses (especially in individual annuities), and solid internationalperformance. Including one-time items, GAAP EPS rose to $3.14 from $3.09 a year earlier, due in part to stock buybacks. Netincome declined to $1.36 billion from $1.37 million due to losses from derivatives, mark-to-market decreases on certain assets,and asset divestitures.

Revenue rose 7% year-over-year to $12.9 billion, but missed our estimate of $13.0 billion and the consensus of $13.3billion. Operating ROE was 13.7%, down from 14.1% in 1Q17, and the adjusted book value at the end of the quarter was $93.55per share, up from $88.67. The operating margin declined to 13.4% from 13.8%. The shares fell 4% following the earnings report.

In December 2017, management projected 2018 EPS of $11.20-$11.70. However, this guidance assumed a 26% tax rate,higher than the 21% rate in 1Q, suggesting that full-year earnings may exceed management’s forecast. The company nonethelessexpects ROE to decline slightly in 2018.

Prudential and other insurers should benefit from a recent court decision striking down the U.S. Department of Labor’sFiduciary Rule, which had been intended to protect consumers seeking financial advice and purchasing investment products. Inearly April 2018, the U.S. Appeals Court for the Fifth Circuit ruled that the Labor Department had overstepped its authority inissuing the rule. On May 2, the court rejected a bid by the states of New York, California, and Oregon, and the AARP to appealthis decision.

On February 6, Treasury Secretary Steven Mnuchin told the House Financial Services Committee that regulators wouldreconsider Prudential’s SIFI designation in the “near future” this year. On September 29, 2017, the FSOC rescinded AIG’sdesignation as a SIFI, suggesting that Prudential could receive the same treatment.

EARNINGS & GROWTH ANALYSISTo generate our insurance company earnings estimates, we analyze ROE trends, rather than quarterly growth trends,

which can be volatile. In our view, Prudential is now delivering sustainable low double-digit ROE, much better than the 9% long-term median for peers.

Over the long term, we like the company’s growth prospects (especially in international markets), business mix, focuson share buybacks, and capital position. Despite market volatility and low interest rates, we expect Prudential to continue toperform better than peers.

We are raising our 2018 EPS estimate to $12.18 from $12.03, based on the strong 1Q EPS, continued business growth,and a 21% tax rate, below the 22% we had expected. We are also raising our 2019 estimate to $12.78 from $12.70. Our EPSassumptions imply an ROE of 13.0% over the next two years, at the high end of management’s guidance range of 12.0%-13.0%.Our five-year earnings growth rate projection is 8%.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on Prudential is Medium, the midpoint on our five-point scale. The company receives

average marks on our three main financial strength criteria of debt levels, fixed-cost coverage, and profitability. Debt/capital was35% at the end of the first quarter, compared to a median of 24% for peers. First-quarter EBIT covered interest expense by a factorof 6.0, compared to 6.2 for peers. The adjusted net margin of 7.7% was below the peer median of 9.5%, while the ROE of 13.7%was above the peer median of 11.3%.

The company pays a quarterly dividend of $0.90 per share, or $3.60 annually. The shares yield about 3.7%, comparedto a median of 2.2% for peers. Over the past five years, PRU has raised its dividend at a compound annual rate of 18%. Our dividendestimates are $3.60 for 2018 and $3.64 (down from $3.68) for 2019.

During the first quarter, the company returned $760 million to shareholders. This included repurchases of 3.3 millionshares for $375 million, as part of its $1.5 billion buyback authorization.

MANAGEMENT & RISKSJohn Strangfeld, 63, is the chairman and CEO of Prudential. He has been with the company since 1977. Of note, he was

the highest paid insurance industry CEO in 2017, with $29 million in total compensation.We note that some investors have been concerned about Prudential’s deployable capital, i.e., capital above and beyond

the capital that must be reserved to pay claims. In particular, Prudential’s aggressive buyback and dividend policies, along with

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the higher reserves required by the SIFI designation, may strain deployable capital. However, according to management, 60% ofoperating earnings will be available to boost deployable capital. Given the company’s strong ROE, we believe that it has morethan sufficient capital to maintain its current buyback program and grow the dividend. Additionally, the SIFI label appears morelikely to be removed under the current Republican administration.

Prudential investors also face risks related to the strong U.S. dollar, uneven international growth, and volatile equitymarkets.

COMPANY DESCRIPTIONPrudential Financial Inc., based in New Jersey, is a leading diversified insurance company. The company operates

through three subsidiaries, U.S. Retirement Solutions and Investment Management, U.S. Individual Life and Group Insurance,and International Insurance and Investments. The company has over $1.4 trillion in assets under management. PRU shares areincluded in the S&P 500 index.

VALUATIONWe think that PRU shares are attractively valued at current prices near $98. Over the past 52 weeks, the shares have traded

in a range of $96-$127.From a fundamental standpoint, the shares are trading at 8.2-times our 2018 EPS estimate, below the peer median of 9.5

and below the midpoint of the five-year historical range of 6.3-11.8, and at 0.8-times book value, below the peer median of 1.1and below the midpoint of the five-year range of 0.6-1.3. Compared to a group of life insurance peers, PRU also appears attractivelyvalued based on long-term ROE and dividend yield.

Our target price of $125 implies a multiple of 10.3-times projected 2018 earnings, above the peer median.On May 4, BUY-rated PRU closed at $100.66, up $3.06. (Jacob Kilstein, CFA, 5/4/18)

SAP SE (NYSE: SAP, $114.02) .............................................................................................. BUY

SAP: Reaffirming BUY with $130 target* SAP looks for margin expansion in 2018 as its cloud platform investments begin to gain leverage.

* SAP has made its S4 HANA in-memory computing platform the center of its strategy, and is moving rapidly intocloud-based solutions and data analytics, as well as other emerging enterprise IT areas.

* We are lowering our 2018 EPS forecast to $5.27 from $6.08 and our 2019 forecast to $5.79 from $6.63.

* Our target of $130 implies a P/E of 24.7-times our 2018 EPS estimate, well below the peer average.

ANALYSISINVESTMENT THESISWe are maintaining our BUY rating on SAP SE (NYSE: SAP) to a target price of $130. SAP looks for margin expansion

in 2018 as its cloud platform investments begin to gain leverage.We think that SAP stole a march on competitors by developing its S4 Hana in-memory computing platform, which is

still in the early stages of adoption by customers. SAP has coupled S4 HANA with a powerful set of business process applications,many of which it acquired and integrated into its platform. SAP’s platform has the ability to deliver cloud-only or hybrid cloudon-premise solutions that appeal to a wide range of enterprise customers. With its latest acquisition, Callidus, SAP is bolsteringits customer relationship management offering. SAP sees future growth opportunities for its platform and applications as itsenterprise customers increasingly focus on cloud computing, data centricity, intelligent computing (a/k/a artificial intelligence ormachine learning), digital commerce, business networks, and the Internet of Things. SAP has also been ramping up marketingefforts by adding to its field sales staff.

SAP is competing with cloud-based competitors like Salesforce and Workday that have capitalized on the efforts of ITdepartments to get more value from cheaper, scalable cloud solutions and to reduce their reliance on traditional on-premisesystems. It is also competing with established incumbents like Oracle. Based on its recent quarterly results and strong growthprospects for non-IFRS cloud subscriptions and support revenue, we think that SAP is slowly gaining traction in this area;however, the cloud business still represents a relatively small proportion of total sales.

