MARKET DIGEST

- 1 -

WEDNESDAY, MARCH 7, 2018MARCH 6, DJIA 24,884.12

UP 9.36

Good Morning. This is the Market Digest for Wednesday, March 7, 2018, with analysis of the financial markets and commentson Marvell Technology Group Ltd., Domino’s Pizza Inc., Quest Diagnostics Inc., KKR & Co. L.P., The Kraft HeinzCompany, Wendy’s Co. and KB Home.

IN THIS ISSUE:* Initiation of Coverage: Marvell Technology Group Ltd.: Launching with BUY rating and $28 target (Jim Kelleher)

* Change in Rating: Domino’s Pizza Inc.: Raising to BUY with $260 target (John Staszak)

* Change in Rating: Quest Diagnostics Inc.: Upgrading to BUY with $116 target (Jasper Hellweg)

* Growth Stock: KKR & Co. L.P.: Reiterating HOLD following 4Q results (Stephen Biggar)

* Growth Stock: The Kraft Heinz Company: Maintaining BUY but lowering target on weak organic growth (DeborahCiervo)

* Growth Stock: Wendy’s Co.: Reiterating $19 target (John Staszak)

* Value Stock: KB Home: Raising estimates on lower tax rate (Chris Graja)

CONFERENCE CALL ANNOUNCEMENT:Argus Research will host a conference call for clients at 11 a.m. ET on Wednesday, March 7, 2018. The call is entitled

Industrial Sector: Challenges & Opportunities in a Growing Global Economy.Argus Director of Research Jim Kelleher, CFA, will host the call, which will be in webinar format. He will be joined by

Argus President John Eade. The outlook for Industrial stocks is increasingly favorable, given weakness in the dollar that bolstersU.S. competitiveness, and improving economic fundamentals worldwide. The sustained recovery in energy prices has revitalizedoil patch capital spending, benefiting industrial activity, while recovery in commodity prices is lifting spending by miningcompanies. The sector also faces challenges, most recently from President Trump’s proposed tariffs, which threaten to spark abroad trade war and potentially crimp demand for U.S. goods. Jim and John will engage in a discussion on these and other topics,while also seeking to identify best investment ideas in various sector niches.

Please note that the Investments & Wealth Institute has accepted Argus’ Monthly Conference Call for one (1) hour ofcontinuing education (CE) credit toward the CIMA/CIMC/CPWA certifications.

The program has also been accepted by CFP Board for one (1) hour of CE credit.Please visit https://attendee.gotowebinar.com/register/1677148146625643266 to register for the call. Once on the site,

follow simple instructions to sign up for the call and receive a call-in number and passcode. If you have any problems registering,please contact us at clientservices@argusresearch.com or by calling (212) 425-7500.

The call, as always, will be interactive with a question-and-answer period. We will be recording the call, and a rebroadcastwill be available on the password-protected portion of our website.

Slides related to the presentation will be posted on our website the day of the call and also will be available via the webcastitself.

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

- 2 -

MARKET REVIEW:Among our market indicators, our technical composite sank into bearish territory recently, hurt by large drops in breadth

and trading. NYSE breadth measures fell on a large selloff in down volume and stocks above their 150-day moving average, andCBOE trading measures were hard hit.

Meanwhile, our strategic composite slipped a bit, but remained in bullish/positive trading ranges. Market internals hada moderate drop on relative weakness in Industrials, Materials and Consumer Discretionary stocks, but Technology was strongand Financials/Energy were steady.

Market external indicators had a small dip on relative weakness in crude oil, but industrial commodities and metals weresteady. Emerging market currencies remained strong versus developed market currencies.

We note that over the past eight years, major and prolonged corrections have occurred when both our technical andstrategic indicators are bearish. But when strategic indicators are bullish and technicals are bearish, as is currently the case,corrections tend to be moderate and short lived, although broad market trading ranges may persist until technical indicators turnpositive.

The date 3/9/18, marks the ninth birthday for the bull market that began at the market bottom on 3/9/09. It has been agreat market run and the strongest in points appreciation, though not in percentage appreciation.

Many investors believe the bull market ended in summer-fall 2011, when the S&P 500 missed the bear market tag (down20% or more) by a whisker. These investors point out that multiple asset classes, including DJ Transports, emerging market stocks,and even the S&P 500 on a median-stock basis (down 25%), were comfortably in bear territory. Never one to throw shade at abirthday party, we consider this bull market to be intact, still running, and (in fact) in fine shape.

We looked at bull markets since World War II to see what we could glean from history. Including the current bull run,we count 12 bull markets of varying size. Their average duration on the S&P 500 was 58 months. Most of the early bulls wereshorter in duration. If we count only bulls since 1970 and longer than six years, the average duration is 98 months. That includesthis bull, now in month 108.

The great 1990s bull market wears the mantle as the longest-running post-WWII bull, and also the one with the highestappreciation. Between the low on 10/11/90 and the closing high on 8/30/99, the ‘90s bull appreciated 368% over the course of113 months. The current bull market has appreciated 301% and has also run for five fewer months. Unlike the ‘90s bull, whichwheezed into the finish, this bull just got a major upgrade in EPS projections via the tax act. (Jim Kelleher, CFA, Director ofResearch)

MARKET DIGEST

- 3 -

MARVELL TECHNOLOGY GROUP LTD. (NSM: MRVL, $23.57) ............................................. BUY

MRVL: Launching with BUY rating and $28 target

* This leading provider of storage, networking and connectivity solutions has agreed to buy Cavium, which willdouble its TAM, provide entry into complementary product markets and customers, and should be immediatelyaccretive to non-GAAP EPS.

* Marvell is stabilizing revenues and in position to resume top-line growth after several years of sales declineprimarily related to asset portfolio reorganization and dispositions.

* Amid improving execution, Marvell is expanding margins, leading to superior EPS growth potential. MRVL sharesappear attractively valued at current levels.

* Based on the company’s gathering momentum in key markets as well as attractive valuations, we are initiatingcoverage of Marvell with a BUY rating and a 12-month target price of $28.

ANALYSISINVESTMENT THESISWe are launching coverage of Marvell Technology Group Ltd. (NSM: MRVL) with a BUY rating and a $28 target price.

The company is a provider of semiconductor-based solutions to the storage, networking, and connectivity markets. All thecompany’s end markets are experiencing strong growth, amid digital transformation in both traditional markets such as PCs andsmartphones, as well as evolving markets such as Cloud, Big Data, Social Mobile, IoT, robotics, and AI.

The company has improved execution by tightening its focus on value-added opportunities. Marvell has also exitedmarkets where it lagged, such as mobile device basebands. Under CEO Matt Murphy and team, Marvell appears to have movedbeyond past issues, most notably a damaging accounting scandal that prompted the replacement of prior management.

In November 2017, Marvell announced a definitive agreement to purchase Cavium, a provider of network processors,network security solutions, ARM server processors, DCI (data center interconnect) solutions, Ethernet connectivity, and otherproducts. We believe the move makes strategic sense for Marvell.

The acquisition of Cavium would add a leading HBA (server & storage connectivity) business to Marvell’s already strongstorage platform. It would also add complementary assets in networking, DCI, connectivity, and other areas, with minimaloverlaps in products, markets and customers. Even if the Cavium deal falls through, MRVL appears well positioned to executeas it broadens its exposure in numerous growth markets.

The share price has recovered from trough levels brought on by an accounting scandal. The MRVL share price was alsoheld back over the longer term by the company’s ultimately unsuccessful foray into mobile device basebands business. Althoughthe shares have moved higher in the past year, our analysis suggests the stock is still undervalued compared to peers and basedon historical comparable valuations and cash flow growth prospects.

Based on the company’s gathering momentum in key markets as well as attractive valuations, we are initiating coverageof Marvell with a BUY rating and a 12-month target price of $28.

RECENT DEVELOPMENTSMRVL shares are up 9% year-to-date, compared with an 8% gain for the peer group of Argus covered semiconductor

companies. The shares rose 54% in 2017, compared to a 35% rise for Argus peers, and recovered by 61% from trough levels in2016. The shares declined 37% in 2015, compared to a 6% gain for peers, and edged up 5% in 2014.

Based in Bermuda with headquarters operations primarily in Silicon Valley, Marvell is a fabless semiconductor providerhigh performance ASSPs (application-specific standard products). The company leverages its expertise to develop integratedcircuit solutions in analog, mixed signal, DSP, embedded and standalone applications.

In recent years, according to the company, Marvell has transitioned from a supplier of stand-alone semiconductorcomponents to a supplier of fully integrated platform solutions. The transition was prompted by technological changes andanticipated needs by device makers in the client, campus, enterprise, service provider and data center markets requiring secure,integrated solutions. The company is increasingly integrated multiple technologies and solutions on a single die to create systemon a chip (SoC) products.

In April 2016, Marvell founder and CEO Sehat Sutardja and his wife, President Weili Dai, resigned from the company.In spring 2016, the board determined that pressure from the top had prompted sales and marketing personnel to doctor results inpursuit of unrealistic sales goals. Matthew Murphy was named CEO and President.

MARKET DIGEST

- 4 -

In November 2016, the company announced plans to restructure operations, refocus R&D, and improve efficiency andprofitability. These actions were largely completed by fall 2017. The company announced plans to divest two unspecifiedbusinesses, which are widely believed to multi-media related; those units were moved to discontinued operations. Based on thisrealignment, for the fiscal 2017 year (ended January 2017), Marvell derived 50% of revenue from Storage; 25% from networking;14% from connectivity; and 11% from Other.

In the storage market, Marvell is a leading supplier of hard disk drive controller, which provide a high-performance I/O interface between the HDD and host system. The company also makes HDD controller SoCs. Additionally, Marvell suppliescontrollers for solid state drives. Marvell supplies all major HDD and SSD manufacturers. Marvell supplies additional componentsused in memory drives.

Other storage products from Marvell include SATA port multipliers; redundant array of independent disk controllers forSATA, SAS, and NVMe; and converged storage processors.

In Networking, Marvell provides Ethernet connectivity solutions for use in networks spanning home office, smallbusiness, enterprise, service provider and data center. The company produces a broad range of Ethernet switches from low-power,five-port switches to highly integrated, multi-terabit Ethernet SoCs; Ethernet physical layer transceivers; and single-chip networkinterface devices. Additionally, for embedded applications Marvell provides ARM processors in SoC form factor targeted atmarkets including networked storage, control plane applications, routers, switches, wireless access points, base stations and homegateways.

In the connectivity market, Marvell provides WiFi solutions, including WiFi/Bluetooth combos in SoC form factors.Additional products include single-stream 1x1 and multi-stream 2x2 and 4x4 MIMO (multi input, multi output) devices; radiocontrol; processing; and RF solutions.

