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Friday, May 21, 2004 9:25:13 PM
U.S. stocks rose as crude oil fell below $40 a barrel in response to Saudi Arabia's proposal to boost output, easing concern that higher energy prices will slow consumer spending. Producers of raw materials such as Phelps Dodge Corp. and Freeport-McMoRan Copper & Gold Inc. advanced along with copper futures. A rally in the price of crude had sent benchmark indexes to their 2004 lows on Monday. The S&P 500 added 4 points (+0.4%) to 1093. An index of producers of raw materials had the biggest gain among the S&P 500's 10 industry groups. The DJIA rose 29 points (+0.3%) to 9966. The Nasdaq Composite Index advanced 15 points (+0.8%) to 1912. Two stocks rose for every one that fell on the NYSE today. Almost 1.3 billion shares changed hands on the Big Board, 15 percent less than the three-month daily average. Some 1.4 billion shares traded on the Nasdaq Stock Market, making it the slowest trading day since Dec. 26. Both the S&P 500 and Dow average completed their fourth consecutive weeks of decline, falling 0.2 percent and 0.5 percent, respectively. That marks their longest such losing streak since February 2003. The Nasdaq rose 0.4 percent since last Friday, its first weekly advance in four.
Strong Sectors: steel, internet, homebuilding, gold, steel, home furnishing, casino
Weak Sectors: oil driller, wireless service
Top Stories . . . Saudi Arabia, the world's largest oil exporter, said it will boost production by about 8 percent and proposed a higher quota for the Organization of Petroleum Exporting Countries to help bring down near-record prices. Crude oil fell 2.1 percent in New York.
A government ink expert who told jurors in the Martha Stewart trial that her broker altered a worksheet listing her holdings was charged by U.S. prosecutors with lying during his appearance on the witness stand.
Former Coastal Corp. Chairman Oscar Wyatt and a group of investors including Citigroup Inc. have agreed to pay $1.77 billion for Enron Corp.'s U.S. natural-gas pipelines, the bankrupt company's largest remaining business.
Philip Morris USA, R.J. Reynolds Tobacco Holdings Inc. and other U.S. cigarette makers must pay more than $590 million to fund quit-smoking programs in Louisiana, a jury in New Orleans decided.
Quotes of Note . . . ``It looks like there is going to be an increase in oil production and that will certainly be a positive. The fundamentals of the economy are strong and those gains should give stocks some momentum.'' Robert Baur, who oversees $22 billion as a managing director at Principal Global Investors.
``We need some clarity going forward around the Iraqi handover of power and with what the Fed is going to do. Until that happens, it will be a choppy, sideways market.'' Robert Arancio, head of Nasdaq trading at Lehman Brothers.
Interest Rates . . . A survey of primary bond dealers says that the Fed will begin raising rates in June, and won't stop until it reaches at least 4.0%, although it may take until the end of 2005, or longer. And, the NewYork Times has a feature on the global speculation that has developed out of 1.0% Fed funds. David Bowers of Merrill Lynch says we had a cluster of financed trades around the turn of the year, all funded by cheap U.S. credit, with a falling dollar. Now, we have the prospect of people being forced to liquidate. When the first really good jobs report came out on April 2nd, markets around the globe headed lower.
Bad Boys . . . The WSJ reports that Richard S. Strong agreed along with his firm to a $175 million settlement of state and federal allegations that he traded rapidly in and out of his firms' funds and allowed similar trading by a hedge fund, hurting long-term investors. Mr. Strong himself will pay $60 million of the fines and restitution, along with making an extraordinary apology. Mr. Strong became the first mutual-fund executive required to apologize to investors in what New York Attorney General Eliot Spitzer called a "public humiliation." Mr. Strong, who also agreed to be barred for life from the securities industry, issued a two-paragraph statement that concluded: "My personal behavior in this regard was wrong and at odds with the obligations I owed my shareholders, and for this I am deeply sorry."
Inflation . . . The inflation problem will be mild, not severe. This is one of the key variables in the economic outlook. Several leading indicators of inflation have either peaked or stabilized. They are responding to the increase in interest rate expectations. Economists are encouraged by the price reaction to the evolving Fed stance, and think it supports our view that the inflation problem will be a mild one.
The dollar price of gold, while still pointing to higher inflation ahead, is currently more than 10% off its highs. This indicates that “measured” rate hikes are considered less inflationary than the previous stance of “patience”.