Our target price of $130 implies a P/E of 24.7-times our 2018 EPS estimate, well below the peer average.RECENT DEVELOPMENTSSAP reported first-quarter results on April 24. Management also raised its full-year guidance to reflect the completion

of the Callidus acquisition on April 5 and the strong 1Q18 performance. SAP raised its 2018 revenue guidance to 24.8-25.3 billioneuros from 24.6-25.1 billion euros, which assumes 5.5%-7.5% constant-currency growth. It also raised its non-IFRS operating

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profit range to 7.35-7.5 billion euros from 7.3-7.5 billion euros, implying 8.5%-11% growth in constant currency. We expectreported growth rates to be lower due to the appreciation of the dollar.

Pro forma revenue was flat year-over-year at 5.26 billion euros (up 9% in constant currency). Since SAP reports in euros,the 2017 decline in the dollar against the euro has weighed on reported revenue. In the core cloud and software-related servicessegment, pro forma revenue rose 9% in constant currency, to 4.74 billion euros. The pro forma operating margin expanded by 80basis points to 23.5%. Management is guiding toward margin expansion in 2018.

Pro forma EPS attributable to SAP was flat at 0.73 euros. Including all items, and based on International FinancialReporting Standards (IFRS), EPS attributable to SAP came to 0.59 euros per share, up from 0.43 euros in 4Q16.

On April 5, SAP completed its acquisition of Callidus Software for $2.4 billion in cash. SAP offered $36 per share foreach Callidus share, a 21% premium over the 30-day volume-weighted average price prior to the announcement. Callidus providescompensation management software that includes sales performance management (SPM) and configure-price-quote (CPQ)applications. We think that SAP is looking to develop its customer relationship management (CRM) capabilities in order tocompete more effectively with Salesforce.com, the acknowledged leader in cloud CRM. SAP’s stated goal is to bolster its CRMoffering by connecting its legacy core “back-office” supply chain and management software functions with Callidus’ salessoftware (the so-called “front office”). Callidus will be integrated with SAP’s Hybris CRM solution, part of SAP’s Cloud BusinessGroup. It will be marketed under the brand “Callidus Cloud” but will remain under current management. After integration,Callidus will be part of an “intelligent cloud experience suite” of solutions, sold both on a stand-alone basis and in packages withother SAP solutions. SAP also sees an opportunity for international expansion at Callidus, which currently generates 80% of itsrevenue in the U.S. The transaction is expected to be neutral to pro forma EPS in 2018 and accretive in 2019.

EARNINGS & GROWTH ANALYSISWe are lowering our 2018 EPS forecast to $5.27 from $6.08 and our 2019 forecast to $5.79 from $6.63. (Changes in

exchange rates can significantly impact dollar-based EPS estimates. Our estimates imply a 3% increase over the next two years,below our 9% long-term growth rate forecast.

SAP’s cloud subscriptions and support revenue rose 18% on a non-IFRS basis in 1Q18, far outpacing the company’s otherbusiness lines. New cloud bookings, a key indicator of the sales pipeline for cloud services, rose 25% in constant currency in 1Q.This was down from 37% growth in 4Q17. Another key indicator of future business, cloud subscriptions and support backlog,grew 27% to 7.2 billion euros. The company’s much more mature core software license and support business (62% of revenue)fell 4% in 1Q18. By geographic region, the company posted constant-currency revenue growth of 8% in EMEA and 9% in theAmericas; sales fell 1% in the APJ region.

We think that SAP rightly sees cloud computing as its future. While cloud computing can be a somewhat nebulous term,we think that for SAP it means both cloud-delivered software services and its business networks based on Ariba. Managementhas pointed to the Hybris e-commerce platform as a growth engine, and has touted the combination of SuccessFactors andFieldglass as a differentiated end-to-end solution in workforce management for both regular and temporary employees. S4/HANAworkloads can run on any of the top three hyper-scale public cloud providers, AWS, Microsoft Azure, and Google Cloud Platform.

SAP’s S4 HANA in-memory computing system business applications suite is central to the company’s go-to-marketstrategy — with SAP touting integrated applications platforms running off the HANA system. S4 HANA enables customers toimprove business processes by making IT simpler, despite the complexity that has come with the data explosion of the last fewyears. As usual in tech, more computer power leads to lower costs, with SAP claiming that customers lower their total cost ofownership by 30%-50% after HANA adoption. S4 HANA also responds to the revolution in big data analytics, as it was designedfor the superfast computing of large amounts of data and is able to give clients real-time insight into their businesses. We believethat SAP showed prescience in its early exploitation of in-memory computing, and note that Oracle and other competitors havenow developed their own in-memory computing solutions. SAP is leveraging the HANA computing architecture not just in itscore businesses of applications, analytics, and database, but also in the newer growth areas of mobile enterprise and cloud.

SAP launched S4 HANA in February 2015 and appears to have reached a positive inflection point in sales. The S4 HANAcustomer base is now 8,300. This includes 400 additions in 1Q18. Further, 80% of SAP’s customer base remains in the S4 HANApipeline, giving management confidence that it will be able to reach its target of sustained 30% growth in cloud revenue.

SAP has launched a marketing campaign around the concept of IT simplicity, with a focus on its integrated set ofenterprise cloud computing solutions. The company will maintain its large on-premises customer base as well as hybrid solutions;however, it is fully embracing cloud computing, with its major selling points of simplicity, scalability, and cost savings forcustomers.

SAP is working to exploit the S4 Hana, powering its Digital Business Platform with an integrated set of businessmanagement applications. Management also see the company’s machine-learning-driven business analytics application, SAP

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Leonardo, as another emerging differentiator. Of course, machine-learning applications can be applied across the board. The firstwave of machine-learning applications is already commercially available, and we expect more to come. SAP has made, and willlikely continue to make, tuck-in acquisitions in emerging tech areas.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating for SAP is High, the top of our five-point scale. S&P and Moody’s assign SAP low A

investment-grade ratings with outlooks from stable to positive.SAP paid an annual dividend of $0.95 in May 2017. Our U.S. dollar-based dividend estimates are $0.95 for both 2018

and 2019. The current yield is about 1.2%.MANAGEMENT & RISKSWith approximately 43% of the company’s revenue derived from the EMEA region, SAP is highly sensitive to economic

conditions in Europe. While technology acquisition budgets often have their own cycle, a general economic retrenchment inEurope could lead businesses to cut spending on new projects.

CEO Bill McDermott consolidated power with the retirement of Jim Hagemann Snabe in May 2014. SAP managementhas stepped boldly with the Sybase, SuccessFactors, Ariba, and Concur acquisitions, though we think the prices may have been high.

Investors face considerable losses if the company fails to meet expectations. Global demand for enterprise software couldweaken, and the company could fail to execute its business plan. Adding complexity to the company’s operations, SAP’s businessis seasonal, with the fourth quarter being relatively strong and the first quarter weak. U.S. investors must also accept currency risk;SAP is based in Germany and obtains about 68% of its sales from outside the U.S.

SAP faces increased competition from mature rivals, including Oracle and Microsoft, as well as from smaller, relativelynew upstarts, such as Salesforce.com and Workday.

COMPANY DESCRIPTIONOne of the world’s largest business software companies, SAP provides software addressing both the management of core

business processes and analytics. The company offers specific solutions for industry segments including high tech, oil and gas,utilities, chemicals, healthcare, retail, consumer products, and the public sector. Based in Walldorf, Germany, SAP has a base of388,000 customers worldwide. Products are maintained through product support services and option upgrades.

