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Thursday, April 15, 2004 11:19:27 PM
The DJIA rose, led by pharmaceutical shares Pfizer and Merck, as investors shifted into companies whose earnings will hold up even if higher interest rates slow the economy. Financial stocks dropped as some investors said the Federal Reserve may lift interest rates as soon as September to prevent economic growth from sparking inflation. The DJIA added 19 points (+0.2%) to 10,397. The S&P 500 gained 0.67(+0.1%) to 1128. Health-care shares had the biggest increase among the benchmark's 10 industry groups. The Nasdaq, which gets 39 percent of its value from computer-related stocks, dropped 22 points (-1.1%) to 2002. About the same number of stocks rose and fell on the New York Stock Exchange. Some 1.57 billion shares changed hands on the Big Board, 5.4 percent more than the same time a week ago. Two stronger-than-expected manufacturing reports helped lift the S&P 500, which is up 41 percent since its 2003 low. Financial shares fell on concern rising interest rates will reduce the value of their bond holdings and crimp demand for mortgages and loans. An index of 83 banks, insurers and brokers in the S&P 500 lost 0.6 percent, extending its decline this week to 3.3 percent.
Strong Sectors: real estate operations, drug, gold, oil services, coal
Weak Sectors: internet, networking, semiconductor, software, telecom, storage, insurance, retail, iron & steel
Top Stories . . . A gauge of manufacturing in New York state rose more than expected this month as companies stepped up hiring to fill increased orders, signaling continued expansion, a Federal Reserve survey showed.
Manufacturing in the Philadelphia region expanded at a faster pace than expected this month as new orders and shipments improved.
The number of Americans filing initial claims for jobless benefits rose to 360,000 last week, a 30,000 increase that was the biggest in more than a year.
International Business Machines, the world's largest computer maker, said first-quarter sales and profit rose as companies bought more machines, software and related services.
Citigroup, the world's largest financial-services company, said earnings rose 29 percent to a quarterly record, boosted by higher fees on credit cards, loans to consumers and share sales.
EnCana, Canada's largest natural-gas producer, agreed to buy Tom Brown for $2.35 billion in cash to boost output in the U.S.
EMC., the world's largest maker of computer data-storage software, said first-quarter profit almost quadrupled as sales rose 35 percent, helped by acquisitions and new products.
PepsiCo, the world's second- largest soft-drink maker, said first-quarter earnings rose 15 percent as new Gatorade flavors and advertising for Lays snacks fueled the biggest sales increase in two years.
Southwest Airlines increased first-quarter profit and Continental Airlines narrowed its loss as more people flew than at the start of 2003, when the Iraq war and the SARS virus reduced travel.
Quotes of Note . . . ``What we're seeing today is more rotation than anything, specifically out of financial stocks. What's preventing us from falling further from here is the market's ability to rotate into other groups'' like health-care companies”. Peter Boockvar, equity strategist at Miller Tabak.
``The Fed is not going to be as easy and profit growth is decelerating. People are looking toward larger stocks with longer-term earnings growth.'' George Burwell, a money manager at Chartwell Investment Partners, which has $7 billion in assets in Berwyn, Pennsylvania.
Gurus . . . Even as these excellent quarterly results roll in, Ned Davis worries about a possible profit margin erosion. While the slow down indication can be early, at current valuations, we don't need any problem with earnings.
What works in 2004 . . . The Wall Street Journal says that dividend paying stocks are getting a bigger play, and that quality dividend names will be the way to go in 2004. Meanwhile, as tax day arrives, USA Today says tax refunds are not as large as expected.
All about Interest Rates . . . Robert Parry, the outgoing President of the San Francisco Fed, told a California conference that the Fed would not become excessively concerned about accelerating inflation until there is a series of increases. In other words, bonds recently have gone berserk, based on one retail sales report, and one inflation statement.
A Bloomberg poll of the 23 primary dealers finds Lehman predicting a September increase, Banc of America guessing August, while Bank One agrees on September. No one is talking May 4th, the next Fed meeting. We acknowledge the discounting process, but three months is far out.
Inflation . . . Wednesday’s CPI data showed evidence of rising inflation. It is not a fluke.
• The dollar has weakened roughly 30% since the end of 2001, stopping the deflation and putting upward pressure on prices.
• Inflation is not dependent on capacity constraints. U.S. prices, including core CPI prices, are more related to the value of the dollar than to other factors.
• The uncertainty stemming from the Fed’s 1% interest rate is a bigger risk -- to the economy and equity markets -- than a rate hike would be.
• Higher inflation would actually be good news if it served to break the Fed out of its 1% paralysis. Rate hikes would help head off a bigger inflation later on. For now, however, higher inflation is mostly a negative – it doesn’t clarify the timing of rate hikes, stop the damage from the 1% rate, or end the uncertainty about the impact of a rate hike.
Caveats
Investors need to understand the unique nature of the economic environment, a multi-year bowl-shaped deflation/inflation process rather than a business cycle.
• No one has any experience with a prolonged 1% interest rate, rate hikes at this low a level, or the record levels of debt and leverage.
• No one knows how much CPI inflation will occur. U.S. prices were sticky on the downside during the deflation but the dollar has weakened substantially since then. U.S. awareness of inflation risks was intense in the 1970s, but declined in the 1980s and 1990s, so it’s unclear how quickly prices and inflation expectations will react..
• No one knows how much inventory the world will want to stock now that the 1980-2001 disinflation process is over.
Our View
• Fed funds futures have now priced in a rate hike in August. Some economists hold open the possibility of a June hike in the event of strong economic or inflation data in April.
• It’s easy for the Fed to accelerate the timing of the interest rate hike. At the Chairman’s discretion, it can hint at hikes, causing the market to price in hikes and then allowing the Fed to follow the market.
• Expect a mild inflation problem over the next several years, higher interest rates, and also strong growth in GDP and corporate profits. Expect further overshoots in commodity prices and demand as the inventory rebuilding process gathers pace.
• We don’t think the latest evidence of inflation, or even the first interest rate hike, will cause a fundamental change in the environment. Expect the “free-lunch” to continue for as much as a year until the Fed shows signs of moving interest rates to neutral. In the meantime, monetary policy will still lag, meaning that it will remain loose and stimulative even as rates are rising. Just as deflation perceptions deepened during the 2001 interest rate cuts, we expect inflation perceptions to worsen a bit more as interest rates rise.
• There was a harsh stress test of higher bond yields in July 2003, with little fallout beyond the bond market losses. As bond yields rose, equities went sideways, waiting for more economic news.
• We don’t think politics is a critical factor in the timing of the rate hikes. Economic data, plus Chairman Greenspan’s thinking on inflation and risk, are the keys. Some will blame the interest rate hikes on the fiscal deficit, making them a political issue. The rate hikes will be evidence of a strengthening economy. Election research shows that voting is affected by GDP growth more than other economic factors and that the incumbent does better when interest rates are rising.
Financials . . . Citigroup reported earnings of $0.98 per share, which excludes a $0.03 gain, $0.03 better than the consensus of $0.95. Revenues rose 15.9% year/year to $21.49 billion versus the $21.47 billion consensus.
The WSJ's "Ahead of the Tape" column discusses bank stocks that may be good buys as interest rates start to rise. According to the article, the banks that have been most aggressively playing the rate curve in the "carry" trade, in which they lend for the long term and borrow at low-cost short-term rates, are obvious candidates to shun. The problem is that this is pretty much every large financial institution, as evidenced by the huge rise in mortgage-backed securities purchases among big banks, according to FED data. But some are more vulnerable than others. According to the article, Investors Financial Services and New York Community Bancorp are among those that have attracted skeptics. The drawback is that the skeptical view on these names has been well aired. One question is how well the consumer will weather higher interest rates. Investors are worried about that, sending stocks such as MBNA and Capital One Financial down almost 3% yesterday. But if they believe the economy is getting better, that means wages and employment will firm up. That could easily offset a gradual rise in rates and suggests that even if those company's are expensive, they won't be hurt substantially in a new higher rate environment.