The Other segment primarily includes SoCs for printers. The segment also provides applications processors for non-mobile applications in markets including IoT and various embedded applications. While Marvell exited the mobile basebandmarket in September 2015, several customers continue to ship the company’s LTE communications processors.

Although Marvell participates in numerous markets, its heaviest exposure is in drive parts, and specifically in HDDcontrollers. During fiscal 2017, three drive customers – Western Digital, Toshiba, and Seagate – accounted for 43% of revenue.

The HDD business is not going away anytime soon, but it is in structural decline. In the client space, the displacementof HDDs by SSDs is well along and should be complete within the next few years. While HDDs are still economically superiorto non-volatile memory solutions in non-mobile environments, such as data center, electronic memory has advantages such as highavailability and always-on. The cost and performance gap between HDD and SSD is ever-narrowing, increasing the urgency forMarvell to broaden its revenue sources.

On 11/20/17, Marvell Technology Group Ltd (NGS: MRVL) and Cavium, Inc. announced a definitive agreement tocombine. The agreement, approved by the boards of both companies, calls for Marvell to acquire all outstanding shares of Caviumstock at an exchange rate of $40 per share in cash and 2.1757 shares of MRVL stock for each CAVM share.

Assuming achievement of the usual regulatory approvals, the two companies are targeting deal close for some time inmid-2018. Marvell has been domiciled in Bermuda since 1995; acquisition of U.S. companies by foreign companies often takeslonger than comparable all-U.S. deals. The deal size is relatively small, however. Management of both firms believe that theirstatus as component companies rather than systems companies should prevent any regulatory roadblocks.

Cavium represents an attractive and relatively inexpensive asset for Marvell as it seeks to position itself for next-generation data center, 5G wireless, and future developments spanning IoT, AI, hyperscale data center, and high performancecomputing. Upon completion of the transaction, Marvell would become an “infrastructure solutions powerhouse,” according toCEO Matt Murphy.

Cavium began as a provider of MIPS-based network processor and network security solutions. The company acquiredQLogic, a maker of fiber channel (FC) host bus adaptors (HBAs) for storage network connectivity, as well as Ethernet connectivityproducts. Based on a successful multi-year expansion strategy, Cavium has become a leader in networking and embeddedprocessors, both MIPS and ARM-based; security and server processors, data center interconnect switches; base station processors;network virtualization cards; FC HBAs; Ethernet connectivity; and other products.

Management at Marvell and Cavium believe their portfolios are highly complementary and present limited overlaps inproducts, markets and customers. Complementary portfolios and scale should enable the combined company to deliver end-to-end solution.

MARKET DIGEST

- 5 -

The combination will alter Marvell’s product and customer mix while reducing over-reliance on storage. The newMarvell would derive 46% of revenue from storage (where Cavium would contribute QLogic’s FC HBAs); 37% from networkingand processing; 11% from connectivity; and 6% from other. The biggest change would be in networking, where Cavium is aleading supplier of network processors to Cisco; base station SoCs to Samsung; DCI solutions to multiple enterprise clients; andother products.

In the data center, Marvell brings networking solutions and HDD/SSD controllers. Cavium brings Xpliant top of rackswitches for interconnect, ThunderX ARM server platforms, LiquidIO for line card virtualization, and Nitrox MIPS-basedsecurity processors. Though just 10% of combined revenue, this business would be on track to grow rapidly.

By acquiring Cavium, Marvell will double its total available market (TAM) opportunity to $16 billion. The new Marvellwill have 20% share within this expanded TAM opportunity, with lots of room to grow. The new Marvell would have a combined$3.4 billion in revenue.

The company is targeting high-single-digit top-line growth for multiple years. Gross margin would be in the 63% range(non-GAAP), with a longer-term target of 65%. Operating margin (non-GAAP) will begin in the 25% range, before synergies;the long-term goal is 35%. The deal will be immediately accretive, according to Marvell CFO Jean Hu (formerly CFO and two-time interim CEO of QLogic, which was acquired by Cavium).

Marvell and Cavium are aiming to achieve $150-$175 million in manufacturing and operating synergies within 18months. The combined company should quickly achieve synergies from eliminating duplicative costs, integrating facilities, andvolume purchasing.

The combination will enable scale in areas including R&D, engineering, process node development, and tape-out costs.Both companies have been developing new processors in 10 nm and 7 nm process node; that process will proceed more efficientlyin a single operation. Revenue synergies, though not modeled, would be natural for two companies operating in adjacent markets(data center and service provider) yet with minimal customer overlap.

Although the deal was initially valued at $80 per share for CAVM holders, movement in the MRVL shares has alreadypushed deal value higher. CAVM currently trades near $88; this reflects the higher MRVL price, but may reflect industry sentimentthat other bids for Cavium could emerge.

As deal close approaches, the likelihood of other bids emerging diminishes. In our view, the acquisition of Cavium wouldadd a leading HBA (server & storage connectivity) business to Marvell’s already strong storage platform. It would also addcomplementary assets in networking, DCI, connectivity, and other areas, with minimal overlaps in products, markets andcustomers. Even if the Cavium deal falls through, MRVL appears well positioned to execute as it broadens its exposure innumerous growth markets. We believe Marvell would also consider other acquisition candidates to broaden its total availablemarket opportunity.

In summary, Marvell is stabilizing revenues and in position to resume top-line growth after several years of sales declineprimarily related to asset portfolio reorganization and dispositions. Amid improving execution, Marvell is expanding margins,leading to superior EPS growth potential. And the stock, long suppressed by its troubles, appears attractively valued at currentlevels.

EARNINGS & GROWTH ANALYSISMarvell reports on a January fiscal year. We expect the company to report results for fiscal 4Q18 and the full fiscal year

on March 8.For fiscal 3Q18 (ended 10/28/17), Marvell reported revenue of $616 million, which was down 6% year-over-year and

up 2% sequentially from 2Q18; revenue exceeded the midpoint of management’s guidance.Non-GAAP gross margin of 61.6% for 3Q18 expanded sequentially from 61.2% and expanded 490 bps from 56.7% a

year earlier. Non-GAAP operating margin was 28.4% for fiscal 3Q18, compared with 26.5% in 2Q18 and 17.6% a year earlier.For 3Q18, Marvell posted non-GAAP EPS of $0.34 per diluted share, up 68% year-over-year and up $0.04 from 2Q18.

Non-GAAP EPS was above the midpoint of management’s guidance range and topped the consensus estimate by a penny.For all of fiscal 2017, Marvell posted revenue of $2.39 billion, which was down 12% from $2.73 billion for FY16. Marvell

posted fiscal 2017 non-GAAP EPS of $0.60 per diluted share, up 61% from $0.37 for FY16.For 4Q18, Marvell guided for revenue of $595-$625 million, which at the $610 million midpoint would be up 7%

annually and down 1% sequentially. Non-GAAP EPS was forecast at $0.29-$0.33, which at the $0.31 midpoint would be up 43%annually and down $0.03 sequentially.

We are implementing a fiscal 2018 non-GAAP EPS estimate of $1.20 per diluted share, which would be up 99% year-over-year. We have also implemented a fiscal 2019 non-GAAP EPS projection of $1.35 per diluted share, which implies further13% growth. Our annualized EPS growth rate forecast is 12%.

MARKET DIGEST

- 6 -

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on Marvell is Medium-High. Although the company carries no debt and appears to be

operating more efficiently, the company’s past accounting issues as well as strategic missteps in the mobile baseband businessargue for a more conservative rating.

Cash, equivalents and short-term investments were $1.57 billion at 3Q18. Cash, equivalents and short-term investmentswere $1.69 billion at the end of FY17, $2.28 billion at the end of FY16, $2.53 billion at the end of FY15, and $1.97 billion at theend of FY14.

Marvell has no debt.The company engaged in significant share repurchase activity in FY14, reducing its basic shares outstanding to 497

million at year-end from 555 million at FY13 year-end. Since then the company has repurchased stock mainly as an offset to share-based compensation and other share grants. We expect the company to maintain a modest share repurchase program going forward.

Marvell implemented a quarterly dividend of $0.06 per common share in 2013. The board has not raised the dividendsince. The annual dividend of $0.24 provides a yield slightly above 1.0%. We estimate coverage of the dividend of about 5.5-timesbased on cash flow from operations and about 5.0-times based on free cash flow.

Our dividend estimate are $0.24 for both FY18 and FY19.MANAGEMENT & RISKSCEO and President Matt Murphy has served in that role since 2016, when he took over for the husband-and-wife team

who founded the company in 1995 but were forced to resign following an accounting scandal. Jean Hu, formerly CFO and two-time interim CEO of QLogic, is CFO. Dan Christman is EVP Storage Group; Chris Koopmans is EVP Networking & ConnectivityGroup. Richard Hill is chairman of the board.

The taint of Marvell’s accounting scandal has receded. Should another such issue emerge, however, twice-bitteninvestors would likely react fiercely. We have no reason to believe that the current management team and board, chastened bythat misadventure, would create a culture in which such malfeasance would resurface.

The acquisition of Cavium will create financial strains and introduce risks related to cultural integration, attainingtargeted efficiencies, and retaining acquired customer relationships. We believe Marvell and Cavium are logical partners forcombination, given complementary rather than overlapping products, markets and customers, and that this lessens risks that thecombination will fail to meet objectives.

Marvell faces the risks of any small company attempting to operate in multiple product niches and end markets. Recentsuccess in improving operation margins suggests Marvell is not over-reaching.

Finally, Marvell has customer concentration risk in the HDD controllers business. Cultivation of new markets and theCavium acquisition should help reduce this risk.

COMPANY DESCRIPTIONMarvell Technology Group Ltd. was founded in 1995. Domiciled in Bermuda, Marvell’s headquarters is based in Santa

Clara, CA. Marvell is a fabless semiconductor provider high performance ASSPs (application-specific standard products) for usein storage, networking, connectivity and other applications. Primary products include HDD and SSD controllers; additionalcomponents used in memory drives; Ethernet switches; Ethernet PHYs; ARM processors in SoC format; WiFi and WiFi/Bluetooth combo chips; and embedded processors and SoCs. The company has rebounded from an accounting scandal in 2015.In November 2017, Marvell announced a definitive agreement to acquire Cavium Inc.

INDUSTRYOur rating on the Technology sector is Over-Weight. Technology is showing clear investor momentum, topping the

market in the year-to-date. At the same time, the average two-year-forward EPS growth rate exceeds our broad-market estimateand sector averages, which has kept technology sector PEG valuations from becoming too rich.

Over the long term, we expect the Tech sector to benefit from pervasive digitization across the economy, greateracceptance 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.

In terms of performance, the sector rose 12.0% in 2016, above the market average, after rising 4.3% in 2015. It stronglyoutperformed in 2017, with a gain of 36.9%. It is performing largely in line with the market thus far in 2018, with a loss of 1.7%.