VALUATIONSAP ADRs have gained 13% on a total-return basis in the last year, compared to a total return of 13.5% for the S&P 500

and a gain of 27% for the S&P Information Technology Index. SAP’s forward enterprise value/EBITDA multiple of 14 is 31%below the peer average, greater than the average discount of 25% over the past two years. We are maintaining our BUY ratingto a target price of $130. Our target implies a P/E of 24.7-times our 2019 EPS estimate, well below the peer average of 33.5.

On May 4, BUY-rated SAP closed at $114.02, up $0.88. (Joseph Bonner, CFA, 5/4/18)

UNITED RENTALS INC. (NYSE: URI, $153.23) ................................................................... HOLD

URI: Looking for attractive entry point* Given URI’s capital-intensive business and leveraged balance sheet, we are concerned that rising interest rates

may limit future share price appreciation.

* On the positive side, the company continues to see healthy activity in its core U.S. markets and should benefit overtime from the recent acquisitions of NES Rentals and Neff Corp.

* We are raising our 2018 EPS forecast to $14.87 from $11.21 and raising our 2019 estimate to $16.13 from $15.59.

* Valuations are mixed. We will look for a nonfundamental pullback as a potential buying opportunity.

ANALYSISINVESTMENT THESISWe are maintaining our HOLD rating on United Rentals Inc. (NYSE: URI). While optimism about increased

infrastructure spending under the Trump administration likely drove URI’s strong run-up in the post-election period, with a gainof more than 75% over the past year, we note that a substantial spending program is not assured. Given the company’s capital-intensive business and leveraged balance sheet, we are also concerned that rising interest rates in the U.S., and now in Canada,may limit future share price appreciation. On the positive side, the company continues to see healthy activity in its core U.S.markets and should benefit over time from the recent acquisitions of NES Rentals and Neff Corp. URI’s valuations are mixed.We will look for a nonfundamental pullback as a potential buying opportunity.

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RECENT DEVELOPMENTSURI shares have underperformed over the past quarter, falling 12%, compared to a 5% decrease in the S&P 500. Over

the past year, the shares have gained 39%, versus an 11% advance for the index. The beta on URI is 1.53.On April 18, URI posted adjusted 1Q18 EPS of $2.87, up from $1.63 a year earlier and $0.44 above the consensus

forecast. Adjusted earnings included a benefit of $0.50 per share from the new U.S. tax law. Total revenue came to $1.734 billion,up from $1.356 billion a year earlier. Overall rental revenue grew 25.1%. Rental revenue on owned equipment rose 25.4%,reflecting increases of 26.1% in the volume of equipment on rent and 1.9% in rental rates.

Along with its 1Q18 earnings report, management reaffirmed 2018 guidance. The company projects revenues of $7.3-$7.6 billion, up from $6.6 billion in 2017; adjusted EBITDA of $3.6-$3.75 billion, up from $3.15 billion in 2017; net cash fromoperating activities of $2.625-$2.825 billion; and net rental capital expenditures of $1.2-$1.35 billion after gross purchases of $1.8-$1.95 billion. URI forecasts full-year free cash flow of $1.3-$1.4 billion.

URI has a growth-by-acquisition strategy. In March 2018, URI acquired the assets of Industrial Rental Services, aprovider of two-way radio solutions and industrial blinds, from JMH Capital.

In early October 2017, URI acquired Neff Corp. for approximately $1.3 billion. The acquisition should expand URI’searthmoving capacity and provide economies of scale, especially in the southern U.S. The acquired assets include $860 millionof equipment (based on original cost) and 69 branch facilities. In April 2017, United Rentals acquired NES Rentals for $965 millionin cash. Management plans to restructure this business and looks for the transaction to be accretive to earnings, revenue, EBITDAand free cash flow. We note that NES has typically rented older and less expensive equipment than URI.

EARNINGS & GROWTH ANALYSISThe company has two operating segments: General Rentals, which includes the rental of general construction and

industrial equipment, aerial work platforms, and general tools and lighting equipment, and the Trench Power and Pump business,which includes the rental of specialty construction equipment such as trench safety equipment, power and HVAC equipment, andpumps that are used by industrial, mining, construction, and agribusiness customers.

Revenue from General Rentals rose 25.1% in 1Q18 to $1.5 billion, primarily reflecting a 26.1% increase in the volumeof equipment on rent. The 1Q18 gross margin in this segment was 37.4%, down slightly from 38.1% a year earlier.

Revenue in the Trench, Power, and Pump segment rose 36.5% to $258 million. The 1Q18 gross margin in this segmentwas 46.1%, up 170 basis points from the prior year.

In 2018, we expect URI to benefit from continued growth in rental volume and specialty operations, contributions fromthe NES acquisition, tax benefits, and a further decline in interest expense. In all, we expect a 14% increase in revenue this year,following a 15% increase in 2017; we look for more moderate 8% top-line growth in 2019.

We are raising our 2018 EPS forecast to $14.87 from $14.61 and raising our 2019 estimate to $16.13 from $15.59.FINANCIAL STRENGTH & DIVIDENDOur financial strength ranking on URI is Medium-Low. The company generally receives below-average marks on our

key financial strength criteria of debt levels, fixed cost coverage, cash flow generation and profitability. S&P rates URI’s creditas BB-/positive, which is below investment-grade.

URI is highly leveraged, with $9.14 billion total debt as of 1Q18. Debt was $9.44 billion at year-end 2018, including $8.52billion in long-term debt. Debt/capital ratio was 75.2% at year-end 2017, down from 80.8% a year earlier.

The company has a stock buyback plan. United Rentals repurchased $1.45 billion of its common stock in 2012-2015.It initiated a new $1 billion repurchase plan in November 2015, and has bought back $627 million of its stock under thisauthorization. In October 2016, URI suspended repurchases as it analyzed acquisition opportunities, including NES Rentals andNeff Corp. In October 2017, it resumed the buyback program. It repurchased $28 million of its stock in 2017, and expects tocomplete the $345 million remaining on its authorization this year.

The company has not paid a cash dividend since its inception, and we do not expect any payments in 2018.MANAGEMENT & RISKSMatthew Flannery has been named president of the company, in addition to his responsibilities as chief operating officer.

Former president Michael Kneeland will remain CEO.URI investors face risks. These include the company’s highly cyclical business, significant debt, and exposure to the oil

and gas industry. The company must also spend heavily to expand and maintain its fleet of rental equipment.COMPANYUnited Rentals is the largest rental equipment company in the world, with a store network nearly three times the size of

any other provider, and locations in 49 states and all Canadian provinces. The company has over 15,000 employees andapproximately 987 rental locations in the U.S. and every Canadian province.

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VALUATIONWe think that URI shares are fairly valued at current prices near $152. Over the past 52 weeks, the shares have traded

between $100 and $190. We downgraded URI to HOLD in February 2017 after a strong post-election run-up.On the fundamentals, valuations are mixed. URI trades at 10.2-times our 2018 EPS forecast and at 9.4-times our 2019

estimate. The five-year historical P/E range is 6.0-24.7. URI shares trade at a discount to an average of 14.5 for a peer group ofArgus industrial companies, but at a premium 1.64-times P/S ratio, compared to 1.14 for peers. We are reaffirming our HOLDrating, but would consider an upgrade in the event of a significant nonfundamental pullback in the shares.