Bank of America after it reported first quarter earnings of $1.83 per share, $0.03 above the consensus mean. This quarter demonstrated the strength of the franchise, with 7% revenue growth and continuing improvements in credit quality and loan growth. The reported EPS number as more or less in line with core or operating earnings. The cost of the mutual fund investigation and
brokerage settlement of $285 million coupled with the $275 million write-down in mortgage banking assets were largely offset by $495 million in securities gains taken in the quarter. Vice Chairman James Hance indicated on the conference call that the bank expects to achieve deeper cost savings from the FleetBoston acquisition, as evidenced by the new targeted full-year run-rate cost savings range of $1.1 billion - $1.375 billion, up from the previously stated goal of $1.1 billion. He also suggested that cost savings in 2004, which were originally estimated to be $250 million, could be as much as three times that number as a result of the earlier-than-anticipated closing of the deal and more cost cuts that could be achieved this year. Analysts are maintaining our above-consensus operating earnings estimates of $7.30 per share for 2004 (versus current consensus mean of $7.18) and $8.15 per share for 2005 because these developments are generally in line with what drove our higher estimates previously. Analysts are raising cash EPS estimates, which we calculate as operating earnings adding back intangible amortization expense related to acquisitions, to $7.53 for 2004 and $8.41 for 2005 because of higher expected intangible amortization expense as disclosed in Bank of America’s latest proforma estimates. Analysts are raising our price target, which is based on 2004 cash earnings estimate and target multiple for Bank of America of 12.5, to $94 from $93.
Transports . . . Southwest Air reported earnings of $0.03 per share, which includes an $18 million charge that was not included in analysts' estimates. On CNBC, C.E.O. says that excluding charge, company "met First Call consensus". First Call consensus is $0.04. Revenues rose 9.8% year/year to $1.48 billion versus the $1.47 billion consensus.
FTN Midwest downgrades Harley Davidson to Neutral from Trading Buy, saying the near-term catalyst of stronger than expected Q1 retail has played out; in addition, firm says their long-term thesis remains that limited motorcycle production capacity will prevent significant EPS upside from the company's core motorcycle business (~80% of sales), and given that the actual motorcycle shipment number generally does not differ materially from guidance, they feel there is limited upside to EPS coming from unit shipments.
Continental Air reported a loss of $1.36 per share, $0.03 better than the consensus of ($1.39) and $0.07 better than the consensus of ($1.43). Revenues rose 11.1% year/year to $2.27 billion versus the $2.26 billion consensus.
Prudential believes Delta Airlines will likely be facing a difficult period of comparison relative to peer players. The firm thinks company faces significant challenges with the uncertainty of market pricing, a noncompetitive cost structure, the possibility of sustained fuel prices amidst an absent hedge position, and continued unsustainable losses. Analyst lowers 2004 EPS estimate to -$6.33 from -$5.96. Target price moves to $7 from $11.
ExpressJet reported earnings of $0.53 per share, $0.03 better than the consensus of $0.50. Revenues rose 18.7% year/year to $364.0 million versus the $352.9 million consensus.
Food & Beverage . . . PepsiCo reported earnings of $0.46 per share, in line with the consensus of $0.46. Revenues rose 10.9% year/year to $6.13 billion versus the $6.03 billion consensus. The company guides 2004, sees EPS of approx $2.29 versus the consensus of $2.30. The company also increases its annual dividend by 44%, from $0.64 to $0.92 per share.
Retail . . . UBS believes that weak mortgage application indices are negative for Home Depot and Lowes.
The Washington Post's tech section reports that Amazon.com quietly launched an Internet search service Wednesday, jumping into a marketplace already crowded with offerings from Google, Yahoo! and Microsoft. The service, in test mode for now, is operated by a Palo Alto-based subsidiary and branded separately. Like its competitors, Amazon's A9.com offers both a Web site and an Internet Explorer toolbar from which users can enter search terms. Searches also can be limited to just Amazon.com products, as well as the text of books available at Amazon.com. A9's service relies heavily on Google, which supplies many of the search results, and Amazon's Alexa subsidiary, which provides traffic, related sites and other information on specific Web sites.
UBS says that Abercrombie's April sales will likely by soft; even though the company likely started April strongly given the residual clearance activity and resurgence in mall traffic and more seasonal weather. They believe that lean inventories are likely to hold back results; and while they believe there is modest upside in gross margin. The firm thinks the weak sales trend increases the likelihood of negative leverage on occupancy costs and SG&A. Raises target to $38 from $36.
Barron's Online highlights auto part chains, such as AutoZone and O'Reilly Automotive, as the recent selloff may create some buying opportunities in these rapidly growing retailers. "More people are driving, resulting in more people working on their cars, and more miles being driven per year per vehicle," proclaims Cid Wilson, an analyst with Whitaker Sec. And because cars are generally made better and last longer these days, that's good news for auto parts dealers."Older cars need more frequent repairs" says Michael Cox, analyst with Piper Jaffray. Also, more people will visit body shops to replace and update parts because of wear and tear, and that helps auto parts retailers' commercial business. The popularity of SUVs bodes well for these retailers, too, since SUV parts can cost up to 50% more than parts for smaller vehicles. Total sales for the auto parts market is estimated at $180 bln, and they're growing at 4% annually, says Christopher Svezia, analyst with Wells Fargo. AutoZone stock has fallen 20% off its 52-w high, and it now sells at only 12.5x earnings for the fiscal year. That's below its long-term annual earnings growth rate of 15%, so its PEG rate is an eye-catching 0.84. O'Reilly Automotive trades 11.5% off its 52-w high, sports a P/E multiple that's still below its 20% projected annual long-term earnings growth rate. And it's trading at a slight discount to its median P/E of 19x projected earnings for the last five years.
Healthcare . . . UnitedHealth Group reported earnings of $0.88 per share, $0.01 better than the consensus of $0.87. Revenues rose 16.8% year/year to $8.14 billion versus the $8.25 billion consensus. The company now sees 2004 EPS guidance of $3.75-3.78 versus the consensus of $3.75.
Biotech . . . Cepheid has been granted an export license for its GeneXpert Anthrax test cartridge and GeneXpert system by the US State Department in accordance with export regulations, including ITAR (International Traffic in Arms Regulations - 22 C.F.R. 120 - 130). The export license provides Government clearance for Cepheid to market its state-of-the-art technology for biothreat use to specific government agencies in the United Kingdom, Germany, France, Belgium and Switzerland. The system has been designed to enable users to rapidly and accurately detect the potential presence of anthrax, going from raw specimen to result in as little as 30 minutes.
Corcept Therapeutics priced its IPO at $12 late yesterday, and traded for the last hour on Wed, opening at $12.25. The $12 pricing was below the expected $15-$17 range. It's rare to see an IPO price and open so late in the day which allowed it to slip past us. Some traders like these late openers as they trade well the next day thanks to a lack of initial exposure. However, the pricing was poor as the supply of biotech/pharma IPOs in 2004 has outpaced demand... The co makes drugs to treat severe psychiatric and neurological diseases. Its lead product candidate, Corlux, is currently in Phase III clinical trials and has been granted "fast track" status by the FDA for the treatment of the psychotic features of psychotic major depression, a disorder that affects 3 million people in the US each year and for which there are no FDA-approved treatments. The company has also initiated a clinical study to evaluate the tolerability and efficacy of Corlux in improving cognition in patients with mild to moderate Alzheimer's disease. This is a 5 million share deal, led by Thomas Weisel and Piper Jaffray.
Media . . . Knight-Ridder reported earnings of $0.70 per share, $0.03 better than the consensus of $0.67. Revenues rose 1.9% year/year to $712.3 million versus the $704.3 million consensus.
Merrill Lynch out positive on Pixar saying they believe underlying fundamentals and importantly, investor sentiment, will continue to improve over the balance of the year; several catalysts ahead, reiterating Buy, 78 target.
Goldman Sachs expects CNET Networks to be weak and would take profits as firm believes valuation is ahead of the fundamentals. Firm also cautions investors invested in other second tier online ad driven companies in the hope that these companies would see the level of growth and outperformance similar to Yahoo!
Tribune reported earnings of $0.40 per share, excluding a $0.05 charge, $0.03 worse than the consensus of $0.43. Revenues rose 3.3% year/year to $1.33 billion versus the $1.34 billion consensus.
CSFB maintains their Outperform rating on CNET and raises their target to $17 from $11 after the company reported stronger than expected 1st quarter results. The firm views the stock as a high growth Internet media play with significant leverage to the increasing momentum of the advertising recovery. The firm also believes it is relatively early in the advertising cycle generally, and in the tech ad cycle specifically, and that will be the ultimate driver and catalyst for the eventual earnings power of the company and the stock price as well.