Similarly, the Journal of Commerce index of industrial materials prices excluding petroleum, after having soared throughout the second half of 2003, began to stabilize in March 2004 and more recently has retreated from its highs.
The dispersion of commodity price increases has also begun to narrow. The diffusion index that we have constructed from the eighteen individual components of the Journal of Commerce index has fallen to 80, after being at 100 for four consecutive months (when every individual price in the index had increased over the preceding six months). While the current reading of 80 is still high, the decline from 100 indicates that upward pressure on commodity prices is becoming less widely spread.
The Baltic dry index, a measure of ocean shipping charges, has receded from the astronomical highs reached earlier in 2004. While its current reading still points to continuing upward pressure on shipping-related prices, the recent decline implies that pressures are moderating.
The price of steel scrap, which is thought to be one of Fed Chairman Greenspan’s preferred inflation indicators, has leveled off, but remains at record highs.
Some cautions on our forecast of mild inflation:
• There is substantial inflation uncertainty – there’s no history on how prices in a floating-exchange rate environment react after a deflation.
• Even mild inflation is bad, reducing the growth outlook relative to what it would have been in a more constructive reflation. However, mild inflation is better than faster inflation.
• U.S. monetary policy will still be accommodative even as the Fed raises rates, given the very low starting point. Hence, the upcoming inflation is likely to be persistent.
• Some indicators are still showing accelerating inflation, including: the ISM diffusion index, the Philly Fed’s indicators of prices paid and prices received (both at new near-term highs), the PPI and the CPI. These reflect the weakness of the dollar in late 2003 and will be responsive over time to the Fed’s new stance.
Financials . . . CIBC upgrades Morgan Stanley to Outperform from Sector Perform, as they think the co is better positioned than its competitors for a rising rate environment, Discover's outlook is improving, and its current valuation is depressed. Target is $65.
Oil & Gas . . . The NY Times reports that the president of the Organization of the Petroleum Exporting Countries said Thursday that there was little the group could do to lower fuel prices anytime soon, because OPEC's oil production quotas were not the main problem. His remarks contradicted statements last week by Saudi Arabia calling for increases in the quotas to ease price pressures. Purnomo Yusgiantoro said that the recent sharp rise in retail prices for gasoline and other fuels was "due to factors beyond OPEC's scope." In a meeting with reporters Thursday morning, Mr. Purnomo said that speculation, geopolitics and structural problems in the United States gasoline market were to blame for the run-up in pump prices in America. Even so, he said, representatives of OPEC members will meet informally this weekend at an oil industry conference in Amsterdam to consider Saudi Arabia's proposals for raising production quotas by 1.5 mln barrels a day.
Transports . . . Frontier Airlines cut to Market Perform from Outperform at Raymond James. The downgrade is primarily due to the recent rise in fuel prices to around $41 per barrel for crude oil, firm is lowering its EPS forecast for FRNT as follows: from $0.11 to $0.05 in 1st quarter 2005; from $0.30 to $0.15 in 2nd quarter 2005; from $0.20 to $0.10 in 3rd quarter 2005; and from $0.11 to $0.01 in 4th quarter 2005. This forecast reflects an average price per barrel for crude oil of around $40 per barrel in 1st quarter 2005 and assumes that fuel prices will be around $37per barrel in 2nd quarter 2005 and remain around $35 per barrel for 3rd quarter 2005 and 4th quarter 2005. Given firm's sharp reduction in FRNT's fiscal 2005 EPS forecast from $0.72 to $0.31, which reflects a 38% YOY decline in earnings.
Barron's Online highlights Continental Airlines, which said this week it would raise fares, but that may not give it enough additional revenue to offset rising jet fuel prices. The price of crude oil has risen 11% over the past month to roughly $41 per barrel. Meanwhile, jet fuel prices have shot up to $1.17 per gallon. According to the article, there may be more stormy weather ahead. "Fuel prices are more than likely to go higher," says Robert W. Mann, an independent airline analyst. "The issue really is, airlines have run through hedge positions and have been unable to replace [contracts] at ... rational prices." Mr Mann thinks $1.15-per-gallon jet fuel will be the new annual average price. That's 77% higher than the historical average of 65 cents per gallon. Continental announced this week it would raise ticket prices between $20 and $40 per round-trip flight. But if other airlines don't follow it, those higher fares won't stick. That's why the airline still may need to lay off some workers and get wage and benefit concessions from employees. According to the article, the stock does look cheap at 1.9 x trailing-12-months cash flow, compared with a 5-year average of 4.3 x cash flow. And if Continental can wring out costs through job cuts or labor concessions, the stock could perk up. But the co is losing money, and it is producing cash flow per share well below peak levels. Plus, negotiating with unions takes time.