On May 4, HOLD-rated URI closed at $153.23, up $3.43. (Jim Kelleher, CFA, and Angus Ferguson, 5/4/18)

NEWMONT MINING CORP. (NYSE: NEM, $39.65) ................................................................. BUY

NEM: Reiterating BUY and $43 target* On April 26, Newmont posted 1Q18 adjusted net income from continuing operations of $185 million or $0.35 per

share, up from $136 million or $0.26 per share a year earlier. Adjusted EPS topped our estimate of $0.34 and theconsensus forecast of $0.33.

* We are raising our 2018 EPS estimate to $1.51 from $1.49, but are lowering our 2019 estimate to $1.57 from $1.65.

* In March 2018, Newmont raised its quarterly dividend by 87% to $0.14 per share, or $0.56 annually, for a yield ofabout 1.4%.

* NEM shares appear favorably valued at 25.9-times our 2018 EPS estimate, compared to a five-year historicalrange of 7.4-34.0 and a peer average of 28.5. The shares are also trading below the peer average for price/book,price/sales, and price/cash flow.

ANALYSISINVESTMENT THESISWe are maintaining our BUY rating on Newmont Mining Corp. (NYSE: NEM) with a target price of $43. The company

posted strong adjusted net income in 1Q18, driven by higher realized gold prices. Looking ahead, we expect Newmont to makefurther progress as it invests in new development and exploration projects. Given the company’s strong free cash flow andproductivity, we believe that NEM offers value at current prices.

RECENT DEVELOPMENTSNEM shares have underperformed over the last three months, falling 0.1% while the Basic Materials index (IYM) has

risen 0.2%. They have outperformed over the past year, however, rising 21.4% while the Materials index has risen 10.8%.On April 26, Newmont posted 1Q18 adjusted net income from continuing operations of $185 million or $0.35 per share,

up from $136 million or $0.26 per share a year earlier. Adjusted EPS topped our estimate of $0.34 and the consensus forecast of$0.33. On a GAAP basis, the company reported a net loss from continuing operations of $170 million or $0.32 per share.

First-quarter revenue rose 8% to $1.8 billion, driven by higher average realized gold prices. Capital expenditures rose28% to $231 million, reflecting spending on the Quecher Main, Subika Underground, and the Ahafo Expansion projects.

Newmont reported 1Q18 gold production of 1.21 million ounces at an average realized price of $1,270 per ounce. First-quarter all-in sustaining costs (AISC) for gold were $982 per ounce.

For copper, first-quarter production fell to 12,000 tons from 13,000 tons a year earlier. The average realized price was$2.88 per pound in 1Q18, up from $2.68 in 1Q17. AISC rose 17% to $2.07 per pound.

EARNINGS & GROWTH ANALYSISManagement projects 2018 gold production of 4.9-5.4 million ounces (at an AISC of $700-$750 per ounce) and copper

production of 40,000-60,000 tons. In 2017, gold production totaled 5.3 million ounces at an AISC of $924 per ounce, and copperproduction totaled 51,000 tons at an AISC of $1.80. Management’s assumptions for 2018 also include an average gold price of$1,200 per ounce, an average copper price of $2.50 per pound, $55 per barrel WTI, and an average exchange rate of US$0.75 tothe Australian dollar.

The company’s free cash flow fell 29% year-over-year to $266 million in the first quarter on higher working capitaloutflows. Free cash flow fell by $162 million to $35 million due to lower operating cash flow and increased investment in growthprojects. In 2018, Newmont expects capex to rise to $1.2-$1.3 billion.

We are raising our 2018 EPS estimate to $1.51 from $1.49, but are lowering our 2019 estimate to $1.57 from $1.65.

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Gold prices recovered in 2016, climbing 8% for the year, while in 2015, gold declined by the same 8%. In 2017, goldprices rose 13.6%. In 2018, we believe that higher interest rates and moderate inflation will be headwinds for gold. We expectgold to trade in a range of $1,250-$1,500 per ounce, with an average price of $1,375. The current price is $1,307 per ounce.

FINANCIAL STRENGTH & DIVIDENDWe rate Newmont’s financial strength as Medium, the midpoint on our five-point scale. Newmont’s debt is rated Baa2/

stable by Moody’s and BBB/stable by Standard & Poor’s.At the end of 1Q18, the debt/capitalization ratio was 26.2%, compared to 27.9% at the end of 1Q17. Newmont had cash

and equivalents of $3.17 billion at the end of 1Q18, up from $2.97 billion a year earlier. Total debt was $4.1 billion, down from$4.6 billion at the end of 1Q17.

In March 2018, Newmont raised its quarterly dividend by 87% to $0.14 per share, or $0.56 annually, for a yield of about1.4%. Our dividend estimates are $0.56 for 2018 and $0.64 for 2019.

RISKSThe primary risks for NEM investors involve fluctuations in the price of gold and copper. In addition, the company faces

a range of political, financial, operational, country, regulatory and foreign exchange risks.COMPANY DESCRIPTIONFounded in 1921, Colorado-based Newmont Mining is one of the largest gold-mining companies in the world, with assets

and operations in North America, South America, Australia/New Zealand, Asia, Europe and Africa. While approximately 96%of its revenues come from gold, the company is also a major producer of copper and zinc. The company has approximately 30,000employees and contractors worldwide.

VALUATIONNEM shares trade at 25.9-times our 2018 EPS estimate, compared to a five-year historical range of 7.4-34.0 and a peer

average of 28.5. They are also trading at a price/book multiple of 2.0, near the high end of the five-year range of 0.7-2.1 but belowthe peer average of 4.6. The price/sales ratio is 2.8, in the upper half of the historical range of 1.0-3.7 but below the peer averageof 3.8. The price/cash flow ratio of 9.5 is near the high end of the five-year range of 3.3-10.2 but below the peer average of 11.7.The dividend yields about 1.4%. We are maintaining our BUY rating with a target price of $43.

On May 4, BUY-rated NEM closed at $39.65, down $0.16. (David Coleman, 5/4/18)

PACKAGING CORP. OF AMERICA (NYSE: PKG, $114.15) .................................................... BUY

PKG: Maintaining BUY and $130 target* We expect Packaging Corp. to benefit from recent price increases for paper, containerboard and corrugated

products, as well as from acquisitions.

* On April 25, Packaging Corp. reported 1Q18 earnings. Excluding special items, adjusted net income rose to $147million or $1.55 per share from $120 million or $1.27 per share a year earlier. EPS beat our estimate by a penny.First-quarter revenue rose to $1.69 billion from $1.54 billion in 1Q17.

* The company does not issue full-year guidance, though it does provide estimates for the current quarter. It projects2Q18 EPS of $1.96, which assumes price increases in the paper segment and strong packaging segment demand;however, it also looks for lower volumes in the paper segment as it converts the No. 3 machine at the Wallula Millfrom paper to linerboard.

* We are raising our 2018 EPS estimate to $7.80 from $7.47. Our revised estimate reflects management’s second-quarter guidance and expected benefits from a lower tax rate, partly offset by higher input costs. We are also raisingour 2019 estimate to $8.50 from $7.97.

ANALYSISINVESTMENT THESISWe are maintaining our BUY rating on Packaging Corp. of America (NYSE: PKG) with a target price of $130. Looking

ahead, we expect the company to benefit from recent price increases for paper, containerboard and corrugated products, as wellas from acquisitions. We believe that PKG offers value at current levels and that a BUY rating remains appropriate. The stockalso offers a dividend yield of about 2.2%, above the peer average of 1.9%.