Telecom . . . Covad and Qwest Communications sign a 3-year commercial line sharing agreement. The agreement enables Covad to continue to offer high-speed DSL service to thousands of small and medium businesses and home users in the seven states within the Qwest region where Covad offers service. The co notes that this marks the first time a competitive communications carrier and a regional Bell operating company have negotiated commercial terms for access to line sharing since the FCC's Triennial Review decision.
The WSJ's "Tracking the Numbers" column reports that shareholders of cellular carrier Nextel Communications who care about executive pay dug into the company's proxy statement last week and found out that Timothy M. Donahue, Nextel's president and chief executive, took home a hefty pay package in 2003 of nearly $30 million. In Mr. Donahue's case, a Form 4 shows that he was awarded 1 million restricted Nextel shares last August. That exercise ends up with a grant valued at $17.9 million. Mr. Donahue was also awarded options on an additional 400,000 Nextel shares in February 2003.
IT Services . . . Unisys reported earnings of $0.13 per share, excluding impact of pension accounting, $0.04 better than the consensus of $0.09. Revenues rose 4.6% year/year to $1.46 billion versus the $1.46 billion consensus. The company also reaffirms 2004 EPS guidance of $0.83-0.87, excluding impact of pension accounting, versus the consensus of $0.71.
EMS . . . Solectron held an upbeat Analyst meeting at the New York Stock Exchange yesterday. Management reiterated May quarter revenue guidance of $2.9 - $3.2B (up 6% Quarter/Quarter) and EPS of ($0.02) - $0.01, maintained that the gross margin and free cash flow would be up Quarter/Quarter in May (as anticipated in our preview), and outlined a compelling roadmap to
an incremental 650-800 bps of gross margin over the current 4.5%. SLR provided convincing detail of its changing approach to its core manufacturing competency with its recent introduction of Lean Six Sigma which is focused on eliminating labor, and overhead transformation costs (15-20% of COGS). Typical lean implementations reduce transformation costs by 20-30% over 18-24 months yielding a potential 300-600bps margin opportunity (some shared with OEMs). SLR also highlighted other key gross margin initiatives which we estimate as another 350 bps opportunity
including: (1) more disciplined quoting process for new business (200bps of improvement on new business ramps), (2) increased capacity utilization, (3) leveraging design, (4) renegotiating pricing on select contracts, and (5) changing sales compensation to be profitability focused. Analysts have increased confidence in normalized EPS estimate of $0.42. The 650-800 bps of gross margin opportunity are more than enough to double the current 4.5% gross margin and allow management to achieve its target of a 4-5% EBIT margin and 11-18% after-tax ROTIC exiting 2005. SLR would need only a 2.2% EBIT margin to reach its ROTIC target in today's zero tax environment. SLR's stock is down 5% YTD, but down 32% from its Jan 20 high of $8.20. SLR is currently trading at 18x 2005 EPS estimate of $0.31 which is a 22% discount to the EMS group average of 23x, and only 13x our normalized EPS estimate of $0.42. A $9 target price is 21x our normalized EPS estimate, 28x our 2005 EPS estimate of $0.31, and below $11 DCF.
Network Equipment . . . SG Cowen comments that Redback Networks exceeded expectations on many fronts, giving firm increasing confidence with respect to Redback Network's ability to capitalize on the growing DSL market and achieve break even by year-end. SG Cowen believes shares should outperform market given solid initial execution and firm's expectation that company will turn profitable by year's end. RBAK is one of firm's favorite names and would recommend adding to positions.
Thomas Weisel believes Extreme Networks estimates remain too optimistic, and that significant DSO rise and departure of head of sales add wrinkles.
Schwab Soundview says that Texas Instrument’s 50% sequential growth in Digital Light Processing chips as well as commentary on strong demand reflects positively on JDS Uniphase, which supplies sealants and lenses for D.L.P. display products and suggests an area that might provide upside to rev at JDSU this quarter. Firm says TXN's commentary on D.L.P. growth highlights an area of investment for JDSU that they expect is a theme over the next 18 months -- light engines and optical components for high definition projection TVs -- since TXN's DLP chips are increasingly used in large rear projection display TVs, and JDSU benefits as a supplier.
The WSJ reports that even though the cellphone market is booming, Nokia is facing a third year in succession with no growth in sales amid increasing signs that competitors are narrowing its long-held market lead. Nokia, which is due to report its full 1st Quarter results tomorrow, remains the world's largest handset maker. But it shocked investors last week by warning that its revenue in the quarter declined 2% to €6.6 billion ($7.9 billion) because of currency movements and a loss of market share. Nokia may be able to win back market share in the second half of this year, but many observers expect growth in the handset market to have slowed by then. Some analysts are now forecasting that Nokia's sales will be flat this year, while others anticipate a decline of as much as 5% to less than €28 billion from €29.46 billion in 2003. Although cost-cutting means Nokia's net profit may still rise this year, another decline in annual revenue would be a big blow to the company's efforts to convince investors that it is a growth stock. Kulbinder Garcha, a London-based analyst with CSFB, says this is the first time that Nokia has had to contend with "the four players below them executing effectively at the same time."
Storage . . . EMC reported earnings of $0.07 per share, $0.01 better than the consensus of $0.06. Revenues rose 35.2% year/year to $1.87 billion versus the $1.82 billion consensus. The company sees 2nd quarter EPS of $0.08 versus consensus of $0.08 on revenues of $1.950-1.975 billion versus consensus $1.91 billion.
WR Hambrecht upgrades Lam Research to Buy from Hold and raises its target to $30 from $26 after the company reported a strong March quarter last night. As demand for etch equipment leads other process tools in a cyclical upturn, bookings of $350 million were up 30% this quarter and guidance calls for another 10%-15% increase in June Quarter. Gross margins improved by 80bp and are estimated to improve by more than a point next quarter, with further improvement to 49% in 2005. Higher margins and accelerating revenue growth lead the firm to increase its 2004 and 2005 EPS estimates to $0.49 and $1.63 (from $0.43 and $1.40).
Semiconductor Equipment . . . Artisan Components announced that UMC has licensed Artisan's Advantage Platform for its 90-nanometer (nm) process technology. The agreement provides system on chip (SoC) designers with proven 90nm design platform targeted for UMC's latest process generation.
Semiconductors . . . Fairchild Semi reported pro forma earnings of $0.17 per share, $0.02 better than the consensus of $0.15. Revenues rose 12.6% year/year to $397.8 million versus the $384.9 million consensus.
Piper Jaffray upgrades Microchip Tech to Outperform from Market Perform and raises their target to $35 from $31. The firm believes that top-line growth will accelerate as the co exits the March quarter due to broad-based strength in most of its end markets, and after essentially flat gross margins over the last two years, they believe the company is reaching an inflection point for a resumption in gross margin expansion. Also, firm says checks indicate that lead-times have lengthened and are now approaching 6-8 weeks.
AMD reported strong revenues and earnings which were driven by a 11% Quarter over Quarter revenue increase in Flash and a less than seasonal revenue decrease of 2% Quarter over Quarter in MPU. AMD reported revenues of $1.236 billion higher than estimates of $1.195 billion and consensus of $1.172 billion. EPS of $0.12 came in higher than our estimate of $0.04 and consensus of $0.03. AMD saw its GM increase by 240bp from 35.4% to 37.8%. Guidance for 2nd quarter was stronger than consensus. AMD guided for a flat Quarter over Quarter revenues. In the
Flash business AMD expects sales to be modestly up for the quarter. With regards to microprocessors, AMD believes that revenues will be down within industry seasonal patterns. Going into earnings, analysts had expected that AMD would beat 1st quarter estimates and provide strong/aggressive guidance. With regards to Flash, AMD has shown strong performance in 1st quarter on the heels of growth in both low density flash and high density Mirrorbit flash. Though, AMD’s flash guidance is impressive, Intel had signaled significant price cuts on the high density NOR flash which may make this flash strength temporary. Though AMDs microprocessor ASP gains are impressive in 1st quarter and we expect further ASP gains in 2nd quarter, analysts are not expecting market share gains in 2nd quarter as units are expected to decline by more than seasonality. With regards to its product mix, AMD continues to successfully ramp up its 64-bit MPU family which we estimate comprised about 8% of total MPU units shipped in 1st quarter. However, with Intel's 64 bit processors ramping, AMD's ability to increase ASPs in 3rd quarter will be challenging. Although analysts are raising 2nd quarter EPS estimates from $0.01 to $0.08 and for 2004 and 2005 from $0.25 to $0.48 and $0.40 to $0.58 respectively , we are maintaining our Peer Perform rating because: 1) The strong 2nd quarter guidance is already priced into the stock; 2) Intel has significant cost advantage over AMD given its lead in 300mm
and 90nm technologies and 3) AMD’s ability to gain market share in desktop or server MPUs is remote despite its 64-bit efforts.