Fundamentals for the Technology sector look reasonably balanced. By our calculations, the P/E ratio on projected 2018earnings is 19.6, above the market multiple of 18.7. Earnings are expected to grow 22.9% in 2018 and 29.4% in 2017 followinglow single-digit growth in 2015-2016. The sector’s debt ratios are below the market average, as is the average dividend yield.

MARKET DIGEST

- 7 -

VALUATIONMRVL trades at 19.4-times our FY18 non-GAAP EPS estimate and at 17.2-times our FY19 forecast; the two-year-

forward P/E of 18.3 is in line with the average multiple of 18.0-times over the past five years. The two-year-forward relative P/E of 0.99 is now below the trailing five-year relative P/E of 1.03. Our comparable valuation range for MRVL is in the high teensto low-$20s, slightly below current prices but in a clear rising trend.

Compared with its peer group, MRVL trades at discounts on absolute and relative P/E, EV/EBITDA, and PEGY. Ourforward-looking discounted free cash flow model points to a value in the mid to upper $30s, in a rising trend.

Our blended valuation for MRVL is in the high $20s to low $30s, in a rising trend. We are establishing a 12-month targetprice of $28 Appreciation to our 12-month target price of $27, including the dividend yield of 1%, implies a risk-adjusted totalreturn in excess of our forecast total return for the S&P 500 and is thus consistent with an intermediate-term BUY rating.

On March 6, BUY-rated MARV closed at $23.57, up $0.08. (Jim Kelleher, CFA, 3/6/18)

MARKET DIGEST

- 8 -

DOMINO’S PIZZA INC. (NYSE: DPZ, $221.44) ...................................................................... BUY

DPZ: Raising to BUY with $260 target

* At current prices, we believe that DPZ shares inadequately reflect prospects for rapid earnings growth andincreased market share.

* Reflecting management’s long-term plan to increase the store count by 6%-8% annually, we think that revenuegrowth will be increasingly driven by the opening of new restaurants.

* We also expect the company’s loyalty program, as well as its mobile and online ordering systems, to boost domesticcomps in the coming quarters. Digital orders accounted for 63% of orders in 2017, up from 60% in 2016.

* We are boosting our 2018 EPS estimate to $8.30 from $6.25, reflecting the company’s history of positive earningssurprises and the accelerated pace of new U.S. store openings. We are setting a 2019 EPS estimate of $9.50.

ANALYSISINVESTMENT THESISWe are upgrading Domino’s Pizza Inc. (NYSE: DPZ) from HOLD to BUY and setting a target price of $260. At current

prices, we believe that DPZ shares inadequately reflect prospects for rapid earnings growth and increased market share. Reflectingmanagement’s long-term plan to increase the store count by 6%-8% annually, we think that revenue growth will be increasinglydriven by the opening of new restaurants. In addition, Domino’s franchised business model reduces its exposure to rising costsand benefits margins. We also expect the company’s loyalty program, as well as its mobile and online ordering systems, to boostdomestic comps in the coming quarters.

Our long-term rating is now also BUY.RECENT DEVELOPMENTSDomino’s reported 4Q17 results on February 20. Reflecting higher domestic and international same-store sales and

global store growth, revenue rose 8.8% to $892 million; however, revenue missed the consensus estimate of $905 million.U.S. same-store sales rose 4.2% in 4Q17, down from 12.2% growth in 4Q16 and below the consensus forecast of 6.0%.

However, domestic same-store sales have risen for 27 straight quarters. Following a 4.3% gain in 4Q16, international same-storesales rose 2.5%, below the consensus estimate of 6.0%. International same-store sales have increased for 96 consecutive months.Management said that the company opened 422 stores in 4Q17 and 1,045 stores in 2017.

Fourth-quarter operating earnings came to $2.09 per share, up from $1.48 in the prior-year period and above theconsensus estimate of $1.95. The positive earnings surprise reflected the impact of new restaurants, increased margins, and a lowershare count. The gross margin rose 40 basis points to 31.5%. G&A expense rose slightly, to $105.6 million, but fell 90 basis pointsto 11.8% of revenue, below the consensus estimate of 12.5%. The operating margin rose 130 basis points to 19.7%, reflecting lowerG&A expense as a percentage of revenue, and topped the consensus estimate of 18.7%. Interest expense rose to $38.7 million from$33.4 million in 4Q16. The share count fell from 49.1 million to 44.6 million.

For all of 2017, revenue rose nearly 13% to $2.8 billion, while earnings rose to $5.94 per share from $4.30 in 2016.As discussed in previous reports, Domino’s is working to increase the number of orders placed online and using

smartphones. Digital orders accounted for 63% of orders in 2017, up from 60% in 2016. The benefits of digital orders include ahigher average check, lower labor costs, and more accurate orders. Domino’s believes that prospects for digital orders are strong.We believe that Domino’s has a competitive advantage in this area and note that it continues to take market share from smallermom-and-pop pizzerias.

Management plans to finish remodeling its stores by the end of 2017. However, perhaps because most customers havetheir orders delivered and do not eat at restaurants, remodeled locations have reported only low single-digit sales growth.

EARNINGS & GROWTH ANALYSISWe are boosting our 2018 EPS estimate to $8.30 from $6.25. Our higher estimate reflects the company’s history of

positive earnings surprises and the accelerated pace of new U.S. store openings. We also expect the operating margin to increasemodestly this year based on more favorable commodity costs and carefully managed expenses. For 2019, we are setting an estimateof $9.50.

MARKET DIGEST

- 9 -

FINANCIAL STRENGTH & DIVIDENDWe rate Domino’s financial strength as Medium-Low, the second-lowest rank on our five-point scale. At the end of 4Q17,

the company had $3.15 billion in long-term debt and other accrued liabilities. On July 24, 2017, DPZ completed its recapitalization,issuing $1.6 billion of fixed-rate senior secured notes and $300 million of floating-rate senior secured notes, and arranging a new$175 million variable-rate funding facility. Part of the recapitalization was used to repay $910.5 million of the company’s 2012fixed-rate notes.

The board also authorized a new $1.25 billion share repurchase program. This authorization replaced the remaining$136.4 million available under a previously approved $250 million buyback program. DPZ also completed a $1.0 billionaccelerated share repurchase with a counterparty prior to the end of the third quarter. In the fourth quarter, DPZ repurchased937,000 shares, including nearly 660,000 shares authorized as part of an earlier accelerated share repurchase program.

Operating income covered interest expense by a factor of 4.5 in the fourth quarter, essentially unchanged from the prior-year period. We prefer to see an interest coverage ratio above 5.0.

Domino’s resumed quarterly dividend payments in March 2013 after suspending its regular payout in early 2007. Thecompany did pay a $13.50 per share special dividend in 2007 as part of a recapitalization plan and another $3 special dividendin March 2012.

In March 2018, the company raised its quarterly dividend by 19.6% to $0.55, or $2.20 annually, for a yield of about 1.0%.Our dividend estimates are $2.20 for 2018 and $2.40 for 2019.

RISKSDomino’s Pizza is subject to competition that would be considered extreme in almost any other industry, but is considered

normal for quick-service restaurants. Moreover, the company has faced additional pressure in recent years as delivery menus haveexpanded to meet consumer demand for “healthy” and “gourmet” fare. There has also been strong growth in the casual diningsegment over the past few years, and casual dining establishments have begun to challenge the delivery segment by expandingtakeout service and, in some cases, by offering delivery as well. Within its segment, the company competes not only with otherlarge pizza delivery chains, but also with many local pizzerias.

In our opinion, the company will likely face increasing difficulty in obtaining domestic franchisees unless it sacrificesmargins in its distribution operations.

With a market capitalization of about $9.5 billion, Domino’s Pizza is considered a small-cap issue, despite the company’sstrong name recognition.

COMPANY DESCRIPTIONDomino’s Pizza Inc. is a leader in the pizza delivery business, having pioneered the concept 50 years ago. The company

completed its initial public offering in July 2004. Domino’s is primarily a franchise operation that derives revenue from fees andthe sale of materials to franchisees. The company also directly owns almost 600 stores and uses them as a base for testing menuchanges and as a pool for franchise liquidity. The company has operations in 80 countries.

INDUSTRYWe have raised our rating on the Consumer Discretionary sector to Over-Weight from Market-Weight. The sector has

shown solid market momentum, reflecting investor expectations for strong durable goods demand in the wake of tax cuts. At thesame time, Consumer Discretionary stocks have been out of favor for multiple quarters, and appear undervalued relative to peers.

The sector accounts for 12.6% of the S&P 500. We think investors should consider allocating 13%-14% of theirdiversified portfolios to the group. Over the past five years, the weighting has ranged from 8% to 13%. The sector underperformedin 2016, with a gain of 4.3%, after outperforming in 2015, with a gain of 8.4%. It slightly outperformed in 2017, with a gain of21.2%, and is outperforming thus far in 2018, with a gain of 1.9%.

Consumer Discretionary earnings are expected to increase 13.4% in 2018 and 3.6% in 2017 after rising 9.4% in 2016.On valuation, the 2018 projected P/E ratio is 22.0, above the market multiple of 18.7. The sector’s debt ratios are high, with anaverage debt-to-cap ratio of 52%. Yields are below average at 1.0%.

VALUATIONDPZ shares are trading at 26.7-times our 2018 EPS estimate and at 23.3-times our 2019 forecast. Since the company’s

IPO in July 2004, they have traded at an average projected P/E of 17.4. The price/sales ratio of 3.4 and the price/cash flow multipleof 15.4 are also above peer averages. However, we believe that these multiples inadequately reflect prospects for solid same-storesales, new restaurant openings, and reduced costs under the franchised business model. Based on prospects for accelerating unitexpansion in the U.S. and continued sales growth, we are raising our rating to BUY with a target price of $260.

On March 6, BUY-rated DPZ closed at $221.44, up $1.83. (John Staszak, CFA, 3/6/18)

MARKET DIGEST

- 10 -

QUEST DIAGNOSTICS INC. (NYSE: DGX, $104.14).............................................................. BUY

DGX: Upgrading to BUY with $116 target

* We have a favorable view of Quest’s cash generation, strong cost controls, and focus on stock buybacks anddividends. On February 1, the company raised its dividend by 11% — the first increase since 1Q16.

* Looking ahead, Quest should also benefit from a range of recent acquisitions, as well as from a lower tax rate.

* We are raising our 2018 EPS estimate to $6.59 from $5.79. We are also setting a 2019 estimate of $6.91, but notethat changes in Medicaid payment rates for lab fees may limit growth next year. Our long-term EPS growth rateforecast is 7%.

* Our target price of $116 implies a total potential return, including the dividend, of 14% from current levels.