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RECENT DEVELOPMENTSPKG shares have underperformed over the past three months, falling 4.4%, compared to a 2.4% decline for the S&P 500.

However, they have outperformed over the past year, with a gain of 11.2%, compared to a 9.6% advance for the broad market anda 9.2% increase for the Basic Materials sector ETF (IYM). The beta on the stock is 1.97.

On April 25, Packaging Corp. reported 1Q18 earnings. Excluding special items, adjusted net income rose to $147 millionor $1.55 per share from $120 million or $1.27 per share a year earlier. EPS beat our estimate by a penny. First-quarter revenuerose to $1.69 billion from $1.54 billion in 1Q17.

According to management, the 1Q results reflected higher pricing and volume, and a more favorable product mix in thePackaging segment; higher volume in the paper segment; and a favorable tax rate. These positives were partly offset by higheroperating, outage, depreciation and freight costs, as well as higher interest expense.

EARNINGS & GROWTH ANALYSISPackaging Corp has two operating segments, Packaging and Paper.In the Packaging segment, first-quarter EBITDA, excluding special items, rose to $307.9 million from $273.9 million

in 1Q17, while revenue rose to $1.403 billion from $1.257 billion. Corrugated product shipments per day (with one less day in1Q18) rose 6% year-over-year.

In the Paper segment, first-quarter EBITDA, excluding special items, came to $31.3 million on sales of $269.45 million.This compared to EBITDA of $41.9 million on sales of $259.2 million in 1Q17. Sales volume rose by 33,000 tons from the prioryear; production volume also rose, reflecting the absence of scheduled plant outages. However, pricing and product mix wereweaker than in 1Q17.

The company does not issue full-year guidance, though it does provide estimates for the current quarter. It projects 2Q18EPS of $1.96, which assumes price increases in the paper segment and strong packaging segment demand; however, it also looksfor lower volumes in the paper segment as it converts the No. 3 machine at the Wallula Mill from paper to linerboard. Managementexpects higher costs for other raw materials, energy, and freight, as well as higher depreciation and interest expense, offset by loweroutage costs and a lower tax rate.

We are raising our 2018 EPS estimate to $7.80 from $7.47. Our revised estimate reflects management’s second-quarterguidance and expected benefits from a lower tax rate, partly offset by higher input costs. We are also raising our 2019 estimateto $8.50 from $7.97.

FINANCIAL STRENGTH & DIVIDENDWe rate the financial strength of Packaging Corp. as Medium, the midpoint on our five-point scale. The company’s long-

term debt is rated Baa2/stable by Moody’s and BBB/stable by Standard & Poor’s.In September 2016, PKG raised its quarterly dividend by 15% to $0.63, or $2.52 annually, for a current yield of about

2.2%. It previously raised the payout by 37.5% in February 2015. Our dividend estimates are $2.52 for both 2018 and 2019.MANAGEMENT & RISKSMark W. Kowlzan has served as the company’s CEO since July 2010. From 1998 through June 2010, Mr. Kowlzan

managed the company’s containerboard mill system, first as vice president and general manager and then as senior vice president– Containerboard.

In June 2015, Robert Mundy was named senior vice president and chief financial officer, replacing Richard West. Mr.Mundy was previously senior VP and CFO at Verso Corp. Before that, he worked for more than 20 years at International Paper.

PKG requires a healthy global economy to sustain price increases and drive revenue growth. Other risk factors includeindustry overcapacity and unexpected plant outages. The company’s performance is also dependent on its ability to set pricingin the containerboard and box segments. On the other hand, it must accept market prices for the wood fiber, energy, and chemicalsused in the production process.

COMPANY DESCRIPTIONPackaging Corp. of America is a manufacturer of containerboard and corrugated products. It is the fourth largest producer

of containerboard products and the third largest producer of uncoated freesheet paper in the North America. The companyproduces various corrugated packaging products, including conventional shipping containers used to protect and transportmanufactured goods. PKG also produces multicolor boxes and displays for packaged retail products and meat boxes and wax-coated boxes for agricultural suppliers. Packaging Corp. of America was founded in 1867, and operates eight mills and 94corrugated products plants and related facilities.

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VALUATIONPKG shares have traded between $98 and $131 over the past 52 weeks and are currently in the middle of the range.The shares are trading at 14.6-times our 2018 EPS forecast, close to the peer average of 14.0 and below the midpoint of

the five-year range of 9.3-22.2, and at 13.4-times our 2019 estimate. The price/sales ratio is 1.6, above the peer average of 1.1 andabove the midpoint of the five-year range of 0.8-2.0. The price/book multiple is 4.9, above the peer average of 3.1 and in the upperhalf of the five-year range of 2.7-5.9. We believe that PKG deserves to trade at higher multiples and are maintaining our BUYrating and target price of $130. The stock also offers a dividend yield of about 2.2%, above the peer average of 1.9%.

On May 4, BUY-rated PKG closed at $114.15, up $0.47. (David Coleman, 5/4/18)

TJX COMPANIES INC. (NYSE: TJX, $82.83)....................................................................... HOLD

TJX: Previewing fiscal 1Q19 earnings* TJX is scheduled to report 1Q19 earnings on May 22. Our estimate is $1.02 per share, down from $1.04. Our

reduction is mostly a result of higher expectations for employee payroll. We are raising our estimate of the SG&Arate and reducing our estimate of pretax profit to 10.2% of sales from 10.9% previously.

* The average analyst estimate is $1.02 per share. The range is $0.99-$1.15 with a standard deviation of three cents.The company’s guidance from the 4Q call was $1.00-$1.02. There has not been any movement in consensus overthe last four weeks.

* In April of calendar 2018, the company raised the quarterly payout by almost 25% to $0.39. We are raising our FY19dividend estimate to $1.48 from $1.35. We are initiating a FY20 dividend estimate of $1.68. Over the last five yearsthe company has raised the dividend at a compound annual rate of 22%.

* Using a dividend discount model with our assumptions, we arrive at a value of approximately $85 per share, in linewith current levels, and helped by the lower tax rate and the increase in the dividend. At an enterprise value of 12-times our EBIT estimate of about $4.1 billion for FY19, the shares would be worth about $81.

ANALYSISINVESTMENT THESISWe believe that HOLD-rated TJX Companies Inc. (NYSE: TJX) has excellent financial strength, an efficient cost

structure, and the ability to deliver value-priced merchandise in an increasingly competitive retail environment. If the stock retreatsto the low $70s on market-related weakness, we would consider raising our rating. The company’s valuation relative to the markethas also declined. This could be another potential catalyst for upgrading the shares.

We think that many shoppers will continue to see the company’s T.J. Maxx, Marshall’s and HomeGoods stores as a nicecompromise that allows them to purchase designer-label merchandise while trying to be frugal. TJX has shown impressivestability, generating positive same-store sales during the 1982, 1991 and 2002 recessions and posting a 1% comp increase in fiscal2009. In fact, TJX has posted 22 consecutive years of comp sales increases.