Analysts generally positively surprised by Advanced Micro's results with some seeing current strength offering a short-term trading opportunity to the upside. Yet, even the positive ones note that expectations on AMD might be getting ahead of what an investor should reasonably expect and believe the stock could see some weakness post the positive digestion of the 1st quarter upside. CSFB is out raising their 2004 estimates from $4.9 billion and $0.39 to $5.3 billion and $0.67 and 2005 from $5.2 billion and $0.44 to $5.6 billion and $0.62. They believe the stock can continue to benefit near-term off richer PC mix and Flash demand although still see risks including execution and competitive threats longer from Intel MPU's and a more crowded space in flash memory. Also, SG Cowen raising their estimates and noting they believe that there is a near- term trading opportunity in AMD stock that they expect to last through the end of 2nd quarter. By 3rd quarter the firm believes AMD is likely to underperform due to increasing competition in the flash market from Intel and others, below-industry growth prospects caused by weak competitive positioning in both emerging markets and notebook processors, and the high relative valuation.
NVIDIA cut to Hold from Buy at Wedbush Morgan. The firm is downgrading stock b/c current valuation is not compelling enough even on firm's well above consensus 2005/2006 EPS estimates of $1.10/$1.30 respectively (consensus estimates are $0.68/$0.99). Currently, it is selling at P/E of 20x firm's 2005 estimate vs ATI's (ATYT) 15x..
Texas Instruments reported 1st quarter revenue and EPS at the high end of guidance and in line with consensus as a result of stronger than seasonal growth in its semi business in general and in its high performance Analog and catalog DSP in specific. Guidance for 2nd quarter was stronger than consensus. Revenue had a mid point of $3.205 billion compared to estimate of $3.101 billion, and EPS was $0.23-0.26 versus $0.23 estimate. With regards to wireless, due to TI’s consignment inventory program with Nokia there is no inventory impact on TI. Analysts are estimating a 2.2% Quarter over Quarter wireless revenue increase in 2nd quarter as the weakness in Nokia is more than offset by market share gains at SonyEricsson and LG, continued increase of overall wireless silicon BOM per handset and strength in wireless infrastructure. In 1st quarter, TI experienced strong demand in both standard logic and linear devices and has had its customers on allocation since early March. The strength in standard logic ASPs will have a stronger impact on rev in 2nd quarter than in 1st quarter because of the time lag between bookings and shipping. High-performance analog was particularly strong in 1st quarter where TI experienced market share gains, and we expect this to continue into 2nd quarter 2004. Analysts are raising 2nd quarter revenues from $3.101 billion to 3.205 billion and our EPs estimates from $0.23 to $0.25 on the heels of improving commodity analog and logic ASPs, strength in high-performance analog and improving demand for logic (MCU, DLP etc.). In addition analysts are raising 2004 and 2005 EPS estimates from $0.99 to $1.03 and from $1.33 to $1.37 respectively. TI could hit a price target of $38 because of: 1) leading analog and DSP capabilities with exposure to high growth semi segments; 2) shift to 2.5G and 3G favors TI’s wireless product portfolio; 3) ability to gain market share in wireless . In 2nd quarter TI is to benefit from strength in all semiconductor
segments, particularly in analog and commodity products. Its results demonstrate that it can easily overcome any weakness in Nokia through its other legs.
Boxmakers . . . Silicon Graphics sells Alias Software to private equity investment firm Accel-KKR for $57.5 million in cash. The transaction is expected to close in the current quarter, and SGI expects to realize approx $50 million in net proceeds after working capital adjustments and transaction costs. SGI had previously announced in Feb that it was in negotiations to sell the Alias subsidiary.
Apple handily beat estimates from record iPod shipments and some counter-seasonal strength in consumer PCs and again provided favorable forward guidance. While it's now the fourth consecutive quarter of above-consensus results and outlook, analysts are maintaining a Peer Perform rating on valuation which seems to already reflect investor optimism on iPod. AAPL reported 2Q04 EPS of $0.14 (vs. $0.04), above our and consensus EPS of $0.09, based on higher revenues of $1.91billion (vs. $1.48 billion). Highlights included strength in iPod (record units of 807K) as well as counter-seasonal stability in consumer PCs (iBook/iMac revs were flat Quarter/Quarter), while Power Mac G5 units (down 16% Quarter/Quarter) stalled further which Apple attributed to inventory reduction. On a positive note, AAPL’s results benefited from more synchronized strength across its business along with continued pent-up demand for iPod, and we see further potential 2H catalysts (iPod from H-P, new iMac, Power Mac G5 speed bump). Conversely, our concerns are that the G5 cycle has disappointed, Apple is still ceding PC share (units up just 5%) and at some point iPod supply will catch demand. Analysts are raising estimates for 2004 from $0.50 to $0.65 in EPS (vs. $0.20) on higher revenues of $7.9 billion, up 28% Year/Year and for 2005 from $0.65 to $0.80 on revenues of $8.8bn, up 11% Year/Year. Also, we’re initiating an 2006 EPS estimate of $0.95 on revenues of $9.6bn, up 9% Year/Year. For 3rd quarter 2004, EPS goes from $0.11 to $0.15 (versus $0.05) on revenues of $1.93 billion (vs. $1.55 billion) versus guidance of $0.14-$0.15 on $1.925 billion. As to valuation, if we apply a 25x multiple on 2005 operating EPS of $0.74 and add back “excess” cash of around $10, we arrive at a fair value of $29, in line with AAPL’s after-market price. A 25x multiple is warranted as it’s a discount to target multiple on Dell which is twice as profitable with more engines of growth, though Apple's momentum could provide further business upsides.
Analysts astonished by the magnitude by which Apple managed to surpass their expectations as strong iPod and iBook sales kicked in. We are seeing firms raise their 2004 and even 2005 estimates significantly as they see iPods becoming significant contributor to Apple's revenue stream, accounting for about 22% of sales in 2nd quarter 2004 vs. about 13% in the prior quarter and only 2.0% in 2nd quarter 2003. Among the more positive firms, UBS is raising their 2004 EPS estimate to $0.65 from $0.46 with 2005 going to $0.80 from $0.60. Price target goes to $35 from $30. Yet, we think it's also worth noting the co saw weakness in its PowerMac line with the long-awaited upgrade cycle still lagging expectations. As the most important source of long-term profits for Apple, one would expect market participants to take note. Prudential among the more negative one's out noting that if one strips out excess cash and interest income from the operating earnings calculation, at $29 Apple is trading 29x 2005 EPS estimate. By point of contrast, Dell is currently trading at 28.5x current 2006 (CY05) earnings estimate. They would expect the shares to trade back down once the euphoria and the momentum begins to subside. Firm sees fair value at $25.
Software . . . Network Associates was upped to Buy from Hold at Legg Mason. The upgrade is based on four reasons: 1) the firm believes NET will post solid 1st quarter 2004 results and that there is the potential for an upward revision to Street estimates or improved visibility on current estimates at the least; 2) belief that NET will look to sell/divest Sniffer over the next few quarters, which the firm estimates will be neutral at worst and positive from an investor perception perspective; 3) opinion that NET could look to buy back its outstanding convertible debt, which would be accretive even at its current premium to par and; 4) combination that the first three factors could put upward pressure on the Street's 2005 consensus est of $0.83 and could get the Street looking to a potential of $1.00 in EPS in 2005. Applying a 25 multiple to $1.00 in EPS potential yields $25 or over 30% potential upside from current levels.