Food & Beverage . . . CSFB upgrades Kraft Foods to Outperform from Neutral and raises their target to $34 from $32 based on valuation, as firm notes that on either a P/E or EV/EBITDA basis, the stock trades at close to a 17% discount to the group as a whole. While KFT clearly has its fundamental problems, firm believes the price level to its peers is unwarranted.
The market loves protein and foodservice exposure but Hormel is a little too expensive for our value orientation. Hormel had a solid quarter ($0.37 operating versus our $0.34 estimate) already appears in stock. Weak grocery trends (volumes down 6% but against tough comparisons) may stay sluggish if two new chili competitors are aggressive and if price increase is not well received. Strong refrigerated and turkey trends are pleasing to see but investors usually assign a lower multiple to these earnings than to grocery where operating profits were down 22%. Bottom line, we own no Hormel at this time we kick ourselves for not upgrading during Mad
Cow scare right before Christmas. Target price raised to $30 from $29 and 2004 estimate raised from $1.56 to $1.60.
Retail . . . Roth Capital upgrades Restoration Hardware to Buy from Neutral and increases its target to $7.50 from $5 after the company reported April Quarter results last night. Sales increased by 21%, well ahead of the firm's expectations. Comps increased 9% on top of an 11.9% comp in 1st quarter 2003 which indicates the company's changes to merchandising and marketing strategies are paying off. Due to the strength in the direct business, the improved gross margin exhibited during 1st quarter 2004, and the upcoming merchandising initiatives, the firm thinks the future for Resto is beginning to brighten considerably.
Barron's Online highlights Kohl's, which saw its stock lose 14% during the last 12 months. But, according to the article, the worst may be over for Kohl's due to leaner inventories and better products, featuring both private-label and branded goods, and a realignment of its merchandising department. "Kohl's boasts an attractive merchandise selection [and] environment and convenient locations," says Bernard Sosnick, analyst with Oppenheimer. And despite its stumbles last year, Sosnick views Kohl's as "a retailer with a proven growth concept over a long period of time." Barron's Online says the retailer is trying to keep its merchandise fresh for its typical shopper. For example, a clothing line under the moniker of Daisy Fuentes, an actress and model, debuted in March. "New brand introductions are key for any retailer," says Jeff Stinson, an analyst with FTN Midwest Research. "Whether it is private-label or national brands, retailers need to add some newness to the mix. Daisy Fuentes has done that for them." According to the article, Kohl's stock is real bargain, it was almost 32% off its 52-week high and 43% off its 2002 all-time high. And although its P/E ratio is slightly above its projected long-term annual earnings growth rate, it looks cheap by other measures. Fetching about 21x estimated earnings for the FY ending next Jan, it is trading way below its median P/E of 41.7x projected earnings for the last 5 years. It's also selling below its median 2.9x sales for the last 5 years.
Piper Jaffray says it would buy Electronics Boutique on weakness after it reported a strong quarter last night. Same store software comps were positive and used software growth exceeded new during the quarter. The firm thinks the stock's valuation remains attractive with a long-term EPS growth rate of 14%. Its average PE multiple during 2002-2003 was 15.9x forward earnings and its closest competitor GameStop's (GME) comp PE was 16.8x. The firm thinks the stock has pulled back recently with market conditions and lack of headlines, but the fundamentals remain strong.
UBS upgrades Rite Aid to Buy from Neutral following recent price weakness. While Rx sales may lag its peers, this is not new and RAD's excellent mgmt team has continued to execute well at the front end. Furthermore, the co has continued to generate decent cash flow, helping to increase investment in the store base. Recent 4th quarter results showed EBITDA growth of 22% Year Over Year. While this outstanding performance may moderate in the medium term, the firm still feels confident that the co can grow EBITDA by 12-15% in the current year. Analyst feels 1st quarter results, due late June, should confirm continued strong profitability. Price target moves to $5.50 from $6.