ANALYSISINVESTMENT THESISWe are raising our rating on Quest Diagnostics Inc. (NYSE: DGX), a provider of diagnostic testing services, to BUY

from HOLD. The company annually serves one in three adult Americans as well as half of U.S. physicians and hospitals. It alsooperates facilities in Mexico and India. We have a favorable view of Quest’s cash generation, strong cost controls, and focus onstock buybacks and dividends. On February 1, it raised its dividend by 11% — the first increase since September 2016. Lookingahead, the company should also benefit from a range of recent acquisitions, as well as from a lower tax rate. Although Quest mayface pressure from lower Medicaid payment rates for clinical laboratory tests, we expect a greater impact on smaller peers, whichmay lead to additional acquisition opportunities. Our target price of $116 implies a total potential return, including the dividend,of 14% from current levels.

RECENT DEVELOPMENTSDGX shares have outperformed over the past quarter, gaining 5.1% versus a 3.5% gain for the S&P 500. The shares have

underperformed over the past year, however, with a gain of 4.6%, versus a 14.6% advance for the index. Over the past five years,DGX has gained 83.0% versus a 74.8% gain for the index. Quest’s beta is 0.91, above Laboratory Corp of America’s 0.82.

On February 1, Quest reported 4Q17 adjusted EPS of $1.40, up from $1.31 a year earlier and above the consensus of$1.38. On a GAAP basis, diluted EPS rose to $1.82 from $1.09 in 4Q16, largely due to the impact of the new U.S. tax law. Revenuerose 4.1% to $1.94 billion. Tax benefits from stock-based compensation added $0.02 to diluted EPS, up from $0.01 in 4Q16. Forall of 2017, adjusted EPS rose 10.1% to $5.67, while GAAP EPS rose 22.0% to $5.50. The tax benefit from stock-basedcompensation added $0.27 to full-year diluted EPS, up from $0.21 in 2016. Given that adjusted EPS will exclude excess taxbenefits beginning in 2018, management noted that 2017 adjusted EPS presented on this basis would have been $5.40. Cash fromoperations rose 9.9% to $1.2 billion.

Along with its fourth-quarter and full-year results, management offered guidance for 2018. The company expects dilutedEPS of $5.42-$5.62 and adjusted EPS of $6.50-$6.70, excluding the impact of amortization and excess tax benefits. It expectsrevenue of $7.70-$7.77 billion, implying growth under its new revenue recognition methodology of 4%-5%. It also expects cashfrom operations of $1.3 billion and capital expenditures of $350-$400 million.

On November 17, the Centers for Medicare & Medicaid Services (CMS) published final 2018 Medicaid payment ratesfor clinical laboratory tests in accordance with the Protecting Access to Medicaid Act of 2014 (PAMA). The new guidelines cutthe rates that may be charged by laboratory test providers. In December 2017, the American Clinical Laboratory Association(ACLA) filed a lawsuit challenging the method used by CMS to calculate the new rates, arguing that the data used in the calculationwas incomplete and did not reflect the market-based approach suggested by Congress. Supporting the lawsuit, Quest argued thatless than 1% of laboratories submitted data about their rates; in addition, Quest alone provided nearly 40% of the submitted marketdata, despite its smaller 15% share of the Medicaid market. The company expects a court ruling by midyear. If the lawsuit isunsuccessful, the company estimates that the reduced rates would lower fee revenue by approximately 4% in 2018 and 10% inboth 2019 and 2020. While reduced rates would weigh on near-term earnings, management noted that new rates could also leadto greater industry consolidation and to potential acquisition opportunities.

MARKET DIGEST

- 11 -

In 2017, Quest completed seven acquisitions. In early May, it acquired the outreach laboratory services of PeaceHealthLaboratories (PHL) for $101 million. In mid-July, it acquired Med Fusion LLC and Clearpoint Diagnostic Laboratories LLC for$150 million, adding to its capabilities in oncology diagnostics. In late September, Quest acquired the outreach laboratory servicebusinesses of The William W. Backus Hospital and The Hospital of Central Connecticut for $30 million. In early December, itacquired Cleveland HeartLab for $94 million, net of $12 million cash acquired; the lab provides diagnostic information servicesfocusing on risk assessment and treatment protocols for heart disease. Also in December, Quest acquired certain clinical andanatomic pathology laboratory assets of Shiel Holdings, LLC for $176 million, of which $6 million will be contingent on achievingcertain volume benchmarks. The seven acquired companies are now included in Quest’s Diagnostic Information Services (DIS)business. In all, acquisitions led to 2.1% revenue growth in the DIS segment in 2017, above management’s forecast of 1%-2%growth.

On February 1, Quest completed the acquisition of Mobile Medical Examination Service, or MedXM, a national providerof home-based health risk assessments and related services. The acquisition will allow Quest to expand into the mobile and homesegments, while strengthening its capabilities in extended care. Financial terms were not disclosed.

On February 26, the company announced the opening of the “Quest Diagnostics Sports Science Laboratory at the RutgersCenter for Health & Human Performance,” in collaboration with Rutgers University – New Brunswick. Combining Rutgers’athletic research capabilities with diagnostics from Quest’s “Blueprint for Athletes” service, the new laboratory will seek tounderstand “how diagnostic information, specifically blood biomarkers, can improve health and athletic performance.” Anyresulting intellectual property will be jointly owned by Quest and Rutgers University.

EARNINGS & GROWTH ANALYSISQuest’s core Diagnostic Information Services business, or DIS, represented 96% of 2017 revenue. DIS develops and

delivers diagnostic testing information and services, including routine testing, gene-based testing, and drug abuse testing, as wellas anatomic pathology services. DIS revenues grew 3.3% in 2017 to $7.37 billion and 4.5% in 4Q to $1.85 billion. This segment,which has grown through acquisitions, operates under the Quest Diagnostics brand, as well as under the brand names of a rangeof acquired companies, including AmeriPath, Dermpath Diagnostics, Athena Diagnostics, ExamOne, and Quanum. Thecompany’s Diagnostic Solutions segment (4% of 2017 revenues) offers risk assessment services for life insurers and healthinformation technology solutions for healthcare organizations and clinicians. Diagnostic Solutions revenue fell 10% in 2017following the sale of Focus Diagnostics.

Quest has grown in part by helping health insurers manage customer utilization and keep laboratory testing in-network.Within Quest’s DIS business, health insurers accounted for 47% of segment volume and 51% of revenue at the end of 2017, whilegovernment payers accounted for 15% and 17%, respectively. Client payers accounted for 37% of volume and 29% of revenue,and individual patients accounted for 1% of volume and 3% of revenue.

Quest has been able to drive modest revenue growth over the last several years after posting a 3.2% decline in 2013. Therecovery reflects management’s focus on higher-growth areas of diagnostic testing and improved execution following a corporatereorganization. However, we note that 2016 revenue of $7.52 billion was essentially flat with the prior year while revenue grewonly 2.6% in 2017. The company is targeting compound annual revenue growth of 3%-5% in 2017-2020, driven primarily bypartnerships and a 1%-2% contribution from acquisitions. The company had previously projected 2020 EPS of $6.00-$7.00,assuming that reduced rates for lab testing would push earnings to the low end of the range; however, due to the new tax law, itnow expects EPS to exceed $7.00.

Quest has been managing costs through a multiyear program called Invigorate, designed to achieve $1.3 billion inannualized savings by the end of 2017 (relative to the end of 2011); management has stated in recent filings that savings from thisprogram have exceeded its initial target, but did not provide specifics. Management believes the program will be able to achieveadditional savings over time and said that it would offer periodic updates, rather than setting precise targets. The company hasalso sold six assets since 2012, generating gross proceeds of more than $1 billion.

Based on management’s guidance, the impact of a lower tax rate, and acquisitions over the past year, we are raising our2018 EPS estimate to $6.59 from $5.79. We are also setting a 2019 estimate of $6.91, but note that changes in Medicaid paymentrates for lab fees may limit growth next year. Our long-term EPS growth rate forecast is 7%.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating for Quest is Medium-High. In 2017, Quest generated $1.18 billion in cash from operations,

up 9.9% from 2016; in the fourth quarter, cash from operations rose 6.3% from the prior year to $323 million. Free cash flow asa percentage of revenue grew to 12.5% in 4Q17 from 9.5% in 4Q16. Over the past four quarters, Quest’s trailing free cash flowyield is 6.9%.

MARKET DIGEST

- 12 -

Quest had $3.78 billion in long-term debt at the end of 4Q17, up from $3.73 billion at the end of 4Q16. The debt/cap ratioat the end of 4Q17 was 43.3%, down from 44.5% at the end of 4Q16. Debt/cap has ranged from 43% to 53% over the past fiveyears, with a mean of 46%.

Quest pays a dividend. Along with its 4Q results, the company announced an 11% increase in its quarterly payout to $0.50,or $2.00 annually, for a projected yield of about 1.9%. It previously raised its payout in September 2016, and has paid dividendsevery year since 2004. Our dividend estimates are $1.95 for 2018 and $2.10 for 2019.

Quest repurchased 1 million shares of common stock for $100 million in 4Q17 and 4.6 million shares for $465 millionin 2017. At the end of the fourth quarter, the company had $917 million remaining on its buyback authorization.

Moody’s rates DGX credit as Baa2/stable while Standard & Poor’s rates it as BBB+/stable.MANAGEMENT & RISKSStephen Rusckowski is Quest’s chairman and CEO. He joined the company as CEO in May 2012 and became chairman

in December 2016. Over the past five years, Mr. Rusckowski has sought to transform the company by refocusing on core diagnosticinformation services, selling noncore assets, improving capital deployment, and simplifying the company’s organization. Priorto joining Quest, Mr. Rusckowski served as the CEO of Philips Healthcare, which became the largest unit of Philips Electronicsunder his leadership.

Risks for Quest include changes in the U.S. healthcare landscape, including pressure on reimbursement rates andpotential declines in the insured population. Quest could also be hurt by the loss of market share during a period of industryconsolidation.

The clinical testing business is fragmented and highly competitive. Quest competes with other commercial clinicallaboratories, hospital-affiliated laboratories, and physician-office laboratories. Quest’s largest commercial competitor isLaboratory Corporation of America Holdings, Inc. (NYSE: LH).

COMPANY DESCRIPTIONQuest Diagnostics, Inc. is a leading global provider of clinical diagnostic laboratories and services that help to identify

and treat disease, and improve healthcare management. The company incorporated in Delaware in 1990; its predecessorcompanies date back to 1967. Quest is based in Madison, New Jersey.