Under former CEO Carol Meyrowitz, management placed a strong emphasis on merchandising. We expect that tocontinue under Ernie Herrman, who succeeded Ms. Meyrowitz at the end of January 2016. Ms. Meyrowitz remains with thecompany as executive chairman. Under the current executive team, TJX has raised the number of buyers from approximately 500to more than 1,000 over the last few years and has encouraged them to take more risks and to negotiate deals with vendors. Webelieve that this focus and a reputation for paying vendors promptly enabled the company to open about 2,000 new vendorrelationships during the recession. With more than 18,000 vendor relationships in 100 countries, TJX has ready access to designermerchandise that creates a “treasure hunt” atmosphere and drives store traffic.

While the retail sector is under pressure from internet competition, the need to upgrade e-commerce and informationtechnology systems, to raise employee wages and fierce competition from retailers who are struggling to maintain market share,we believe that “Off-Price” is one of the best segments of retail and that TJX is better positioned to compete than most of theretailers we follow. The company’s comps have been driven by customer traffic. This is a sign of the business’s vitality in a sectorthat is generally seeing traffic declines of about 3%. We have recently been impressed with both the quality and the turnover ofmerchandise in the TJX stores we have visited.

EARNINGS & GROWTH ANALYSISTJX is scheduled to report 1Q19 earnings on May 22. Our estimate is $1.02 per share, down from $1.04. Our reduction

is mostly a result of higher expectations for employee payroll. We are raising our estimate of the SG&A rate and reducing our

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estimate of pretax profit to 10.2% of sales from 10.9% previously. On the plus side we are making a small increase to our estimateof sales based on more favorable exchange rates than we had modeled, we also trimmed our estimates of interest expense, the taxrate and the share count based on trends we saw in 4Q.

The average analyst estimate is $1.02 per share. The range is $0.99-$1.15 with a standard deviation of three cents. Thecompany’s guidance from the 4Q call was $1.00-$1.02. There has not been any movement in consensus over the last four weeks.

Earnings day is usually pretty uneventful for TJX. If we exclude 4Q in which the shares rallied, TJX had topped consensusin the previous 10 quarters. Based on activity in the options market, traders are expecting an earnings-day move of 3.8%, accordingto Bloomberg analytics. The average absolute move is about 3%.

We are expecting sales to be up approximately 9% to $8.48 billion. This growth rate is up about 100 basis points fromour previous estimate based mostly on more favorable exchange rates than we had anticipated. We expect comparable sales tobe up about 2% driven by traffic, with the rest of the sales growth coming from square footage. The company’s total sales havecome in above consensus in eight of the last 10 quarters. Our gross margin estimate is 28.6%, which is at the top of the company’sguidance range. We reduced our estimate by 20 basis points on the possibility for higher supply chain costs. Our SG&A estimateis 18.3%, up from 17.8% previously based on the prospect for higher payroll costs. Our estimate of EBT dollars is $646 million.The Bloomberg consensus is about $650 million. Our estimate of the tax rate is now 25.7% down from our previous estimate of27%.

As a reminder, on February 28, TJX reported fourth-quarter adjusted earnings of $1.37 per share on a GAAP basis. Salesof $10.96 billion were stronger than the $10.8 billion we expected with comp sales up 4% compared with consensus for a 2%increase. Comps were driven by strong traffic, which is very encouraging. Gross margin was lower than we expected, but it washurt by some shipping delays to HomeGoods. The company orders its merchandise to be sold right when it is delivered. We believethat some holiday merchandise had to be marked down because it arrived later than expected. SG&A looks a bit high on the surface,but if we exclude associate bonuses, contributions to retirement plans and a contribution to the company’s charitable foundation,the expense rate was 40 basis points lower than we expected.

EARNINGS & GROWTH ANALYSISWe are lowering our FY19 EPS estimate to $4.80 from $4.92 per share. Our new estimate represents a 19% increase from

the GAAP $4.04 that the company earned in FY18. For the record, we are using the GAAP number in our model. On a normalizedbasis that adjusts for last year’s extra week and the fact that FY19 will have the benefit of a full year at reduced tax rate, earningsshould be up 4%-6%

We are reducing our estimate of pretax earnings to 10.6% of sales from 11.4%. Most of the reduction is based on thelikelihood that TJX will be paying out higher wages and salaries than we had expected. There is a small offset based on net interestexpense shaping up to be lower than we expected. We still expect comparable sales growth of approximately 2%. On top of thatwe expect the company to raise the store count by about 6% to 4,308 stores at the end of FY19 from 4,070 stores at the end of FY18.We expect full-year sales of $37.8 billion, which is at the top of the company’s guidance range. Management expects the tax rateto be 25.9%, which is just below the 27% we had modeled. The company’s estimate of the share count is also slightly lower thanours. The full-year consensus is $4.86 and the company’s guidance is $4.73-$4.83. Consensus sales are $37.9 billion just aboveour estimate and the top of the guidance range.

We are initiating a FY20 EPS estimate of $5.30 per share. This reflects 6% sales growth, about a 10-basis-point increasein pre-tax margin to 10.7% from 10.6%. We are modeling a flattish gross margin and a slight improvement in the expense rate.We expect the tax rate to remain at about 25.9% and we expect continuing share repurchases.

Our five-year average annual EPS growth rate forecast remains 12%. This is based on our assumption that square footagewill increase 4%-5% annually and that same-store sales will rise about 2%. We believe that store openings in Europe are likelyto be a major driver of sales growth. TJX plans to raise its presence in Canada to 600 stores from 454 and lift Marmaxx to 3,000stores from 2,285. In all, management sees an opportunity to operate about 6,100 stores globally, up from about 4,070 at the endof FY18. In the current environment, with other retailers closing stores, the company should still have opportunities to lease U.S.properties under attractive terms. We also expect a few percentage points of EPS growth from share buybacks. The company istargeting a multiyear growth range of 10%-13%.

FINANCIAL STRENGTH & DIVIDENDWe recently increased our financial strength rating for TJX to Medium-High from Medium, as we have discussed in

previous notes. The increase is based on the company’s consistent growth and ability to use cash for new projects, stockrepurchases, and dividends. The company’s FY15 operating margin of 12.4%, FY16 operating margin of 12.0%, FY17 marginof 11.6%, and FY18 margin of 11.1% are strong for the retailers we follow, despite the downward trend. Our FY19 estimate is

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10.6%. TJX has earned an annual profit and generated positive free cash flow for more than a decade. The company also maintainsa relatively lean cost structure and management is well aware of the need to tightly control inventories. Good inventorymanagement reduces the need for markdowns and keeps new merchandise flowing to the shelves. Fresh merchandise also givesshoppers a reason to visit regularly.

Total debt was about 32% of capital at the end of 4Q, which is relatively low for the retailers we follow. Leverage declinedon a year-over-year basis because shareholders’ equity increased. In FY08, interest income exceeded interest expense, which isa very positive sign, but net interest expense was about $14 million in FY09 and $40 million in FY10 and FY11. EBIT coverednet interest expense by more than 60-times in FY12-FY15. EBIT covered interest expense by 80-times or more in FY16, FY17,and FY18, and should be at least that strong in FY19.

TJX has operating leases, which Argus treats as debt even though they don’t appear on the balance sheet. This is asignificant consideration because TJX leases virtually all of its store space. The company does own some of its office space anddistribution centers. We estimate the present value of the company’s operating leases at about $6.5 billion. This raises thecompany’s adjusted debt to about 63% of capital, which is slightly higher than the average ratio of other retailers we follow. Webelieve this calculation facilitates a more relevant comparison between companies that lease their stores and companies that buytheir stores. The company’s debt is rated in the single-A range, which is very solidly investment grade. We estimate that thecompany’s debt (adjusted for leases) was about 2.5-times EBIT plus depreciation and rental expense at the end of fiscal 2011, 2.4-times at the end of FY12, 2.3-times in FY13, and 2.2-times at the end of both FY14 and FY15. We believe this is consistent withthe company’s single-A credit ratings. The ratio was approximately 2.4-times at the end of FY16, 2.5-times at the end of 2017and 1.9-times at the end of FY18. As of December 15, 2018, TJX will begin to recognize lease assets and liabilities on its balancesheet to increase transparency.