Piper Jaffray raises its target on Aeropostale to $31 after the company reported a strong 1st quarter report last night including robust same-store sales growth of 19%, with all merchandise lines performing well. Margins looked good this quarter: gross margin improved 230 basis points to 29.3%, G&A expenses dropped by 70 basis points, for an overall operating margin of 6% (a significant improvement over 2.9% operating margin in 1st quarter 2004).
After the close, Nordstrom reported 1st quarter 2004 EPS of $0.48 vs. $0.20, above the consensus of $0.43. Earnings per share were much better than the original company plan of $0.23 to $0.28, driven by strong sales, lower markdown levels, buying and occupancy leverage and expense leverage. Results included an $0.08 per share charge for early retirement of debt. Same-store sales were up 13.2%, beating the original plan of 4-6% comps. Inventory continued to be well controlled, with inventory per square foot down 8.6% at quarter-end. Looking ahead, the plan is for 2nd quarter 2004 EPS of $0.70 to $0.74 based on 4%-6% comps and full year 2004 EPS of $2.42 to $2.46 based on 4%-6% comps. This compares to full-year 2004 EPS guidance given at the beginning of the year of $2.02-$2.08 based on a 1-3% comp. Analysts are raising estimates as follows: 2nd quarter 2004 EPS to $0.74 from $0.62, 20Y04 EPS to $2.50 from $2.27 and FY05 EPS to $2.80 from $2.50. We are assuming 6% comps in 2nd quarter 2004, in line with the plan for a 4%-6% increase and projected full year 2004 same-store sales of 6.1%, slightly higher than company plan.
Gap Stores 1st quarter 2004 sales rose 9.4% to $3.7 billion, with comps of 7% vs.12% LY. The top line was driven by same store sales growth of 21% at Banana Republic, 9% at Old Navy, and 5% at Gap Domestic. Strong product assortments and effective marketing put some fire power in the top line! The 1st quarter 2004 gross margin rose 490 bps to 43.0% driven by merchandise
margin expansion and the leverage of fixed costs in COGS. The 1st quarter 2004 SG&A ratio rose 150 bps to 28.0% due to marketing initiatives and premiums paid for early debt retirement. GPS's operating margin rose 340 bps to 15.0%. GPS now targets a 2004 operating margin at the low end of its mid-teen guidance range (13.5%-16.4%), a year faster than expected. This accelerated timeframe is being driven by more regular price selling and higher markdown margins - its merchandising, marketing, and operating strategies are gaining more traction. While GPS raised its SG&A guidance (see details below), the considerable gross margin expansion it has realized in recent quarters will continue, serving as an offset. As such, anlaysts are maintaining 2004 and 2005 EPS estimates of $1.40 and $1.55, respectively. This translates into annual EPS growth of 28% in 2004 and 10% in 2005.
Medical Devices . . . CIBC spoke with Boston Scientific management, given concerns on Wall Street about the Taxus drug-eluting stent involving the balloon sticking issue. In the company's words "there are no issues with any of their stents." Share gains in the coronary stent market also support its comments. The co may have as much as 75% US coronary stent share at this juncture. The firm's industry checks have told it that "Taxus VI will put to bed any concerns about overlapping stents in longer and more complex coronary lesions," implying the data will be good. Data will be presented on 5/25 at the Paris Course (PCR) medical conference, the largest interventional cardiology conference in Europe.
SunTrust Robinson Humphrey upgrades Conceptus to Neutral from Reduce, as they believe there are a handful of catalysts (combined with 7.5 million shares short) that could limit downside and potentially drive the stock higher in the near-term. The firm says the co should receive FDA approval for a 3-year enhanced effectiveness claim (of 99.8%) for labeling on its Essure device in the very near future; the co has submitted the additional data needed for the JNJ enhanced labeling revision, and they believe the approval will come by the end of June; and firm expects JNJ to begin launching the product right after the enhanced labeling claim is granted.
Drugs . . . Bernstein downgrades AstraZeneca to Market Perform from Outperform, as the stock is trading at a 10% premium to peers on 2005 EPS despite earnings growth for 2005-08 that is just in-line with the industry. The firm says their prior Outperform rating was premised on the potential of Crestor, Iressa, and Exanta, but with these stories now understood, firm sees investors becoming increasingly concerned with post-2005 growth when there is no pipeline heir apparent.