INDUSTRYOur recommended weighting on the Healthcare sector is Over-Weight. The sector accounts for 14.2% of the S&P 500,

and includes companies in the pharmaceuticals, medical devices, healthcare services, and insurance industries. After underperformingin 2015-2016, the sector bounced back in 2017 with a gain of 20.0%. It is slightly outperforming thus far in 2018, with a loss of1.3%. While pharma stocks have attracted attention due to the high prices of certain specialty and oncology drugs, stocks ofmedical device and insurance companies as a group have outperformed pharma stocks over the past year.

VALUATIONDGX trades at 15.6-times our 2018 EPS estimate, above the multiple of 14.9 for peer Lab Corp. The projected 2018 P/

E is also slightly above the five-year average of 15.4.From a technical standpoint, the stock had been trading in a pattern of higher highs and higher lows from February 2016

through late September 2017. However, the shares fell sharply following the release of 2018 Medicaid reimbursement rates forclinical lab tests on September 22. The shares have begun to recover since that time, with the 50-day moving average nowapproaching the 200-day average, though we believe that concerns about lower rates are still reflected in the DGX share price.Although the recently filed ACLA lawsuit appears unlikely to reverse the rate cuts, we expect Quest to benefit from recentacquisitions, cost savings from the Invigorate program, and a lower effective tax rate. We believe that DGX offers value at currentlevels and are setting a target price of $116.

On March 6, BUY-rated DGX closed at $104.14, up $1.25. (Jasper Hellweg, 3/6/18)

MARKET DIGEST

- 13 -

KKR & CO. L.P. (NYSE: KKR, $22.28) ................................................................................ HOLD

KKR: Reiterating HOLD following 4Q results

* On February 8, KKR reported 4Q17 economic net income (ENI) of $0.48 per unit, up from $0.40 per unit a yearearlier but below the consensus of $0.52.

* ENI benefited from higher carried interest gains as well as from increases in transaction and management fees.

* Reflecting the impact of the new U.S. tax law, management is evaluating whether to convert the company froma partnership to a corporation.

* Although KKR is trading at a discount to historical ENI multiples, we are maintaining our HOLD rating givenexpectations of limited ENI growth in 2018.

ANALYSISINVESTMENT THESISWe are maintaining our HOLD rating on KKR & Co. L.P. (NYSE: KKR) following the company’s 4Q results.While economic net income rose sharply in 2017 after a weak 2016, we expect that ENI growth will be sluggish in 2018,

and remain below the levels recorded in 2013 and 2014. Although assets under management have been helped by a robust equitymarket, net gains from investment activities were lower in 4Q17 than a year earlier. Alternative investment managers may alsoface increased competition from a less regulated banking industry under the Trump administration.

KKR is unique among alternative asset managers in that it moved in late 2015 to a new capital management strategy thatincludes a lower fixed distribution, initially $0.16 per quarter and now $0.17, and the reallocation of capital to stock buybacksand private and public market investments. Alternative asset managers have historically paid variable distributions based onmonetization efforts and gains on investments.

Investors have traditionally been attracted to alternative asset managers because of their high yields. While KKR has astrong record of generating above-market investment returns, investors’ participation in these returns will now come less in theform of quarterly distributions. We expect the company to increase fixed distributions over time, in line with growth in more stablefee revenues.

The stock’s yield is about 3.1%, based on the current annualized distribution of $0.68 per share. Although managementhas noted that this yield is well above that of the S&P 500, we do not believe that investors put the benchmark index and alternativeasset managers in the same risk camp. The shares have rebounded over the past year, but appear fairly valued on an ENI multiplebasis in light of the current phase of the harvesting cycle, as well as on price/book and our dividend discount model.

RECENT DEVELOPMENTSOver the past year, KKR shares have risen 23%, compared to a 15% increase in the broad market.On February 8, KKR reported 4Q17 economic net income (ENI) of $0.48 per unit, up from $0.40 per unit a year earlier

but below the consensus of $0.52. Revenues rose 58% to $405 million, aided by higher transaction and management fees.Distributable earnings were $427 million, up from $390 million a year earlier.

For all of 2017, revenues increased 57% to $1.50 billion, while ENI rose to $2.38 from $0.69 in 2016.Total investment income was $356.6 million in 4Q, down from $440.1 million a year earlier. The decrease reflected a

lower level of net gains, partially offset by an increase in dividend income.Assets under management (AUM) rose 30% year-over-year, to $168 billion, as of December 31, 2017, reflecting strength

in both private equity and public markets and capital raising.EARNINGS & GROWTH ANALYSISThe company has historically reported results for three operating segments: Private Markets, Public Markets and Capital

Markets. In 4Q15, it added a fourth segment, Principal Activities. However, KKR’s quarterly earnings release now focuses ontotal firm performance, while segment P&Ls are reported only in quarterly and annual SEC filings.

The change in reporting was prompted in part by the growth of the company’s balance sheet since its public offering.Book value is now about 64% of the current stock price. The new Principal Activities segment shows stand-alone balance sheetperformance, as well as the allocation of operating expenses across segments. It also shows the impact of capital commitmentspreviously excluded from AUM, and the pro rata portion of strategic partnerships.

MARKET DIGEST

- 14 -

Long-term financial objectives for the company include: growing profits and book value to create an additional $20billion of market capitalization, controlling headcount and limiting complexity, controlling the share count and limitingshareholder dilution, keeping ROE attractive, and limiting leverage.

Improved market values, especially for public market holdings, boosted results in 2017. The company’s top five holdingsas of December 31 were First Data Corp., USI Inc., KKR Real Estate Finance Trust, PortAventura Entertainment, and WMIHCorp.

Reflecting a better AUM environment, we are raising our 2018 ENI forecast to $2.46 per share from $2.37, and initiatinga 2019 forecast of $2.66.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on KKR is Medium, the middle of our five-point scale. The company ended 4Q17 with a

book value of $14.20 per unit. KKR’s primary asset is a portfolio of investments with a fair value of about $8.5 billion as ofDecember 31, 2017. Other assets include cash and short-term investments of $3.2 billion and unrealized carry of about $1.6 billion.Liabilities are about $3.6 billion.

In October 2015, KKR announced a $500 million unit repurchase program. In January 2017, it announced an additional$250 million buyback. Through February 5, 2018, it repurchased 31.7 million units for $459 million under these authorizations.

Prior to 4Q15, the company made quarterly cash distributions of substantially all cash earnings from its investmentmanagement business. It made distributions of $1.58 per unit in 2015. However, in 1Q16, it began paying a fixed distribution(initially $0.16 per quarter) tied to its fee-generating business, and in 1Q17, it raised this amount to $0.17 per quarter. Our dividendestimates are $0.68 for 2018 and $0.72 for 2019.

MANAGEMENT & RISKSKKR is led by co-chairman and co-CEOs Henry R. Kravis and George R. Roberts, who co-founded the firm in 1976.An investment in KKR carries substantial risks. Investors must be comfortable with the opaque nature of the alternative

asset manager business model. In short, investors in KKR are betting that the company’s outstanding investment track record willcontinue in the future. The firm also depends on favorable credit market conditions in order to fund its investments.

Carried interest, essentially the investment manager’s portion of investment gains, is currently taxed as a capital gain at20% (increased from 15% in January 2013). However, there have been various legislative proposals to tax these earnings asordinary income. Higher taxes on carried interest would be paid by individual holders of the units – both insiders and public unitholders.

COMPANY DESCRIPTIONFounded in 1976, KKR & Co. is a leading global investment management firm. KKR manages assets through a variety

of investment funds and accounts covering multiple asset classes, mostly private equity. It seeks to create value by bringingoperational expertise to its portfolio companies and through the active oversight and monitoring of its investments.

VALUATIONKKR shares are currently trading about 10% below their 52-week range. While 2017 ENI rebounded substantially from

2016, we expect only a modest ENI increase in 2018.Alternative asset managers are an admittedly difficult group to value. ENI is volatile and difficult to predict since it

includes mark-to-market gains and losses. Cash carry is also difficult to predict from quarter to quarter.We believe that book value and ENI multiples are useful valuation tools. KKR’s book value was $14.20 per unit as of

December 31, implying a price/book multiple of 1.56, above the historical average. The units trade at about 9.0-times our 2018ENI estimate. While we would normally expect a multiple of more than 10-times current-year ENI, market sentiment remainsdepressed for alternative asset managers.

Given KKR’s new fixed dividend strategy, a dividend discount model can also be used. Using our projected 2019dividend of $0.72, an expected 6% growth rate, and a 10% cost of capital, we derive a value of $18 per share, above current levelsand consistent with a HOLD rating.

On March 6, HOLD-rated KKR closed at $22.28, up $0.30. (Stephen Biggar, 3/6/18)

MARKET DIGEST

- 15 -

THE KRAFT HEINZ COMPANY (NGS: KHC $67.77).............................................................. BUY

KHC: Maintaining BUY but lowering target on weak organic growth

* On February 16, KHC reported a 1% increase in 4Q17 adjusted EPS to $0.90. The consensus estimate was $0.96.For the full-year, adjusted EPS rose 6.6% year-over-year to $3.55.

* Based on the company’s slower-than-expected sales and gross margin trends, we are trimming our 2018 adjustedEPS estimate to $3.83 from $3.93. Our estimate implies 8% growth from 2017. We are also establishing a 2019EPS estimate of $4.12.

* KHC shares have fallen sharply year-to-date and the stock is currently trading near its 52-week low following 4Qand 2017 full-year results.

* We think the recent pull-back in share price provides a favorable entry point. Our target price of $74 implies amultiple of 19.3-times our 2018 EPS estimate, in line with the peer average.

ANALYSISINVESTMENT THESISWe are maintaining our BUY rating on The Kraft Heinz Company (NGS: KHC), one of the world’s largest food and

beverage producers, with a target price of $74, reduced from $93. KHC shares fell sharply after reporting weaker-than-expected4Q17 results. In an industry undergoing transformative changes, the company faces added pressure to keep up with consumers’shifting preferences. KHC’s earnings gains have been driven by cost cutting rather than by top-line growth as sales remainsluggish, and market share has sagged in certain categories. Organic sales in the U.S., which accounts for 70% of the total, continueto decline as the company faces pressure from retail competition in developed markets. In Canada, which represents 8% of totalsales, sales are also down, adversely impacted by lower retail inventories? a trend which is expected to persist. On the bright side,the Rest of World segment is growing and we believe the company has significant opportunities for global expansion.

We expect improvement in the next 12-months as KHC focuses its efforts on boosting sales and consumption growththrough its recent investments in data-driven marketing, category management, and go-to-market capabilities. We also expect thecompany to benefit from an increased focus on healthier foods. Additionally, Heinz and Kraft continue to leverage their respectivesales platforms. Our rating remains BUY. However, given the company’s challenging near-term prospects, we would considerdowngrading if we don’t see an improvement in sales and a clear catalyst for sustainable growth.