The New York Times reports that RealNetworks made a direct appeal last week to Apple Computer, suggesting that the two company's form a common front against Microsoft in the digital music business. The offer to create a "tactical alliance" was made by Rob Glaser, CEO of RealNetworks in an e-mail message to Steven P. Jobs, Apple's chairman. But if an alliance with Apple could not be struck, Mr. Glaser strongly hinted in the e-mail message that he might be forced to form a partnership with Microsoft to pursue "very interesting opportunities" because support for Microsoft's media-playing software seems to be growing. Apple executives would not comment on the message. But it seems likely Mr. Jobs will rebuff the offer. Mr. Glaser said he had not received a response from Mr. Jobs, and in his e-mail message Mr. Glaser said he was going to be in Silicon Valley this week and suggested that he meet with Apple executives today.
RBC Capital out saying Take-Two remains their Top Pick despite yesterday's warning; firm sees limited downside from current levels. Price target $44.
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Strong Sectors: real estate operations, drug, gold, oil services, coal
Weak Sectors: internet, networking, semiconductor, software, telecom, storage, insurance, retail, iron & steel
Top Stories . . . A gauge of manufacturing in New York state rose more than expected this month as companies stepped up hiring to fill increased orders, signaling continued expansion, a Federal Reserve survey showed.
Manufacturing in the Philadelphia region expanded at a faster pace than expected this month as new orders and shipments improved.
The number of Americans filing initial claims for jobless benefits rose to 360,000 last week, a 30,000 increase that was the biggest in more than a year.
International Business Machines, the world's largest computer maker, said first-quarter sales and profit rose as companies bought more machines, software and related services.
Citigroup, the world's largest financial-services company, said earnings rose 29 percent to a quarterly record, boosted by higher fees on credit cards, loans to consumers and share sales.
EnCana, Canada's largest natural-gas producer, agreed to buy Tom Brown for $2.35 billion in cash to boost output in the U.S.
EMC., the world's largest maker of computer data-storage software, said first-quarter profit almost quadrupled as sales rose 35 percent, helped by acquisitions and new products.
PepsiCo, the world's second- largest soft-drink maker, said first-quarter earnings rose 15 percent as new Gatorade flavors and advertising for Lays snacks fueled the biggest sales increase in two years.
Southwest Airlines increased first-quarter profit and Continental Airlines narrowed its loss as more people flew than at the start of 2003, when the Iraq war and the SARS virus reduced travel.
Quotes of Note . . . ``What we're seeing today is more rotation than anything, specifically out of financial stocks. What's preventing us from falling further from here is the market's ability to rotate into other groups'' like health-care companies”. Peter Boockvar, equity strategist at Miller Tabak.
``The Fed is not going to be as easy and profit growth is decelerating. People are looking toward larger stocks with longer-term earnings growth.'' George Burwell, a money manager at Chartwell Investment Partners, which has $7 billion in assets in Berwyn, Pennsylvania.
Gurus . . . Even as these excellent quarterly results roll in, Ned Davis worries about a possible profit margin erosion. While the slow down indication can be early, at current valuations, we don't need any problem with earnings.
What works in 2004 . . . The Wall Street Journal says that dividend paying stocks are getting a bigger play, and that quality dividend names will be the way to go in 2004. Meanwhile, as tax day arrives, USA Today says tax refunds are not as large as expected.
All about Interest Rates . . . Robert Parry, the outgoing President of the San Francisco Fed, told a California conference that the Fed would not become excessively concerned about accelerating inflation until there is a series of increases. In other words, bonds recently have gone berserk, based on one retail sales report, and one inflation statement.
A Bloomberg poll of the 23 primary dealers finds Lehman predicting a September increase, Banc of America guessing August, while Bank One agrees on September. No one is talking May 4th, the next Fed meeting. We acknowledge the discounting process, but three months is far out.
Inflation . . . Wednesday’s CPI data showed evidence of rising inflation. It is not a fluke.
• The dollar has weakened roughly 30% since the end of 2001, stopping the deflation and putting upward pressure on prices.
• Inflation is not dependent on capacity constraints. U.S. prices, including core CPI prices, are more related to the value of the dollar than to other factors.
• The uncertainty stemming from the Fed’s 1% interest rate is a bigger risk -- to the economy and equity markets -- than a rate hike would be.
• Higher inflation would actually be good news if it served to break the Fed out of its 1% paralysis. Rate hikes would help head off a bigger inflation later on. For now, however, higher inflation is mostly a negative – it doesn’t clarify the timing of rate hikes, stop the damage from the 1% rate, or end the uncertainty about the impact of a rate hike.
Caveats
Investors need to understand the unique nature of the economic environment, a multi-year bowl-shaped deflation/inflation process rather than a business cycle.
• No one has any experience with a prolonged 1% interest rate, rate hikes at this low a level, or the record levels of debt and leverage.
• No one knows how much CPI inflation will occur. U.S. prices were sticky on the downside during the deflation but the dollar has weakened substantially since then. U.S. awareness of inflation risks was intense in the 1970s, but declined in the 1980s and 1990s, so it’s unclear how quickly prices and inflation expectations will react..
• No one knows how much inventory the world will want to stock now that the 1980-2001 disinflation process is over.
Our View
• Fed funds futures have now priced in a rate hike in August. Some economists hold open the possibility of a June hike in the event of strong economic or inflation data in April.
• It’s easy for the Fed to accelerate the timing of the interest rate hike. At the Chairman’s discretion, it can hint at hikes, causing the market to price in hikes and then allowing the Fed to follow the market.
• Expect a mild inflation problem over the next several years, higher interest rates, and also strong growth in GDP and corporate profits. Expect further overshoots in commodity prices and demand as the inventory rebuilding process gathers pace.
• We don’t think the latest evidence of inflation, or even the first interest rate hike, will cause a fundamental change in the environment. Expect the “free-lunch” to continue for as much as a year until the Fed shows signs of moving interest rates to neutral. In the meantime, monetary policy will still lag, meaning that it will remain loose and stimulative even as rates are rising. Just as deflation perceptions deepened during the 2001 interest rate cuts, we expect inflation perceptions to worsen a bit more as interest rates rise.
• There was a harsh stress test of higher bond yields in July 2003, with little fallout beyond the bond market losses. As bond yields rose, equities went sideways, waiting for more economic news.
• We don’t think politics is a critical factor in the timing of the rate hikes. Economic data, plus Chairman Greenspan’s thinking on inflation and risk, are the keys. Some will blame the interest rate hikes on the fiscal deficit, making them a political issue. The rate hikes will be evidence of a strengthening economy. Election research shows that voting is affected by GDP growth more than other economic factors and that the incumbent does better when interest rates are rising.
Financials . . . Citigroup reported earnings of $0.98 per share, which excludes a $0.03 gain, $0.03 better than the consensus of $0.95. Revenues rose 15.9% year/year to $21.49 billion versus the $21.47 billion consensus.
The WSJ's "Ahead of the Tape" column discusses bank stocks that may be good buys as interest rates start to rise. According to the article, the banks that have been most aggressively playing the rate curve in the "carry" trade, in which they lend for the long term and borrow at low-cost short-term rates, are obvious candidates to shun. The problem is that this is pretty much every large financial institution, as evidenced by the huge rise in mortgage-backed securities purchases among big banks, according to FED data. But some are more vulnerable than others. According to the article, Investors Financial Services and New York Community Bancorp are among those that have attracted skeptics. The drawback is that the skeptical view on these names has been well aired. One question is how well the consumer will weather higher interest rates. Investors are worried about that, sending stocks such as MBNA and Capital One Financial down almost 3% yesterday. But if they believe the economy is getting better, that means wages and employment will firm up. That could easily offset a gradual rise in rates and suggests that even if those company's are expensive, they won't be hurt substantially in a new higher rate environment.
Bank of America after it reported first quarter earnings of $1.83 per share, $0.03 above the consensus mean. This quarter demonstrated the strength of the franchise, with 7% revenue growth and continuing improvements in credit quality and loan growth. The reported EPS number as more or less in line with core or operating earnings. The cost of the mutual fund investigation and
brokerage settlement of $285 million coupled with the $275 million write-down in mortgage banking assets were largely offset by $495 million in securities gains taken in the quarter. Vice Chairman James Hance indicated on the conference call that the bank expects to achieve deeper cost savings from the FleetBoston acquisition, as evidenced by the new targeted full-year run-rate cost savings range of $1.1 billion - $1.375 billion, up from the previously stated goal of $1.1 billion. He also suggested that cost savings in 2004, which were originally estimated to be $250 million, could be as much as three times that number as a result of the earlier-than-anticipated closing of the deal and more cost cuts that could be achieved this year. Analysts are maintaining our above-consensus operating earnings estimates of $7.30 per share for 2004 (versus current consensus mean of $7.18) and $8.15 per share for 2005 because these developments are generally in line with what drove our higher estimates previously. Analysts are raising cash EPS estimates, which we calculate as operating earnings adding back intangible amortization expense related to acquisitions, to $7.53 for 2004 and $8.41 for 2005 because of higher expected intangible amortization expense as disclosed in Bank of America’s latest proforma estimates. Analysts are raising our price target, which is based on 2004 cash earnings estimate and target multiple for Bank of America of 12.5, to $94 from $93.