JP Morgan is out positive on Sepracor saying that following the 21% decline from its April 26 one-yr high, they would be buying the shares. Firm attributes the weakness to insider selling, the approach of the late-May/early-June response to the Estorra approvable letter, and strangely lingering confusion about the 6-month turnaround they expect for a Class II resubmission. Post-APA, they continue to remain exceedingly bullish on the "second coming" of the insomnia market, although investors seem to still underestimate the size. With rates of prevalence as high as 30% of the normal population, underdiagnosis of the condition, firm projects at least 25% CAGR for the insomnia market to grow from $1.8 billion in 2003 to $5.3 billion in 2008. Also, there seems to be an underappreciation of the timeline slippage on Estorra's competitor, indiplon, as Pfizer/Neurocrine need to take extra time to reorganize the NDA filing strategy. Firm reiterates that SEPR is one of their top picks for 2004.
Hotel & Leisure . . . Goldman Sachs downgrades Alliance Gaming to In-Line from Outperform in order to make room for Starwood Hotels as an Outperform-rated stock. Considering that AGI has missed slot sales expectations the last two quarters, firm does not expect the stock to show significant appreciation until the co reports results in August and investors' confidence is restored.
Goldman Sachs raises their view of the Lodging sector to Attractive from Neutral, and upgrades Starwood Hotels to Outperform from In-Line; with the economy accelerating (even with fed tightening) and some pent up demand, firm expects more business travelers to hit the road. Also, firm's latest proprietary forecast suggests RevPAR growth will average 6% per year through 2006. Firm also points out that both MAR and HLT should be attractive to new investors in an improving lodging environment.
Telecom . . . The Federal Communications Commission has pulled back its approval of a plan backed by Nextel Communications Inc. to secure valuable new airwaves on which to transmit its phone traffic, sources close to the commission said. This week, FCC Commissioner Michael K. Powell pulled his vote supporting the 1.9 gigahertz exchange, effectively extending negotiations and increasing the possibility that Nextel may be forced to take the less-desirable frequencies it says it will not accept, sources close to the FCC said.
AmTech suggests investors avoid "buying the pullback" on Nextel but look to "lighten into strength." NXTL's version of the plan is to clean up the 800MHz band in order to reduce harmful interference of public safety radio communications calls for replacement spectrum in the 1.9GHz band. In return, the company would then pay for the public safety's relocation costs as well as giving up some of its own spectrum in the 800MHz band. It now appears more than likely that the FCC will rule that NXTL can NOT switch to the valuable 1.9GHz spectrum. Instead, the co may be forced to use the 2.1GHz band (which would create higher costs for phones). Both sides of the debate are still locked firm in their positions. However, FCC Chairman Powell has just switched sides and indicated his desire to complete the FCC's decision by the end of the month.
The WSJ's "Heard on the Street" column highlights Global Crossing, which saw its shares tumble by 27% three weeks ago after executives startled investors with word that the telecom provider expects to restate 2003 results and withdrew its 2004 earnings forecast, sparking the Nasdaq to consider delisting the stock. But possible troubles ahead doesn't scare Mexican billionaire Carlos Slim Helu, who became the latest big-time investor to buy up a serious chunk of Global Crossing shares. Mr. Slim, who has invested heavily in the telecom business, said he may increase his stake to nearly 20%, according to the article, citing filings he made with regulators in several states. Mr. Slim and his family currently own a 9.9% stake in the co. Word of the possible higher stake comes just a week after Richard Rainwater, the Texas investor, said he also had been buying up shares after the stock's recent stumble, and days after Global Crossing sewed up a key $100 mln bridge loan from Singapore Telemedia Pte Ltd., the biggest investor in the co. "The Slim buying doesn't change anything," says Romeo Reyes, a telecom analyst at Jefferies & Co., who has an "underperform" rating on the stock. "The business has gotten progressively worse since they've come out of bankruptcy."
IT Services . . . Wedbush Morgan initiates coverage of RSA Security with a Buy rating and $21 target. The firm believes that the identity management market is the fastest growing market in the security industry and will benefit from spend dollars shifting to internal security and infrastructure. The firm believes that RSAS is getting its house in order after a stumble a few years ago, and they believe the cash cow SecurID product will give the co the leverage to expand into new product lines, such as ClearTrust, which now has its own dedicated sales force.