RECENT DEVELOPMENTSKHC shares are down 12.8% year-to-date and the stock is currently trading near its 52-week low after posting 4Q17 and

full-year results. The S&P 500 is down 0.2% year-to-date. The stock has also underperformed since it began trading under theKHC ticker on July 5, 2015, with a 0.3% loss, compared to a 30.1% advance for the S&P 500.

On February 16, KHC reported a 1% increase in 4Q17 adjusted EPS to $0.90 but fell short of the consensus by $0.06.GAAP earnings rose to $6.54 per share from $0.77 a year earlier, mainly due to benefits from the recently enacted tax reforms.

Net sales rose 0.3% to $6.88 billion, just shy of the consensus forecast of $6.90 billion. Favorable currency translationincreased reported sales by 0.4%. Organic net sales fell 0.6% from the year-earlier period, reflecting a 1.0-percentage-point benefitfrom higher pricing and a negative 1.6-percentage point impact from volume and product mix.

Operating income rose 3.8% to $1.6 billion in 4Q17, as the operating margin expanded to 23.8% from 23.0% in 4Q16.Adjusted EBITDA rose 4.0% to $2.0 billion, driven primarily by cost-savings and a 0.8% favorable currency impact. The grossmargin was 35.0%, down from 35.9% a year earlier. EBITDA was partly offset by commodity headwinds and one-timedistribution costs in the Rest of World segment, as well as investments in marketing, sales teams, e-commerce and supply chainin the U.S.

For all of 2017, Kraft Heinz reported adjusted EPS of $3.55, up 6.6% from $3.33 in 2016, despite a 1.0% decline in netsales to $26.2 billion. Full-year sales were impacted by lower shipments in the U.S. and Canada, as well as lower pricing in Canadaand Europe, which partially offset higher pricing in Rest of World and the United States. Adjusted EBITDA grew 2% in 2017,driven by cost-savings and favorable pricing. The integration of Kraft and Heinz has generated $1.725 billion cumulative costsynergies through 2017?in line with management’s target.

MARKET DIGEST

- 16 -

Management does not provide guidance, but does provide a general outlook for the current year. It expects a decline inEBITDA in the first quarter, followed by growth in the remaining quarter; solid adjusted EPS growth; and a reduction in its taxrate to 20%-24% versus the previous 30%. It also expects higher free cash flows as a result of a reduction in capital expendituresto about $850 million in 2018. While management is focused on organic sales growth, on the negative side, retail markets remainchallenging.

In February 2017, the company withdrew its proposal to acquire Unilever after Unilever rejected the offer, citingdisagreements over strategy. However, KHC remains interested in acquisitions.

EARNINGS & GROWTH ANALYSISKraft Heinz has four geographic segments: the United States (70% of 2017 sales), Canada (8%), Europe (9%) and Rest

of World (13%). Operating results by segment are summarized below.In the United States, 4Q net sales declined 1.1% to $4.8 billion. Pricing rose 0.6 percentage points, while volume and

product mix had a negative 1.7-percentage-point impact. These results were driven by distribution losses in cheese and nuts andcold cuts, offset in part by better performance in macaroni and cheese, Lunchables, Capri Sun and portable protein products.Adjusted EBITDA rose 1.4% from the prior-year period to $1.5 billion, as the EBITDA margin was essentially flat. Cost cuttingand higher pricing boosted U.S. segment EBITDA, while commodity costs, lower volume/mix, and investments in marketing,in-store sales teams, e-commerce and supply chain unfavorably impacted EBITDA in the fourth quarter.

In Canada, total net sales fell 4.1% from the prior year to $591 million as organic sales decreased 8.6%. While pricingwas flat, a positive 4.5-percentage-point from currency was more than offset by a negative 8.6-percentage-point impact fromvolume and product mix. Segment adjusted EBITDA rose 7.1% from the prior year to $162 million, benefiting from a 5.2-percentage-point currency contribution as the EBITDA margin expanded by 294 basis points.

In Europe, sales rose 9.3% to $653 million, with organic sales up 1%. The segment benefited from a positive 8.4-percentage-point currency contribution and 1.8-percentage-point contribution from volume and product mix, partially offset bya 0.9-percentage-point negative impact from pricing. The positive volume/mix was driven by strong sales of condiments andsauces and partially offset by weakness in Italy infant nutrition. Segment adjusted EBITDA rose 7.4% to $203 million.

In the Rest of World, which includes the Asia Pacific region, Latin America, India, the Middle East, Russia, and Africa,net sales increased 5.2% to $843 million as organic sales grew 7%. Pricing contributed 5.7 percentage points to growth and volumeand mix contributed 1.3 percentage points, while currency had a negative 1.8-percentage-point impact. Segment adjustedEBITDA declined 0.8%, reflecting favorable pricing and lower overhead costs which were offset by the impact of businessinvestments to support growth.

Based on the company’s slower-than-expected sales trends, we are trimming our 2018 adjusted EPS estimate to $3.83from $3.93. Our estimate implies 8% growth from 2017 adjusted earnings of $3.55. We are also establishing a 2019 EPS estimateof $4.12.

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

company’s debt is rated BBB-/stable by S&P and BBB-/stable by Fitch.At the end of 4Q17, the company had a debt/total capital ratio of 32%, well below the food industry average of 66.6%.

The company also scores high on profitability, with a 26% operating margin, well above the peer average of 20.8%Kraft Heinz pays a dividend. The company recently raised its quarterly payout by 4.2% to $0.625 per share, or $2.50

annually, for a yield of about 3.7%.The company generates strong cash flow, so we think the dividend is secure. Our dividend forecasts are $2.58 for 2018

and $2.75 for 2019.MANAGEMENT & RISKSBernardo Hees became CEO of Kraft Heinz following the merger in July 2015. He had been the CEO of Heinz since 2013

and served as CEO of Burger King Worldwide Holdings from 2010 through 2013.In addition to merger-related risks, KHC investors face risks related to the highly competitive nature of the food products

industry, the need to correctly anticipate and respond to changes in consumer preferences, and the high proportion of sales thatare made to the company’s largest customers (with Wal-Mart Stores accounting for 21% of sales in 2017).

MARKET DIGEST

- 17 -

COMPANY DESCRIPTIONKraft Heinz is one of the largest food and beverage companies in the world. Its leading brands include Heinz, Kraft, Oscar

Mayer, Planters, Philadelphia, Velveeta, Lunchables, Maxwell House, Capri Sun, Ore-Ida, Kool-Aid and Jell-O. The companywas formed through the merger of Kraft Foods and H.J. Heinz on July 2, 2015. (Heinz was previously owned by BerkshireHathaway and 3G Global Food Holdings LP.) The merger generated annualized cost savings of roughly $1.7 billion at the endof 2017. The merger is also helping Kraft, which previously generated 98% of its sales in North America, to expand internationallyby leveraging Heinz’s strength in overseas markets. Warren Buffet currently sits on the board, however he announced that he willstep down in April 2018 at the end of his term. Berkshire Hathaway has a 27% stake in the company and will maintain two boardseats following Buffet’s departure. Prior to the merger, Heinz generated approximately 60% of its sales from outside NorthAmerica, including 25% in emerging markets.

VALUATIONWe think that the recent pull-back in price provides a favorable entry point. The technical outlook is mixed. The shares

shot to a 52-week high in February on expectations of a merger with Unilever, but have since pulled back and they are now tradingat a 52-week low. The 52-week range is $66-$94.

We have a favorable view of the Kraft Heinz merger, as the two companies have leveraged each other’s sales platformsand geographic strengths. The combined company has achieved its cost savings goal, delivering $1.7 billion through 2017, andwe expect it to deliver sustainable sales growth moving forward.

On a fundamental basis, the shares trade at 17.6-times our 2018 earnings estimate, in line with the peer average but belowtheir recent historical average range of 21-30. Our revised target price of $74 implies a multiple of 18-times our 2019 EPS estimate.

On March 6, BUY-rated KHC closed at $67.77, up $0.34. (Deborah Ciervo, CFA, 3/6/18)

MARKET DIGEST

- 18 -

WENDY’S CO.: (NYSE: WEN, $16.60) .................................................................................... BUY

WEN: Reiterating $19 target

* We believe that Wendy’s has revitalized its brand over the last three years by selling more than 800 company-owned restaurants. At the end of 2017, franchisees owned nearly all Wendy’s restaurants.

* The sale of these restaurants has boosted free cash flow as franchisees bear the brunt of capital expenditures.The sale proceeds are also providing resources for share buybacks and dividend increases.

* The company and its franchisees are pursuing an extensive restaurant remodeling program. The remodeledrestaurants are generating significantly greater revenue on average than older locations.

* We are maintaining our 2018 EPS estimate of $0.56 and setting a 2019 estimate of $0.70. Our long-term EPSgrowth rate forecast is 14%.

ANALYSISINVESTMENT THESISWe are maintaining our BUY rating on Wendy’s Co. (NYSE: WEN) with a target price of $19. We believe that Wendy’s

has revitalized its brand over the last three years by selling more than 800 company-owned restaurants. By the end of 2017, WENhad sold nearly all company-owned restaurants it had planned to sell, and just over 30 locations are now company-owned.Meanwhile, in 2017 Wendy’s remodeled 551 sites, built 40 new restaurants in North America, and opened 24 internationallocations. The company and its franchisees have already remodeled more than 40% of restaurants, and the remodeled restaurantsare generating significantly greater revenue on average than older locations. The company is also working to strengthen its brandthrough new product launches and stepped-up marketing.

RECENT DEVELOPMENTSReflecting solid 4Q17 results, a dividend hike, and an increase in the share repurchase authorization, WEN shares have

gained 15% since our last note on November 15.On February 21, Wendy’s reported adjusted 4Q17 earnings of $0.11 per share, up from $0.08 in the prior-year period

and in line with consensus. On a GAAP basis, the company earned $0.64 per share, up from $0.11 per share a year earlier. Theincrease reflected a reduction in the deferred tax liability following the passage of the new U.S. tax law.

Revenue held steady at $309 million, despite the sale of 90 company-owned restaurants, and was slightly below theconsensus estimate of $312 million. Same-store sales were up 1.3% in North America, but missed the consensus estimate of 1.8%growth. At the end of 4Q17, very few Wendy’s restaurants were company-owned. As a result, the company no longer reportsseparate comps for franchised and company-owned locations. Adjusted EBITDA rose by $13 million to $104 million and toppedthe consensus estimate of $103 million. The adjusted EBITDA margin rose 420 basis points from the prior year to 33.6%, abovethe consensus estimate of 32.9%. The improvement reflected the lower cost of franchising versus owning restaurants, and benefitsfrom store remodeling.

The restaurant-level operating margin (revenue less food, labor and occupancy) fell 130 basis points to 17.5%, reflectingthe impact of higher operating and labor costs. The consensus estimate had called for a restaurant-level operating margin of 17.7%.