Transports . . . Southwest Air reported earnings of $0.03 per share, which includes an $18 million charge that was not included in analysts' estimates. On CNBC, C.E.O. says that excluding charge, company "met First Call consensus". First Call consensus is $0.04. Revenues rose 9.8% year/year to $1.48 billion versus the $1.47 billion consensus.
FTN Midwest downgrades Harley Davidson to Neutral from Trading Buy, saying the near-term catalyst of stronger than expected Q1 retail has played out; in addition, firm says their long-term thesis remains that limited motorcycle production capacity will prevent significant EPS upside from the company's core motorcycle business (~80% of sales), and given that the actual motorcycle shipment number generally does not differ materially from guidance, they feel there is limited upside to EPS coming from unit shipments.
Continental Air reported a loss of $1.36 per share, $0.03 better than the consensus of ($1.39) and $0.07 better than the consensus of ($1.43). Revenues rose 11.1% year/year to $2.27 billion versus the $2.26 billion consensus.
Prudential believes Delta Airlines will likely be facing a difficult period of comparison relative to peer players. The firm thinks company faces significant challenges with the uncertainty of market pricing, a noncompetitive cost structure, the possibility of sustained fuel prices amidst an absent hedge position, and continued unsustainable losses. Analyst lowers 2004 EPS estimate to -$6.33 from -$5.96. Target price moves to $7 from $11.
ExpressJet reported earnings of $0.53 per share, $0.03 better than the consensus of $0.50. Revenues rose 18.7% year/year to $364.0 million versus the $352.9 million consensus.
Food & Beverage . . . PepsiCo reported earnings of $0.46 per share, in line with the consensus of $0.46. Revenues rose 10.9% year/year to $6.13 billion versus the $6.03 billion consensus. The company guides 2004, sees EPS of approx $2.29 versus the consensus of $2.30. The company also increases its annual dividend by 44%, from $0.64 to $0.92 per share.
Retail . . . UBS believes that weak mortgage application indices are negative for Home Depot and Lowes.
The Washington Post's tech section reports that Amazon.com quietly launched an Internet search service Wednesday, jumping into a marketplace already crowded with offerings from Google, Yahoo! and Microsoft. The service, in test mode for now, is operated by a Palo Alto-based subsidiary and branded separately. Like its competitors, Amazon's A9.com offers both a Web site and an Internet Explorer toolbar from which users can enter search terms. Searches also can be limited to just Amazon.com products, as well as the text of books available at Amazon.com. A9's service relies heavily on Google, which supplies many of the search results, and Amazon's Alexa subsidiary, which provides traffic, related sites and other information on specific Web sites.
UBS says that Abercrombie's April sales will likely by soft; even though the company likely started April strongly given the residual clearance activity and resurgence in mall traffic and more seasonal weather. They believe that lean inventories are likely to hold back results; and while they believe there is modest upside in gross margin. The firm thinks the weak sales trend increases the likelihood of negative leverage on occupancy costs and SG&A. Raises target to $38 from $36.
Barron's Online highlights auto part chains, such as AutoZone and O'Reilly Automotive, as the recent selloff may create some buying opportunities in these rapidly growing retailers. "More people are driving, resulting in more people working on their cars, and more miles being driven per year per vehicle," proclaims Cid Wilson, an analyst with Whitaker Sec. And because cars are generally made better and last longer these days, that's good news for auto parts dealers."Older cars need more frequent repairs" says Michael Cox, analyst with Piper Jaffray. Also, more people will visit body shops to replace and update parts because of wear and tear, and that helps auto parts retailers' commercial business. The popularity of SUVs bodes well for these retailers, too, since SUV parts can cost up to 50% more than parts for smaller vehicles. Total sales for the auto parts market is estimated at $180 bln, and they're growing at 4% annually, says Christopher Svezia, analyst with Wells Fargo. AutoZone stock has fallen 20% off its 52-w high, and it now sells at only 12.5x earnings for the fiscal year. That's below its long-term annual earnings growth rate of 15%, so its PEG rate is an eye-catching 0.84. O'Reilly Automotive trades 11.5% off its 52-w high, sports a P/E multiple that's still below its 20% projected annual long-term earnings growth rate. And it's trading at a slight discount to its median P/E of 19x projected earnings for the last five years.
Healthcare . . . UnitedHealth Group reported earnings of $0.88 per share, $0.01 better than the consensus of $0.87. Revenues rose 16.8% year/year to $8.14 billion versus the $8.25 billion consensus. The company now sees 2004 EPS guidance of $3.75-3.78 versus the consensus of $3.75.
Biotech . . . Cepheid has been granted an export license for its GeneXpert Anthrax test cartridge and GeneXpert system by the US State Department in accordance with export regulations, including ITAR (International Traffic in Arms Regulations - 22 C.F.R. 120 - 130). The export license provides Government clearance for Cepheid to market its state-of-the-art technology for biothreat use to specific government agencies in the United Kingdom, Germany, France, Belgium and Switzerland. The system has been designed to enable users to rapidly and accurately detect the potential presence of anthrax, going from raw specimen to result in as little as 30 minutes.
Corcept Therapeutics priced its IPO at $12 late yesterday, and traded for the last hour on Wed, opening at $12.25. The $12 pricing was below the expected $15-$17 range. It's rare to see an IPO price and open so late in the day which allowed it to slip past us. Some traders like these late openers as they trade well the next day thanks to a lack of initial exposure. However, the pricing was poor as the supply of biotech/pharma IPOs in 2004 has outpaced demand... The co makes drugs to treat severe psychiatric and neurological diseases. Its lead product candidate, Corlux, is currently in Phase III clinical trials and has been granted "fast track" status by the FDA for the treatment of the psychotic features of psychotic major depression, a disorder that affects 3 million people in the US each year and for which there are no FDA-approved treatments. The company has also initiated a clinical study to evaluate the tolerability and efficacy of Corlux in improving cognition in patients with mild to moderate Alzheimer's disease. This is a 5 million share deal, led by Thomas Weisel and Piper Jaffray.
Media . . . Knight-Ridder reported earnings of $0.70 per share, $0.03 better than the consensus of $0.67. Revenues rose 1.9% year/year to $712.3 million versus the $704.3 million consensus.
Merrill Lynch out positive on Pixar saying they believe underlying fundamentals and importantly, investor sentiment, will continue to improve over the balance of the year; several catalysts ahead, reiterating Buy, 78 target.
Goldman Sachs expects CNET Networks to be weak and would take profits as firm believes valuation is ahead of the fundamentals. Firm also cautions investors invested in other second tier online ad driven companies in the hope that these companies would see the level of growth and outperformance similar to Yahoo!
Tribune reported earnings of $0.40 per share, excluding a $0.05 charge, $0.03 worse than the consensus of $0.43. Revenues rose 3.3% year/year to $1.33 billion versus the $1.34 billion consensus.
CSFB maintains their Outperform rating on CNET and raises their target to $17 from $11 after the company reported stronger than expected 1st quarter results. The firm views the stock as a high growth Internet media play with significant leverage to the increasing momentum of the advertising recovery. The firm also believes it is relatively early in the advertising cycle generally, and in the tech ad cycle specifically, and that will be the ultimate driver and catalyst for the eventual earnings power of the company and the stock price as well.
Telecom . . . Covad and Qwest Communications sign a 3-year commercial line sharing agreement. The agreement enables Covad to continue to offer high-speed DSL service to thousands of small and medium businesses and home users in the seven states within the Qwest region where Covad offers service. The co notes that this marks the first time a competitive communications carrier and a regional Bell operating company have negotiated commercial terms for access to line sharing since the FCC's Triennial Review decision.