Storage . . . Thomas Weisel says that McData's revenue is likely bottoming creating a favorable risk / reward after the co reported last night. The firm notes that non-EMC revenues were up an encouraging 30% year/year (EMC sales down 29% year/year). Renewed growth depends on stabilization at EMC and success of new products. While competition is not going away, the firm thinks a successful ramp in Nishan (2nd quarter/3rd quarter) and launch of Sanera (3rd quarter/4th quarter) - combined with likely stabilization at EMC due to FICON and Nishan - positions the company for renewed growth.
McData's 1st quarter results and guidance did nothing to make the analyst community feel any better regarding the stock. 1st quarter results came in-line with consensus estimates but 2nd quarter guidance disappointed yet again with the co giving revenue guidance of $92-100 million with an operating EPS loss of ($0.02) to breakeven. MP Securities out noting that of McDATA's greater than 10% customers, IBM posted the worst decline, dropping 26% Quarter/Quarter (after a strong January quarter) while EMC declined by 18% Quarter/Quarter. With the stock trading at approx 47x firm's 2005 EPS estimate, but at a low LTM P/S, they believe the stock will perform in-line with the market. First Albany out downgrading the shares to Underperform from Neutral saying the disappointing revenue trends are primarily the result of two factors: the relative weakness of corporate IT spending at the high end (particularly in the U.S.) and the lengthening of sales cycles especially for large deals due to increased competitive pressure from Cisco (and, to a lesser extent, Brocade). In light of reduced visibility, lack of near-term catalysts, increased competition, and uncertainty regarding various transitions, they think the stock will continue to underperform. The company's cash per share of $1.80 provides some downside protection, although they note that net cash per share is only $0.14.
Network Equipment . . . Raymond James comments that following a prolonged absence, Motorola appears to have cracked into Sprint PCS with the V60v handset. While this is likely a relatively small financial opportunity, all sales to Sprint represent incremental upside to Motorola's handset business. Firm continues to be encouraged by momentum in the company's new product initiatives, and expects healthy trends to continue going forward. Based on a mid-20s multiple of 2005 EPS, firm's price target is $28. This suggests the stock trading at approx 1.7x forward revenues, in-line with peers.
Smith Barney upgrades Tellabs to Buy from Hold, as they view the company's proposed acquisition of AFCI as a good deal. The firm thinks there are nice synergies between AFCI's access and TLAB's transport and data products, and believes that TLAB has the service and support organization to push AFCI products into more accounts in greater volumes. Also, AFCI's products should provide a growth driver for TLAB, and should also give TLAB greater entry into the IOC market for transport and data products.
Merrill Lynch upgrades ADC Telecom to Buy from Neutral based on earnings momentum. The firm expects EPS to grow substantially over the next few years, and says the acquisition of Krone could help the company grow the high-margin connectivity biz and improve gross margin 40-43% by increased volumes in similar product space. The firm also believes the co is in the process of divesting its loss-making billing software and cable businesses, which could bring down operating expenses to a run-rate of $90 million/qtr. Target is $3.20.
Morgan Stanley downgrades Nokia to Underweight from Equal-Weight due to their increased conviction in the company's structural problems. The firm's market share model suggests that NOK's market share drops to 28% by 2008, and with an increasingly price sensitive and lower growth market. The firm's EPS now show a five-year growth rate of -6.6%. In addition, firm says that a Russian market research contact suggests NOK has dropped from #1 to #3 (though NOK does not agree) in Russia -- a key emerging market -- with product, distribution, and marketing issues. Firm also says that valuation is not compelling on an intrinsic value or sum of the parts basis.
Goldman Sachs cut its fair value and earnings forecasts on mobile phone giant Nokia on expectations that growth in the handset market will slow. Goldman said it did not expect Nokia to regain its market share. The bank cut its fair value to 11.5 euros from 13, and its 2004 earnings per share estimate to 0.65 euros from 0.70 euros, keeping its recommendation at "in-line".
Network Equipment Report . . . New market share data from the Dell’Oro Group on the enterprise and carrier routing markets were released last night. Cisco gained roughly 1% market share in the overall routing market up to 81% as its overall router sales increased 6% sequentially. Juniper’s share remained essentially flat, inching up 30 bps to 11%.
Within the carrier core routing market, Juniper saw strength in high-end core routing, where its revenues grew 10% sequentially, boosting its market share to 34% from 31% in the December quarter. Juniper’s T-Series high-end core routers continue to gain ground against Cisco, as Cisco has not yet introduced its competing high end HFR core router. Cisco’s high-end core routing revenues grew 2%, but the company lost 2% market share to Juniper. Pricing in the core router
market remains favorable for both Cisco and Juniper, and each saw mid-single digit sequential price increases.