For all of 2017, revenue fell 14.8% to $1.2 billion, while EPS rose to $0.43 from $0.40 in 2016.Wendy’s now projects adjusted 2018 EPS of $0.54-$0.56 and comp growth of 2.0%-2.5%. It looks for a restaurant-level

operating margin of 17%-18%, and adjusted EBITDA of $420-$430 million. WEN expects commodity costs to rise 1.0%-2.0%.G&A expenses are still expected to come in at $195 million, down from nearly $209 million a year earlier.

As discussed in a previous note, management plans to increase net debt to 5-6 times EBITDA and to use the proceedsfrom the additional debt to repurchase stock.

EARNINGS & GROWTH ANALYSISThe company’s recent refranchising efforts will increase rent and royalties (4% of franchisee revenue), and provide a

more reliable sales and earnings stream. Although operating earnings typically decline following a refranchising, Wendy’sexpects EBITDA to be unaffected, driven by $30 million in annual G&A savings. Refranchising has decreased the number ofcompany-owned restaurants to around 30.

As part of the refranchising, Wendy’s expects franchisees to remodel their restaurants. Remodeling will cost $400,000-$750,000 per restaurant, and is an important part of the company’s efforts to boost its brand image.

MARKET DIGEST

- 19 -

In 2017, the company repurchased 8.6 million shares for $127.4 million. Following the sale of company-ownedrestaurants, free cash flow is likely to increase as franchisees bear the brunt of capital expenditures. This should also allow foradditional share buybacks and dividend increases. At the end of 4Q17, Wendy’s had $23 million remaining on its $150 millionshare repurchase authorization, which expired on March 4, 2018. On February15, Wendy’s authorized the repurchase ofup to $175 million of stock through March 3, 2019.

We are maintaining our 2018 EPS estimate of $0.56 and setting a 2019 estimate of $0.70. Our long-term EPS growthrate forecast is 14%.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on Wendy’s is Medium-High, our second-highest ranking. Standard & Poor’s gives

Wendy’s an investment-grade credit rating of BBB+. Wendy’s long-term debt/capitalization ratio was 79.8% at the end of thefourth quarter, down from 82.4% at the end of 2016. The restaurant-level operating margin fell to 17.5% in 4Q17 from 18.8% inthe prior-year period, primarily reflecting higher operating and labor costs.

On February 15, Wendy’s announced a 21% increase in its quarterly dividend to $0.085, or $0.34 annually, for a projectedyield of about 2.1%. The first payment at the new rate will be made on March 15 to shareholders of record as of March 1. We projectannual payouts of $0.34 in 2018 and $0.40 in 2019.

RISKSKey risks for Wendy’s include commodity inflation, fierce competition from McDonald’s and Burger King, and

increased labor and utility costs. In addition, concerns about health and obesity could lead to reduced spending on fast food.COMPANY DESCRIPTIONWendy’s operates quick-service restaurants, with approximately 6,500 franchise and company-owned restaurants in the

U.S. and 30 countries. With a market cap of approximately $3.9 billion, the shares are generally considered mid-cap growth.VALUATIONReflecting solid 4Q17 results, a dividend hike, and an increase in the share repurchase authorization, WEN shares have

gained 15% since our last note on November 15. We believe that WEN’s projected 2017 EV/EBITDA multiple of 13.1inadequately reflects the higher margins and more stable revenue streams that occur when nearly all restaurants are owned byfranchisees. We believe that the stock merits a higher multiple of 16.0 and that a BUY rating is appropriate.

Our $19 target price implies a multiple of 33.9-times our 2018 EPS estimate, above the average for small to midcap fastfood chains, but warranted, in our view, by Wendy’s efforts to reduce G&A expense, eliminate debt, improve profitability, buyback stock, and raise the dividend.

On March 6, BUY-rated WEN closed at $16.60, up $0.33. (John Staszak, CFA, 3/6/18)

MARKET DIGEST

- 20 -

KB HOME (NYSE: KBH, $29.03).......................................................................................... HOLD

KBH: Raising estimates on lower tax rate

* We are raising our FY18 earnings estimate to $2.50 from $2.00 per share. We are reducing our estimate of thetax rate to 27% for the year from 39%. We are also making about a 40 basis point increase to our estimate of thefull-year operating margin.

* We are initiating a FY19 EPS estimate of $2.75 per share. This reflects about an 8% increase in homebuildingrevenue and a small increase in homebuilding operating margin. The average analyst estimate is $3.02.

* Total debt from mortgages and notes payable was $2.32 billion at the end of 4Q17, which was down from $2.64billion the prior-year. Debt/capital was 55% at the end of 4Q, down from 61% a year earlier. This ratio is just abovethe peer average of 52%. Net debt (debt minus cash) ended the year at 45% of capital, within the company’s 40%-50% target range.

* Based on our EPS estimates for FY18 and FY19 and our assumption that EPS will grow about 10% annually overthe following three years, EPS would be approximately $3.65 in five years. If we assume that the shares trade ata terminal multiple of 12, they would be worth approximately $44 in five years. If we discount the projected $44 shareprice in four years to the present at 9%, we obtain a value of about $29, which is very close to the current price.

ANALYSISINVESTMENT THESISWe expect HOLD-rated KB Home (NYSE: KBH) to generate more consistent growth and profitability, fueled by gradual

improvement in the U.S. housing market, increases in home deliveries, and slightly higher home pricing.We believe that management will make progress on boosting revenue growth by emphasizing markets with favorable

economic and population growth; catering to first-time buyers; boosting profit per home with greater customization, lowerexpenses, and better production efficiency; and improving asset efficiency by scrutinizing land investment and trying to generatehigher sales per community.

A near-term constraint on EPS growth has been softer gross margins as well as higher labor and materials costs. Thatsaid, KBH is working to make operations more efficient and to reduce debt and interest expense.

Based on our valuation analysis, the shares are trading close to our fair value estimate. We remain fairly upbeat on thehousing sector. We currently have BUY ratings on Toll Brothers, Lennar and D.R. Horton.

RECENT DEVELOPMENTSOn January 10, KB Home reported that net income increased 125% to $84.3 million or $0.84 per share for the fourth

quarter of FY17 (ended November 30, 2017).The average analyst earnings estimate for 4Q17 was $0.77 per share, according to StreetAccount. Our estimate was also

$0.77. KBH was able to control costs, growing expenses at a slower rate than sales.Total 4Q revenue rose 18% to $1.4 billion. Homebuilding revenues also rose about 18% helped by a 14% bigger backlog

at the beginning of the quarter. The number of homes delivered rose 9% to 3,340. The average selling price rose 8% to $416,500driven by a 10% increase in selling price on the West Coast. Total revenue was above the StreetAccount consensus of $1.35 billion.Our estimate was $1.36 billion. Units delivered topped the consensus of 2,736, and the average selling price was slightly belowthe consensus of $424,000. Business was particularly strong on the Southwest with Las Vegas leading the way. Overall resultsbenefited from slightly higher sales per community.

New order value rose 9% to $935 million. Units increased 2% to 2,296 homes, which was above the StreetAccountconsensus of 2,187. Orders were constrained as the community count remained essentially flat, at 228, in 4Q. This was expectedat the beginning of the quarter. One factor was that a number of communities in California have sold out. The company expectsthe 1Q community count to be relatively flat with 4Q17 levels and down about 5% on a year-over-year basis. The company expectsthe FY18 community count to be about the same as FY17. KBH invested $1.5

The cancellation rate increased by 300 basis points from the prior year to 28%.The backlog rose 9% year-over-year to $1.66 billion, with units in backlog were flat, at 4,411 homes. Backlog dollars

and units were both slightly below the StreetAccount consensus.The company’s homebuilding operating income increased 136%, to $132 million. The StreetAccount consensus was

$122.4 million.

MARKET DIGEST

- 21 -

Excluding the amortization of previously capitalized interest and inventory-related charges, the adjusted gross marginimproved by 160 basis points to 18.6%. Reported gross margin was 18.1%, which was just below the StreetAccount consensusof 18.2%. The company benefitted from deliveries from newer, lower-margin, communities, a favorable sales mix to moreprofitable regions and leverage from sales growing faster than fixed expenses.

SG&A decreased by 50 basis points to 8.7% of housing revenue. The StreetAccount consensus was 9%. SG&A expenseswere up $12 million on a $211 million increase in housing revenue.

Pretax income increased 150% from the prior year to $137 million. Our estimate was $120 million. The company’s 4Qtax rate was 38.6%.

For FY17 KBH earned $1.85 per share up from $1.12 in FY16. Cash flow from operations improved nicely to $513million for the year from $188 million in FY16. Notable sources of cash were higher net income, higher deferred taxes and, inparticular, lower inventories.

EARNINGS & GROWTH ANALYSISWe are raising our FY18 earnings estimate to $2.50 from $2.00 per share. This is on an adjusted basis. It excludes a tax-

related accounting charge in the first quarter. Based on the company’s expectations, we are reducing our estimate of the tax rateto 27% for the year from 39% that we had modeled previously. We are also making about a 40 basis point increase to our estimateof the full-year operating margin. We are just over the top of the 7.2%- 7.4% guidance range, which was recently increased from7% to 7.5%, as FY18 appears to be off to a solid start. FY17 operating margin for the KBH homebuilding business was an adjusted7.1%. One change to our estimate is that we expect higher gross margin in recently-opened communities, which should still beoffset by higher costs of land and building material.

We also made a small reduction in our estimate of interest expense. For the full year, management expects housingrevenue of $4.5-$4.9 billion. The current Bloomberg consensus is $4.7 billion up about 7.5%. Our estimate is $4.8 billion. Thefull-year consensus is $1.61 per share.

We are initiating a FY19 EPS estimate of $2.75 per share. This reflects about an 8% increase in homebuilding revenueand a small increase in homebuilding operating margin. The average analyst estimate is $3.02.

We expect KBH to grow EPS at a compound annual rate of 10% over the next five years. This assumes a continuedrecovery in the housing market, easing credit conditions for first-time buyers, and margin expansion on higher sales volume. Thecompany’s longer-term objectives are to raise sales above $5 billion in FY19, which represents a compound annual growth rateof about 11.5% from $3.6 billion in FY15. We believe this is attainable. KBH also aims to raise the operating margin to 8%-9%from about 7% in FY17. Among other goals, the company wants to boost return on capital into double digits and raise return onequity to 10%-15%. Challenges include finding lots, raising profitability with the likelihood of higher land prices and lowermargins on smaller or entry-level homes. The company must also deal with labor shortages of carpenters and masons which couldraise some costs. An offset should be expense leverage on higher sales and more productive communities.

FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on KBH is Medium. Business is improving; however, this improvement must continue for

KBH to maintain its financial strength rank relative to peers with stronger metrics. The company ended 4Q17 with $721 millionin cash and equivalents in the homebuilding segment, up from $592 million a year earlier.

KBH made $1.5 billion of land and development investments in FY17. The total dollar value of owned and optioned landincreased by 35% to $2.3 billion in FY13, rose 39% to $3.2 billion in FY14, and climbed a more modest 3% to $3.3 billion in FY15.The dollar value was $3.4 billion at the end of FY16, and $3.3 billion at the end of FY17. The lot count was 46,371 at the end of4Q17, with 75% owned and 25% optioned.

Total debt from mortgages and notes payable was $2.32 billion at the end of 4Q17, which was down from $2.64 billionthe prior-year. Debt/capital was 55% at the end of 4Q, down from 61% a year earlier. This ratio is just above the peer average of52%. Net debt (debt minus cash) ended the year at 45% of capital, within the company’s the 40%-50% target range.

Operating income was approximately 2-times interest expense in FY13 and increased to nearly 10-times in FY14, stayedsolid at 8-times in 2015 and rose to 27-times in FY16 and 46-times in FY17.

In March 2010, KB Home voluntarily terminated its $200 million credit facility and began issuing letters of credit againstcash deposit collateral at a variety of financial institutions. In FY12, it was able to refinance $585 million in debt coming due,pushing back maturities significantly. In FY13, it raised $333 million in an offering of convertible senior notes, completed anequity offering, and issued debt due in 2021. In March 2013, KBH entered into a new $200 million credit facility. In 3Q15, it raisedthe capacity of the revolver to $275 million. In July of 2017 the company raised the capacity to $500 million and extended thematurity to 2021 from 2019. There was no borrowing under the revolver at the end of FY17. The available capacity on the revolverwas about $462 million.

MARKET DIGEST

- 22 -

In February 2015, the company issued $250 million of 7.625% bonds due 2023. KBH’s largest debt maturity is $450million in 2021. Subsequent to the end of the quarter the company repaid about $165 million of debt that was due in in Septemberof 2017. The company had investments in joint ventures with a balance sheet value of $64 million at the end of FY16, $72 millionat the end of FY15, $79 million at the end of FY14 and $130 million at the end of FY13. The investment was $64.8 million at theend of FY17.

We do not expect significant buyback activity in the near term, as we believe the company is more likely to acquire landif it wishes to deploy cash. That said, KBH did repurchase almost 8.4 million shares under a 10 million share program that wasestablished in January of 2016. There was no buyback activity in FY17. There was a remaining authorization to purchase 1.6million shares at the end of 4Q17.

After a weak 1Q12, KBH slashed its annual dividend by 60% to $0.10. KBH paid full-year dividends totaling $0.10 inFY13, FY14, FY15, FY16 and FY17. Our dividend estimates for FY18 and FY19 are $0.10.

The company’s long-term debt is rated B1 by Moody’s, and now BB- as a result of an upgrade by Standard & Poor’s.S&P now has a stable outlook. Moody’s also has a stable outlook. Any reduction in ratings could constrain the company’s abilityto borrow and finance future growth.

Credit default spreads on KBH’s debt are now narrower than those for Macy’s which we assess at Medium (narrowerspreads mean less risk). KBH’s spreads are slightly wider than those of MDC Holdings, which we assess at Medium. Spreads onKBH are also wider than Toll Brothers, which we also assess as Medium. KBH is improving its profitability and its leverage ratioshave improved, particularly with the reversal of the deferred tax valuation allowance. That said, we need to see continuingimprovement from KBH if we are going to maintain our financial strength assessment on a relative basis. It is interesting thatdefault spreads are now suggesting that builders are becoming less risky than department stores.

MANAGEMENT & RISKSJeff Mezger has been CEO of KB Home since 2006, and previously served as chief operating officer. He has been at the

company for 20 years. Jeff Kaminski has been CFO since 2010 and previously held the same role at Federal-Mogul Corporation.Mr. Mezger unfortunately made the mainstream news when a recording emerged of what the Wall Street Journal

described as an “expletive-laced tirade replete with sexist and antigay language,” after his neighbor, the comedian Kathy Griffinor her boyfriend called the police to complain about noise coming from Mr. Mezger’s property in the Bel Air neighborhood ofLos Angeles. The company’s board said, in an SEC filing, that his behavior during the incident was unacceptable and reflectednegatively on the company. The board cut Mr. Mezger’s bonus by 25% and said that he would be fired if there was another suchoutburst. In the 3Q earnings call Mr. Mezger said that he regretted the incident immediately and made a sincere apology.

Housing trends have shown improvement and affordability remains favorable, though home prices have increased. Whilewe expect the housing recovery to continue, helped by an improving job market and still-reasonable interest rates, there are risks:underwriting standards are easing very slowly, and household formation has been well below average for young adults. Labor andmaterials costs could be an ongoing constraint on profitability. That said, KBH has seen stability in markets that are close toemployment centers and have more affluent populations. An ongoing challenge is the limited supply of good building lots in somemarkets. Borrowing conditions are important because about half of KBH’s customers are first-time buyers, and unlike TollBrothers, nearly all of KBH’s buyers finance the purchase of their home.

The improvement in end-market demand has caused builders that managed lean inventories to lag the recovery, whileothers have had the necessary land supply to ride the wave. The company ended FY13 with approximately $2.3 billion of ownedand optioned land, up 35% from the prior-year period. KBH had inventory of approximately $3.25 billion at the end of FY17, whichwas down slightly from FY16. Management’s aim is to control enough land to meet their production goals for the next 3-5 years.Based on the pace of deliveries in FY17, the lots controlled by the company would last about 4.25 years.

KBH is subject to legal and warranty claims as discussed in the annual report.COMPANY DESCRIPTIONKB Home, headquartered in Los Angeles, is one of America’s largest homebuilders, with domestic operations in

California, Arizona, Nevada, Colorado, Texas, Florida, and North Carolina. In FY17, the company delivered 10,909 homes,generating revenue of $4.4 billion. The West Coast segment represents almost half of homebuilding revenue, with just 29% ofhomes delivered helped by high home prices in California. The company targets the lower-middle range of the market, includingfirst-time buyers, but has also expanded into higher-priced markets. KBH’s average selling price was $397 thousand in 2017, up9% from 2016.

MARKET DIGEST

- 23 -

VALUATIONKBH shares have risen approximately 60% over the last 12 months. The shares are trading at 11.4-times our FY18

estimate and 10.4-times our FY19 estimate. With the Great Recession still in memory and a strong housing recovery stillunderway, historical comparisons are challenging. As such, we value the shares using a simple discounted earnings model andbased on peer comparisons with earnings and book value.

Based on our EPS estimates for FY18 and FY19 and our assumption that EPS will grow about 10% annually over thefollowing three years, EPS would be approximately $3.65 in five years. If we assume that the shares trade at a terminal multipleof 12, they would be worth approximately $44 in five years. We arrived at the terminal value in two ways. We used a dividenddiscount model to generate estimates of the terminal stock value and terminal P/E multiple, and we looked at the median multiplefor the admittedly volatile S&P 500 Homebuilding Index over the last 30 years. That multiple is approximately 12, and we arecurrently modeling KBH’s terminal multiple at parity with the index. If we discount the projected $44 share price in four yearsto the present at 9%, which is the standard rate we use for consumer stocks, we obtain a value of about $29, which is very closeto the current price.

Looking solely at P/E multiples for next year, we believe that the shares are fairly-to-fully valued at the peer average.KBH is trading at 11-times the consensus estimate for 2018, versus the peer average of 11.6. We believe these multiples reflectthe potential for recovery-driven earnings over the next few years.

KBH has a growing book value of $22.13 per share. The shares are trading at 1.3-times book value. The company’s peersare also trading at approximately 1.4-times book value based on the group median. We believe that the shares are trading at closeto fair value. Our rating on KBH remains HOLD, but we would consider raising our recommendation to BUY.

On March 6, HOLD-rated KBH closed at $29.03, up $0.52. (Christopher Graja, CFA, 3/6/18)

Argus Research Co. (ARC) is an independent investment research provider whose parent company, Argus Investors’ Counsel, Inc. (AIC),is registered with the U.S. Securities and Exchange Commission. Argus Investors’ Counsel is a subsidiary of The Argus Research Group,Inc. Neither The Argus Research Group nor any affiliate is a member of the FINRA or the SIPC. Argus Research is not a registered brokerdealer and does not have investment banking operations. The Argus trademark, service mark and logo are the intellectual property ofThe Argus Research Group, Inc. The information contained in this research report is produced and copyrighted by Argus Research Co.,and any unauthorized use, duplication, redistribution or disclosure is prohibited by law and can result in prosecution. The content ofthis report may be derived from Argus research reports, notes, or analyses. The opinions and information contained herein have beenobtained or derived from sources believed to be reliable, but Argus makes no representation as to their timeliness, accuracy orcompleteness or for their fitness for any particular purpose. In addition, this content is not prepared subject to Canadian disclosurerequirements. This report is not an offer to sell or a solicitation of an offer to buy any security. The information and material presentedin this report are for general information only and do not specifically address individual investment objectives, financial situations orthe particular needs of any specific person who may receive this report. Investing in any security or investment strategies discussed maynot be suitable for you and it is recommended that you consult an independent investment advisor. Nothing in this report constitutesindividual investment, legal or tax advice. Argus may issue or may have issued other reports that are inconsistent with or may reachdifferent conclusions than those represented in this report, and all opinions are reflective of judgments made on the original date ofpublication. Argus is under no obligation to ensure that other reports are brought to the attention of any recipient of this report. Argusshall accept no liability for any loss arising from the use of this report, nor shall Argus treat all recipients of this report as customers simplyby virtue of their receipt of this material. Investments involve risk and an investor may incur either profits or losses. Past performanceshould not be taken as an indication or guarantee of future performance. Argus has provided independent research since 1934. Argusofficers, employees, agents and/or affiliates may have positions in stocks discussed in this report. No Argus officers, employees, agentsand/or affiliates may serve as officers or directors of covered companies, or may own more than one percent of a covered company’s stock.Argus Investors’ Counsel (AIC), a portfolio management business based in Stamford, Connecticut, is a customer of Argus Research Co.(ARC), based in New York.

Argus Investors’ Counsel pays Argus Research Co. for research used in the management of the AIC core equity strategy and modelportfolio and UIT products, and has the same access to Argus Research Co. reports as other customers. However, clients and prospectiveclients should note that Argus Investors’ Counsel and Argus Research Co., as units of The Argus Research Group, have certain employeesin common, including those with both research and portfolio management responsibilities, and that Argus Research Co. employeesparticipate in the management and marketing of the AIC core equity strategy and UIT and model portfolio products.