The WSJ's "Tracking the Numbers" column reports that shareholders of cellular carrier Nextel Communications who care about executive pay dug into the company's proxy statement last week and found out that Timothy M. Donahue, Nextel's president and chief executive, took home a hefty pay package in 2003 of nearly $30 million. In Mr. Donahue's case, a Form 4 shows that he was awarded 1 million restricted Nextel shares last August. That exercise ends up with a grant valued at $17.9 million. Mr. Donahue was also awarded options on an additional 400,000 Nextel shares in February 2003.
IT Services . . . Unisys reported earnings of $0.13 per share, excluding impact of pension accounting, $0.04 better than the consensus of $0.09. Revenues rose 4.6% year/year to $1.46 billion versus the $1.46 billion consensus. The company also reaffirms 2004 EPS guidance of $0.83-0.87, excluding impact of pension accounting, versus the consensus of $0.71.
EMS . . . Solectron held an upbeat Analyst meeting at the New York Stock Exchange yesterday. Management reiterated May quarter revenue guidance of $2.9 - $3.2B (up 6% Quarter/Quarter) and EPS of ($0.02) - $0.01, maintained that the gross margin and free cash flow would be up Quarter/Quarter in May (as anticipated in our preview), and outlined a compelling roadmap to
an incremental 650-800 bps of gross margin over the current 4.5%. SLR provided convincing detail of its changing approach to its core manufacturing competency with its recent introduction of Lean Six Sigma which is focused on eliminating labor, and overhead transformation costs (15-20% of COGS). Typical lean implementations reduce transformation costs by 20-30% over 18-24 months yielding a potential 300-600bps margin opportunity (some shared with OEMs). SLR also highlighted other key gross margin initiatives which we estimate as another 350 bps opportunity
including: (1) more disciplined quoting process for new business (200bps of improvement on new business ramps), (2) increased capacity utilization, (3) leveraging design, (4) renegotiating pricing on select contracts, and (5) changing sales compensation to be profitability focused. Analysts have increased confidence in normalized EPS estimate of $0.42. The 650-800 bps of gross margin opportunity are more than enough to double the current 4.5% gross margin and allow management to achieve its target of a 4-5% EBIT margin and 11-18% after-tax ROTIC exiting 2005. SLR would need only a 2.2% EBIT margin to reach its ROTIC target in today's zero tax environment. SLR's stock is down 5% YTD, but down 32% from its Jan 20 high of $8.20. SLR is currently trading at 18x 2005 EPS estimate of $0.31 which is a 22% discount to the EMS group average of 23x, and only 13x our normalized EPS estimate of $0.42. A $9 target price is 21x our normalized EPS estimate, 28x our 2005 EPS estimate of $0.31, and below $11 DCF.
Network Equipment . . . SG Cowen comments that Redback Networks exceeded expectations on many fronts, giving firm increasing confidence with respect to Redback Network's ability to capitalize on the growing DSL market and achieve break even by year-end. SG Cowen believes shares should outperform market given solid initial execution and firm's expectation that company will turn profitable by year's end. RBAK is one of firm's favorite names and would recommend adding to positions.
Thomas Weisel believes Extreme Networks estimates remain too optimistic, and that significant DSO rise and departure of head of sales add wrinkles.
Schwab Soundview says that Texas Instrument’s 50% sequential growth in Digital Light Processing chips as well as commentary on strong demand reflects positively on JDS Uniphase, which supplies sealants and lenses for D.L.P. display products and suggests an area that might provide upside to rev at JDSU this quarter. Firm says TXN's commentary on D.L.P. growth highlights an area of investment for JDSU that they expect is a theme over the next 18 months -- light engines and optical components for high definition projection TVs -- since TXN's DLP chips are increasingly used in large rear projection display TVs, and JDSU benefits as a supplier.
The WSJ reports that even though the cellphone market is booming, Nokia is facing a third year in succession with no growth in sales amid increasing signs that competitors are narrowing its long-held market lead. Nokia, which is due to report its full 1st Quarter results tomorrow, remains the world's largest handset maker. But it shocked investors last week by warning that its revenue in the quarter declined 2% to €6.6 billion ($7.9 billion) because of currency movements and a loss of market share. Nokia may be able to win back market share in the second half of this year, but many observers expect growth in the handset market to have slowed by then. Some analysts are now forecasting that Nokia's sales will be flat this year, while others anticipate a decline of as much as 5% to less than €28 billion from €29.46 billion in 2003. Although cost-cutting means Nokia's net profit may still rise this year, another decline in annual revenue would be a big blow to the company's efforts to convince investors that it is a growth stock. Kulbinder Garcha, a London-based analyst with CSFB, says this is the first time that Nokia has had to contend with "the four players below them executing effectively at the same time."
Storage . . . EMC reported earnings of $0.07 per share, $0.01 better than the consensus of $0.06. Revenues rose 35.2% year/year to $1.87 billion versus the $1.82 billion consensus. The company sees 2nd quarter EPS of $0.08 versus consensus of $0.08 on revenues of $1.950-1.975 billion versus consensus $1.91 billion.
WR Hambrecht upgrades Lam Research to Buy from Hold and raises its target to $30 from $26 after the company reported a strong March quarter last night. As demand for etch equipment leads other process tools in a cyclical upturn, bookings of $350 million were up 30% this quarter and guidance calls for another 10%-15% increase in June Quarter. Gross margins improved by 80bp and are estimated to improve by more than a point next quarter, with further improvement to 49% in 2005. Higher margins and accelerating revenue growth lead the firm to increase its 2004 and 2005 EPS estimates to $0.49 and $1.63 (from $0.43 and $1.40).
Semiconductor Equipment . . . Artisan Components announced that UMC has licensed Artisan's Advantage Platform for its 90-nanometer (nm) process technology. The agreement provides system on chip (SoC) designers with proven 90nm design platform targeted for UMC's latest process generation.
Semiconductors . . . Fairchild Semi reported pro forma earnings of $0.17 per share, $0.02 better than the consensus of $0.15. Revenues rose 12.6% year/year to $397.8 million versus the $384.9 million consensus.
Piper Jaffray upgrades Microchip Tech to Outperform from Market Perform and raises their target to $35 from $31. The firm believes that top-line growth will accelerate as the co exits the March quarter due to broad-based strength in most of its end markets, and after essentially flat gross margins over the last two years, they believe the company is reaching an inflection point for a resumption in gross margin expansion. Also, firm says checks indicate that lead-times have lengthened and are now approaching 6-8 weeks.
AMD reported strong revenues and earnings which were driven by a 11% Quarter over Quarter revenue increase in Flash and a less than seasonal revenue decrease of 2% Quarter over Quarter in MPU. AMD reported revenues of $1.236 billion higher than estimates of $1.195 billion and consensus of $1.172 billion. EPS of $0.12 came in higher than our estimate of $0.04 and consensus of $0.03. AMD saw its GM increase by 240bp from 35.4% to 37.8%. Guidance for 2nd quarter was stronger than consensus. AMD guided for a flat Quarter over Quarter revenues. In the
Flash business AMD expects sales to be modestly up for the quarter. With regards to microprocessors, AMD believes that revenues will be down within industry seasonal patterns. Going into earnings, analysts had expected that AMD would beat 1st quarter estimates and provide strong/aggressive guidance. With regards to Flash, AMD has shown strong performance in 1st quarter on the heels of growth in both low density flash and high density Mirrorbit flash. Though, AMD’s flash guidance is impressive, Intel had signaled significant price cuts on the high density NOR flash which may make this flash strength temporary. Though AMDs microprocessor ASP gains are impressive in 1st quarter and we expect further ASP gains in 2nd quarter, analysts are not expecting market share gains in 2nd quarter as units are expected to decline by more than seasonality. With regards to its product mix, AMD continues to successfully ramp up its 64-bit MPU family which we estimate comprised about 8% of total MPU units shipped in 1st quarter. However, with Intel's 64 bit processors ramping, AMD's ability to increase ASPs in 3rd quarter will be challenging. Although analysts are raising 2nd quarter EPS estimates from $0.01 to $0.08 and for 2004 and 2005 from $0.25 to $0.48 and $0.40 to $0.58 respectively , we are maintaining our Peer Perform rating because: 1) The strong 2nd quarter guidance is already priced into the stock; 2) Intel has significant cost advantage over AMD given its lead in 300mm
and 90nm technologies and 3) AMD’s ability to gain market share in desktop or server MPUs is remote despite its 64-bit efforts.