The company has two $500 million revolving credit facilities, but has made no borrowings over the last five fiscal years.It has also made no borrowings under its small foreign currency facilities.

The company paid FY12 dividends of $0.36, FY13 dividends of $0.44, FY14 dividends of $0.55, FY15 dividends of$0.67, FY16 dividends of $0.81 and FY17 dividends of $0.99. TJX raised the quarterly payout to $0.3125 from $0.26 in Aprilof calendar 2017. FY18 dividends totaled $1.20. In April of calendar 2018 the company raised the quarterly payout by almost 25%to $0.39. We are raising our FY19 dividend estimate to $1.48 from $1.35, which includes three payments at the new rate and onepayment at the old rate. We are initiating a FY20 dividend estimate of $1.68. Over the last five years the company has raised thedividend at a compound annual rate of 22%.

The company has an impressive history of repurchasing stock, with more than $10 billion in repurchases over the lastseven fiscal years. In February 2017, the company authorized a new $1 billion buyback on top of the $1.4 billion remaining underits existing authorization. The company repurchased $1.7 billion of its stock in FY17 and it bought back another $1.7 billion inFY18. In the 4Q earnings release, management added an additional $3 billion to its remaining authorization of $1.1 billion, takingthe total capacity to $4.1 billion. The company plans to repurchase $2.5 to $3 billion of shares in FY19.

MANAGEMENT & RISKSErnie Herrman became CEO in January 2016, replacing Carol Meyrowitz, who has become the executive chairman. Mr.

Herrman previously served as the company’s president. He has experience as the head of Marmaxx and as the top merchant atMarmaxx, with a tenure at the company that goes back to 1989.

We believe that the expertise Ms. Meyrowitz gained as a merchant was a tremendous benefit to the company. We alsobelieve that a key to the company’s future success will be using the merchandising savvy of over 1,000 buyers, and theirrelationships with approximately 20,000 vendors, to get high-quality, off-priced merchandise from popular brands and designers.A constant flow of this merchandise will helps to create the “treasure hunt” atmosphere that can drive store traffic and augmentsame-store sales. We believe that executing this strategy depends on the discretion and fortitude of the company’s merchants, andthat could be a risk factor if they aren’t successful.

The availability of off-priced merchandise is another issue that we believe to be on the minds of many investors. We spoketo the company’s investor relations department about this and were told that investors have continually asked about this issue assales have climbed. The company has said that there is abundant merchandise available. Based on our recent store visits we seeno reason to doubt that. While we don’t think that the opportunity to buy such merchandise will disappear, we do wonder whetherthe increasing emphasis on inventory management by manufacturers and retailers, along with the presence of company-ownedoutlets – such as Nordstrom’s growing Rack chain, Saks’ Off 5th, and Williams-Sonoma’s outlet stores – may be a risk factor.Bloomingdale’s and Macy’s are even getting into the act. One thing to note is that some outlets sell merchandise that is designedspecifically to be sold at outlet stores. We believe that this is less desirable to shoppers than the top-tier brands that TJX typicallysells.

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We once asked management which companies it views as its primary competition and were told that the company’s mainfocus is trying to get its own execution right. In our opinion, that is a good answer and probably a good approach. We do thinkthe company has a lot of indirect competition. In addition to the outlets mentioned above, Polo, The Gap, J. Crew, Tommy Hilfiger,Ann Taylor, Eddie Bauer, Armani Exchange and Guess all have outlet stores. We also believe that other stores, such as Target,Kohl’s, J.C. Penney and Wal-Mart, are all striving to offer high-quality and fashionable merchandise in convenient settings andat attractive prices.

HomeGoods faces competition from some outlets and department stores, as well as from retailers like Bed Bath &Beyond, Pottery Barn, West Elm and Pier 1. HomeGoods does differentiate itself from its competition with an eclectic and ever-changing mix of unique items.

Another component of the company’s overall strategy is international growth. In many ways, this can be a risk-reductionstrategy (especially in businesses like retail, where weather and consumer confidence can hurt sales), as well as a means of reachingless saturated markets. Political risk really isn’t a major concern for us, because these stores are mainly in Canada and the U.K.with a smattering in Western Europe and Australia. Still, exchange rates and slow international growth can sometimes surpriseinvestors who don’t pay enough attention to international events. A stronger dollar could be a drag on earnings and lead todisappointments after a period where it helped profits.

TJX is involved in several legal proceedings and regulatory matters, including a class-action suit related to the “Compareat” pricing that appears on the company’s price tags, as reported in its most recent annual report. The outcome of these issues isdifficult to predict. The company does not have significant financial statement accruals against future suits.

COMPANY DESCRIPTIONTJX Companies Inc. sells name-brand merchandise at discounted prices. The company operates 4,070 stores in nine

countries, with almost 3,000 T.J. Maxx, Marshalls, HomeGoods and Sierra Trading Post stores in the U.S., 454 stores in Canada,and more than 630 stores in Europe and Australia. In FY18, the company posted sales of $35.9 billion, with 76% in the U.S., 10%in Canada, and 13% in Europe and 1% in Australia. Clothing and footwear is the major product category, at 52% of sales. Thecompany, based in Framingham, Massachusetts, has approximately 250,000 associates worldwide and now over 20,000 vendorssourcing products from over 100 countries.

The company’s fiscal year ends on the Saturday nearest to the last day of January. The fiscal year that ended on February3, 2018 had 53 weeks. The additional week boosted full-year EPS by about $0.11. The current FY19 ends on February 2, 2019.

VALUATIONTJX shares are up about 7% in the last year. They are trading at 17-times our FY19 estimate and 16-times our FY20 estimate.At 21-times trailing earnings, TJX is trading just above its five-year average multiple of 20.9-times. Historically, the

stock’s trailing P/E multiple has ranged from 17.3 to 24.0.Using a dividend discount model with our assumptions, we arrive at a value of approximately $85 per share, in line with

current levels, and helped by the lower tax rate and the increase in the dividend. With regard to this model, we note that the companyearns high returns on shareholders’ equity and may be able to maintain a very healthy payout ratio in its steady-growth phase.

TJX is trading at an enterprise value of 13.3-times trailing EBIT, just above the five-year average multiple of 12.0. Atan enterprise value of 12-times our EBIT estimate of about $4.1 billion for FY19, the shares would be worth about $81, just belowthe current share price. The multiple of 12 is a benchmark that we use for high-quality retailers with growth potential. We wouldcertainly put TJX in this category. At 13-times, the shares would be worth $85.

We would consider returning TJX to our BUY list, particularly if the shares decline to the low $70s on broad market weakness.On May 4, HOLD-rated TJX closed at $82.83, down $0.73. (Christopher Graja, CFA, 5/4/18)

U.S. STEEL CORP. (NYSE: X, $34.52) ................................................................................... BUY

X: Reiterating BUY with revised target of $47* We expect U.S. Steel to benefit from its asset revitalization plan, continued cost cutting, and new tariffs on imported steel.