New market share numbers for Avici, on which we initiated coverage last night, confirmed what the company said when it reported March quarter results. Avici’s market share dropped to 2.5% from 4.7%, as both new chassis shipments and line card shipments declined. Avici should deliver stronger results in the June quarter as recent contract announcements move to the initial phases of deployment. Procket, a private start-up competitor in the core routing market, shipped 20 routers in the quarter. It appears Procket is beginning to gain some initial traction in the core router market, though it is still in the very early stages. Procket’s 29 chassis shipments over the past six months are even with Avici’s level of shipments over the past year.
In the edge routing market, Cisco’s 2% sequential growth was enough to push its market share up 3% to 74%. Juniper also gained market share slightly by roughly 50 bps to 14.2%. The biggest share drop in the market came from Nortel, whose revenues declined nearly 40% to $22 million (primarily from its Shasta product and Backbone Node router lines), leading to a 3% decline in market share. Nortel’s results in this business have been choppy over the past year, and this is
a relatively small piece of Nortel’s overall portfolio.
Cisco, Lucent, and Alcatel each posted slight 1-2% market share gains against Nortel in the WAN switch market. The combined effect led to a 4% market share decline for Nortel. Cisco, Lucent, and Alcatel each posted essentially flat revenues—an incremental positive given the typical seasonal decline in the March quarter—while Nortel saw a more severe than normal seasonal decline of 19% to $169 million.
Cisco saw 15% sequential growth in low-end enterprise routing and 5% in mid-range enterprise routing, two markets where it continues to dominate with over 90% market share. Pricing remained fairly stable overall—midsingle digit price increases in low-end routers, but an unexpected 8% sequential decline in mid-range ASPs. Mid-range routing ASPs can fluctuate based on the mix of routing modules sold in the quarter, but we had expected new module sales to lead to more stable mid -range ASPs. Given the record level of mid-range chassis shipments—nearly 50,000 chassis in the quarter, the highest level over the past decade—it would appear that Cisco is building its installed base, and add-on module sales will come further down the road.
Semiconductor Equipment . . . Thomas Weisel downgrades Ultratech to Peer Perform from Outperform. There are two reasons for increased caution on the near-term revenue potential: (1) the company's revenue growth trajectory in the current semi equipment upturn does not appear to be keeping pace with its peer group, and (2) the recent decision by INTC to adopt multiple smaller cores in its processors creates increased uncertainty around the timing of potential adoption of UTEK's laser processing technology by the semi industry.
Semiconductors . . . Based on its belief that overall business conditions remain robust, Morgan Stanley raises its estimates for Broadcom. Its 2004e EPS has been increased to $1.32 from $1.25, while 2005e has been raised to $1.50 from $1.40. These are above consensus of $1.29 and $1.47, respectively. This has been driven by expectations for faster revenue growth and better margins, and the firm believes that additional upside potential remains likely.
Morgan Stanley initiates coverage of Conexent with an Overweight rating and $6 target. The firm sees CNXT as an attractive value idea in their semi universe, and foresees a higher multiple on earnings as the co monetizes certain assets, deleverages its balance sheet, and delivers merger-related synergies.
Analysts positive following strong results and guidance from Marvell Tech. July Quarter guidance for 10% revenue growth came in much better than consensus forecast for 5% growth and whisper number of 7-9%. Western Digital's transition to SoC technology contributed significantly to MRVL's storage revenue growth during the quarter. MRVL also benefited from gigE IC ramps at Cisco and other OEMs during the April Quarter. Merrill Lynch out raising their 2004 EPS estimate from $1.40 to $1.53 and 2005 EPS estimate from $1.71 to $1.84 saying they believe MRVL has strong growth opportunities in several new markets in 2005. They expect to see a notable increase in the company's WLAN IC sales later this year from product ramps in a new gaming platform. Firm also continues to be encouraged about power management, which management believes could account for $100+ million in sales in 2005. They are currently modeling only about $35 million from power management in 2005, which means there is potential for significant upside to estimates. Firm is reiterating their Buy rating and $52 target.