Analysts generally positively surprised by Advanced Micro's results with some seeing current strength offering a short-term trading opportunity to the upside. Yet, even the positive ones note that expectations on AMD might be getting ahead of what an investor should reasonably expect and believe the stock could see some weakness post the positive digestion of the 1st quarter upside. CSFB is out raising their 2004 estimates from $4.9 billion and $0.39 to $5.3 billion and $0.67 and 2005 from $5.2 billion and $0.44 to $5.6 billion and $0.62. They believe the stock can continue to benefit near-term off richer PC mix and Flash demand although still see risks including execution and competitive threats longer from Intel MPU's and a more crowded space in flash memory. Also, SG Cowen raising their estimates and noting they believe that there is a near- term trading opportunity in AMD stock that they expect to last through the end of 2nd quarter. By 3rd quarter the firm believes AMD is likely to underperform due to increasing competition in the flash market from Intel and others, below-industry growth prospects caused by weak competitive positioning in both emerging markets and notebook processors, and the high relative valuation.
NVIDIA cut to Hold from Buy at Wedbush Morgan. The firm is downgrading stock b/c current valuation is not compelling enough even on firm's well above consensus 2005/2006 EPS estimates of $1.10/$1.30 respectively (consensus estimates are $0.68/$0.99). Currently, it is selling at P/E of 20x firm's 2005 estimate vs ATI's (ATYT) 15x..
Texas Instruments reported 1st quarter revenue and EPS at the high end of guidance and in line with consensus as a result of stronger than seasonal growth in its semi business in general and in its high performance Analog and catalog DSP in specific. Guidance for 2nd quarter was stronger than consensus. Revenue had a mid point of $3.205 billion compared to estimate of $3.101 billion, and EPS was $0.23-0.26 versus $0.23 estimate. With regards to wireless, due to TI’s consignment inventory program with Nokia there is no inventory impact on TI. Analysts are estimating a 2.2% Quarter over Quarter wireless revenue increase in 2nd quarter as the weakness in Nokia is more than offset by market share gains at SonyEricsson and LG, continued increase of overall wireless silicon BOM per handset and strength in wireless infrastructure. In 1st quarter, TI experienced strong demand in both standard logic and linear devices and has had its customers on allocation since early March. The strength in standard logic ASPs will have a stronger impact on rev in 2nd quarter than in 1st quarter because of the time lag between bookings and shipping. High-performance analog was particularly strong in 1st quarter where TI experienced market share gains, and we expect this to continue into 2nd quarter 2004. Analysts are raising 2nd quarter revenues from $3.101 billion to 3.205 billion and our EPs estimates from $0.23 to $0.25 on the heels of improving commodity analog and logic ASPs, strength in high-performance analog and improving demand for logic (MCU, DLP etc.). In addition analysts are raising 2004 and 2005 EPS estimates from $0.99 to $1.03 and from $1.33 to $1.37 respectively. TI could hit a price target of $38 because of: 1) leading analog and DSP capabilities with exposure to high growth semi segments; 2) shift to 2.5G and 3G favors TI’s wireless product portfolio; 3) ability to gain market share in wireless . In 2nd quarter TI is to benefit from strength in all semiconductor
segments, particularly in analog and commodity products. Its results demonstrate that it can easily overcome any weakness in Nokia through its other legs.
Boxmakers . . . Silicon Graphics sells Alias Software to private equity investment firm Accel-KKR for $57.5 million in cash. The transaction is expected to close in the current quarter, and SGI expects to realize approx $50 million in net proceeds after working capital adjustments and transaction costs. SGI had previously announced in Feb that it was in negotiations to sell the Alias subsidiary.
Apple handily beat estimates from record iPod shipments and some counter-seasonal strength in consumer PCs and again provided favorable forward guidance. While it's now the fourth consecutive quarter of above-consensus results and outlook, analysts are maintaining a Peer Perform rating on valuation which seems to already reflect investor optimism on iPod. AAPL reported 2Q04 EPS of $0.14 (vs. $0.04), above our and consensus EPS of $0.09, based on higher revenues of $1.91billion (vs. $1.48 billion). Highlights included strength in iPod (record units of 807K) as well as counter-seasonal stability in consumer PCs (iBook/iMac revs were flat Quarter/Quarter), while Power Mac G5 units (down 16% Quarter/Quarter) stalled further which Apple attributed to inventory reduction. On a positive note, AAPL’s results benefited from more synchronized strength across its business along with continued pent-up demand for iPod, and we see further potential 2H catalysts (iPod from H-P, new iMac, Power Mac G5 speed bump). Conversely, our concerns are that the G5 cycle has disappointed, Apple is still ceding PC share (units up just 5%) and at some point iPod supply will catch demand. Analysts are raising estimates for 2004 from $0.50 to $0.65 in EPS (vs. $0.20) on higher revenues of $7.9 billion, up 28% Year/Year and for 2005 from $0.65 to $0.80 on revenues of $8.8bn, up 11% Year/Year. Also, we’re initiating an 2006 EPS estimate of $0.95 on revenues of $9.6bn, up 9% Year/Year. For 3rd quarter 2004, EPS goes from $0.11 to $0.15 (versus $0.05) on revenues of $1.93 billion (vs. $1.55 billion) versus guidance of $0.14-$0.15 on $1.925 billion. As to valuation, if we apply a 25x multiple on 2005 operating EPS of $0.74 and add back “excess” cash of around $10, we arrive at a fair value of $29, in line with AAPL’s after-market price. A 25x multiple is warranted as it’s a discount to target multiple on Dell which is twice as profitable with more engines of growth, though Apple's momentum could provide further business upsides.
Analysts astonished by the magnitude by which Apple managed to surpass their expectations as strong iPod and iBook sales kicked in. We are seeing firms raise their 2004 and even 2005 estimates significantly as they see iPods becoming significant contributor to Apple's revenue stream, accounting for about 22% of sales in 2nd quarter 2004 vs. about 13% in the prior quarter and only 2.0% in 2nd quarter 2003. Among the more positive firms, UBS is raising their 2004 EPS estimate to $0.65 from $0.46 with 2005 going to $0.80 from $0.60. Price target goes to $35 from $30. Yet, we think it's also worth noting the co saw weakness in its PowerMac line with the long-awaited upgrade cycle still lagging expectations. As the most important source of long-term profits for Apple, one would expect market participants to take note. Prudential among the more negative one's out noting that if one strips out excess cash and interest income from the operating earnings calculation, at $29 Apple is trading 29x 2005 EPS estimate. By point of contrast, Dell is currently trading at 28.5x current 2006 (CY05) earnings estimate. They would expect the shares to trade back down once the euphoria and the momentum begins to subside. Firm sees fair value at $25.
Software . . . Network Associates was upped to Buy from Hold at Legg Mason. The upgrade is based on four reasons: 1) the firm believes NET will post solid 1st quarter 2004 results and that there is the potential for an upward revision to Street estimates or improved visibility on current estimates at the least; 2) belief that NET will look to sell/divest Sniffer over the next few quarters, which the firm estimates will be neutral at worst and positive from an investor perception perspective; 3) opinion that NET could look to buy back its outstanding convertible debt, which would be accretive even at its current premium to par and; 4) combination that the first three factors could put upward pressure on the Street's 2005 consensus est of $0.83 and could get the Street looking to a potential of $1.00 in EPS in 2005. Applying a 25 multiple to $1.00 in EPS potential yields $25 or over 30% potential upside from current levels.
The New York Times reports that RealNetworks made a direct appeal last week to Apple Computer, suggesting that the two company's form a common front against Microsoft in the digital music business. The offer to create a "tactical alliance" was made by Rob Glaser, CEO of RealNetworks in an e-mail message to Steven P. Jobs, Apple's chairman. But if an alliance with Apple could not be struck, Mr. Glaser strongly hinted in the e-mail message that he might be forced to form a partnership with Microsoft to pursue "very interesting opportunities" because support for Microsoft's media-playing software seems to be growing. Apple executives would not comment on the message. But it seems likely Mr. Jobs will rebuff the offer. Mr. Glaser said he had not received a response from Mr. Jobs, and in his e-mail message Mr. Glaser said he was going to be in Silicon Valley this week and suggested that he meet with Apple executives today.
RBC Capital out saying Take-Two remains their Top Pick despite yesterday's warning; firm sees limited downside from current levels. Price target $44.
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