* U.S. Steel shares have risen more than 50% over the last year, but have fallen from their highs in late Februaryand early March. These sharp price movements have been driven largely by tariff-related news.

* The company reported solid 1Q results on April 26, though the shares sold off after management said thatoperational challenges at a steelmaking facility would lower 2Q EBITDA by $30 million. We believe the pullbackprovides a favorable entry point.

* The shares appear favorably valued at 6.7-times our 2018 EPS estimate, below the peer average of 12.9. Theyare also trading below the peer average for price/sales and price/cash flow.

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ANALYSISINVESTMENT THESISWe are reaffirming our BUY rating on U.S. Steel Corp. (NYSE: X) with a revised target price of $47, reduced from $52.

Looking ahead, we have a favorable view of the company’s asset revitalization plan, which should improve operating efficiencyand help to drive long-term growth. While spending on this plan will weigh on earnings in the near term, we feel that the long-term outlook is encouraging. As expected, the company was able to return to full-year profitability in 2017, with help from strongerpricing, continued cost reductions, and government actions to limit steel imports. We also expect it to benefit from an eventualincrease in infrastructure spending. The shares have risen strongly over the last year on prospects for new steel tariffs, though theyhave fallen from their highs in late February and early March. We continue to see value in U.S. Steel, as the shares are tradingat a discount to peers based on P/E, price/sales, and price/cash flow.

RECENT DEVELOPMENTSU.S. Steel shares have underperformed over the past three months, declining 9.7%, compared to a decline of 4.1% for

the Basic Materials ETF IYM. However, the shares have strongly outperformed over the past year, rising 51.6% compared to again of 10.8% for the sector ETF. The beta on the shares is a high 4.27.

These sharp fluctuations in the share price have been driven in large part by the U.S. government’s recent tariff decisions,notably a new 25% tariff on imported steel. This tariff, along with a 10% tariff on imported aluminum, took effect in late March.The government subsequently granted at least temporary exemptions to producers from the EU, Brazil, Australia and othercountries, though it has also decided to impose quotas in some cases.

On April 26, U.S. Steel reported 1Q18 non-GAAP net earnings of $57 million or $0.32 per share, up from a loss of $145million or $0.83 per share in 1Q17. First-quarter EPS topped the Street forecast of $0.29, but missed our estimate of $0.40. First-quarter sales rose to $3.15 billion from $2.73 billion a year earlier. Adjusted EBITDA came to $255 million.

By business segment, the Flat-Rolled division posted 1Q18 EBIT of $33 million, up from a loss of $88 million in 1Q17,reflecting higher pricing, increased third-party sales and lower energy costs, partly offset by higher raw material costs andmaintenance costs associated with its asset revitalization plan. In the European segment, 1Q18 EBIT rose to $110 million from$87 million due to higher realized prices and positive currency translation, partly offset by an unfavorable FIFO inventory impact.The Tubular segment posted a first-quarter loss of $27 million on the EBIT line, narrower than the loss of $87 million a year earlier.The improvement reflected higher pricing and increased operating efficiencies, partly offset by increased substrate costs and aplanned maintenance outage.

EARNINGS & GROWTH ANALYSISCEO David Burritt noted that the company made progress on its asset revitalization program in 1Q and that it expects

to meet its objectives for further improvement over the remainder of 2018. However, reflecting operational challenges at its GreatLakes manufacturing plant, management expects 2Q adjusted EBITDA of approximately $400 million, and full-year adjustedEBITDA of $1.7-$1.8 billion.

We are raising our 2018 EPS estimate to $5.01 from $3.61 and our 2019 estimate to $5.07 from $3.95. Our estimatesassume benefits from improved pricing, additional cost reductions, and tariffs on imported steel. Our long-term earnings growthrate forecast is 9%.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on U.S. Steel is Medium-Low, the second-lowest point on our five-point scale. The

company’s debt was rated B2/stable by Moody’s. It is rated B/positive by Standard & Poor’s and BB+/positive by Fitch.Thus far in 2018, the company has refinanced $780 million of senior secured notes. It has also extended the term of its

$1.5 billion revolving credit facility from 2020 to 2023.At the end of 1Q18, the company’s total debt/capitalization ratio was 45.3%, down from 58.3% at the end of 1Q17 and

in line with the peer average. U.S. Steel had cash and equivalents of $1.37 billion at the end of 1Q18, up from $1.33 million atthe end of 1Q17. Long-term debt totaled $2.85 billion, compared to $3.03 billion at the end of 1Q17.

Management expects 2018 capital expenditures of approximately $900 million, of which $275-$325 million will be usedfor the asset revitalization program.

U.S. Steel pays a dividend. The company cut its quarterly payout to $0.05 in 2Q09 to conserve cash, saving about $116million annually. Our dividend estimates are $0.20 for both 2018 and 2019. The current yield is about 0.6%.

RISKSThe steel industry is extremely cyclical and highly competitive. It is also affected by excess global capacity, which has

limited price increases during periods of economic growth and led to price decreases during periods of economic contraction. In

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addition, the industry faces competition in many markets from producers of aluminum, cement, composites, glass, plastics andwood. U.S. Steel also faces risks associated with commodity prices, interest and exchange rates, asbestos liability andenvironmental issues.

The company and its peers face risks from the dumping of low-cost foreign steel, though they are beginning to see greaterpricing power due to tariffs on imports from China, India, South Korea and other countries. This pricing power could increasebased on new tariffs and quotas recently enacted by the Trump administration.

COMPANY DESCRIPTIONU.S. Steel, founded in 1901, is an integrated steelmaker with manufacturing capacity of more than 31 million tons at

plants in North America and Eastern Europe. The company’s three reporting segments are Flat-Rolled Products, U.S. SteelEurope, and Tubular Products. In addition to its steel manufacturing assets, the company has iron ore and coke productionfacilities, rail and barge transportation operations, real estate, and engineering and consulting services. The company has morethan 43,000 employees and is headquartered in Pittsburgh.

INDUSTRYOur recommended weighting for the Basic Materials sector is Over-Weight, based on stabilizing commodity prices and

signs that the global economy will avoid recession. The sector accounts for 2.9% of the S&P 500, and includes industries suchas chemicals, paper, metals and mining. Over the past five years, the weighting has ranged from 2% to 4%. We think investorsshould consider allocating about 4% of their diversified portfolios to stocks in this sector. The sector is underperforming thus farin 2018, with a loss of 6.0%. It outperformed in 2017, with a gain of 21.4%, and in 2016, with a gain of 14.1%.

The P/E ratio on projected 2018 EPS is 15.8, slightly below the market multiple. The sector’s debt ratios appear sound,as many in the group have deleveraged in recent years. Yields of 1.5% are below the market average. The Street consensus callsfor earnings growth of 25.4% in 2018.

VALUATIONWe think that U.S. Steel shares are attractively valued relative to peers at current prices near $33, in the middle of their

52-week range. The shares are trading at 6.7-times our 2018 EPS estimate, below the peer average of 12.9. They are also tradingat a price/sales multiple of 0.5 below the peer average of 0.7. The price/cash flow ratio is 7.0, in the upper half of the five-yearrange of 1.9-11.1 but below the multiples of most peers. Based on these generally favorable valuation metrics, we are maintainingour BUY rating with a revised target price of $47.

On May 4, BUY-rated X closed at $34.52, up $1.61. (David Coleman, 5/4/18)

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