The WSJ reports a small Canadian-based computer company has filed a $500 million patent lawsuit against Intel. In a lawsuit filed in U.S. District Court on Thursday, All Computers Inc. alleges that Intel violated patent laws by using the company's patented circuitry in its Pentium processors without a license. Although All Computers is suing for $500 million, attorneys for the co said under patent laws as much as $1.5 billion in damages could be awarded, if the infringement was deliberate. "It's probably one of the largest patent infringements in the U.S. or the world's history because of the volume of sales and the types of products," said William E. Levin of Laguna Beach, Calif., an attorney representing All Computers. "We expect it will have a big impact on the computer industry as a whole." The circuitry controls the frequency of input of the processors, said his partner, Edward F. O'Connor. "Virtually every computer in the world utilizes this technology."
Software . . . BMO Nesbitt Burns upgrades Business Objects to Market Perform from Underperform based on valuation, as the stock now reflects disappointing 1st quarter results. Price target is $26.
Microsoft and Oracle announced a software development agreement on Thursday, signaling an improved relationship between the two corporate database software market rivals. Software developers will be able to work with Microsoft's tools to write programs for Oracle's databases under the accord.
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Strong Sectors: steel, internet, homebuilding, gold, steel, home furnishing, casino
Weak Sectors: oil driller, wireless service
Top Stories . . . Saudi Arabia, the world's largest oil exporter, said it will boost production by about 8 percent and proposed a higher quota for the Organization of Petroleum Exporting Countries to help bring down near-record prices. Crude oil fell 2.1 percent in New York.
A government ink expert who told jurors in the Martha Stewart trial that her broker altered a worksheet listing her holdings was charged by U.S. prosecutors with lying during his appearance on the witness stand.
Former Coastal Corp. Chairman Oscar Wyatt and a group of investors including Citigroup Inc. have agreed to pay $1.77 billion for Enron Corp.'s U.S. natural-gas pipelines, the bankrupt company's largest remaining business.
Philip Morris USA, R.J. Reynolds Tobacco Holdings Inc. and other U.S. cigarette makers must pay more than $590 million to fund quit-smoking programs in Louisiana, a jury in New Orleans decided.
Quotes of Note . . . ``It looks like there is going to be an increase in oil production and that will certainly be a positive. The fundamentals of the economy are strong and those gains should give stocks some momentum.'' Robert Baur, who oversees $22 billion as a managing director at Principal Global Investors.
``We need some clarity going forward around the Iraqi handover of power and with what the Fed is going to do. Until that happens, it will be a choppy, sideways market.'' Robert Arancio, head of Nasdaq trading at Lehman Brothers.
Interest Rates . . . A survey of primary bond dealers says that the Fed will begin raising rates in June, and won't stop until it reaches at least 4.0%, although it may take until the end of 2005, or longer. And, the NewYork Times has a feature on the global speculation that has developed out of 1.0% Fed funds. David Bowers of Merrill Lynch says we had a cluster of financed trades around the turn of the year, all funded by cheap U.S. credit, with a falling dollar. Now, we have the prospect of people being forced to liquidate. When the first really good jobs report came out on April 2nd, markets around the globe headed lower.
Bad Boys . . . The WSJ reports that Richard S. Strong agreed along with his firm to a $175 million settlement of state and federal allegations that he traded rapidly in and out of his firms' funds and allowed similar trading by a hedge fund, hurting long-term investors. Mr. Strong himself will pay $60 million of the fines and restitution, along with making an extraordinary apology. Mr. Strong became the first mutual-fund executive required to apologize to investors in what New York Attorney General Eliot Spitzer called a "public humiliation." Mr. Strong, who also agreed to be barred for life from the securities industry, issued a two-paragraph statement that concluded: "My personal behavior in this regard was wrong and at odds with the obligations I owed my shareholders, and for this I am deeply sorry."
Inflation . . . The inflation problem will be mild, not severe. This is one of the key variables in the economic outlook. Several leading indicators of inflation have either peaked or stabilized. They are responding to the increase in interest rate expectations. Economists are encouraged by the price reaction to the evolving Fed stance, and think it supports our view that the inflation problem will be a mild one.
The dollar price of gold, while still pointing to higher inflation ahead, is currently more than 10% off its highs. This indicates that “measured” rate hikes are considered less inflationary than the previous stance of “patience”.
Similarly, the Journal of Commerce index of industrial materials prices excluding petroleum, after having soared throughout the second half of 2003, began to stabilize in March 2004 and more recently has retreated from its highs.
The dispersion of commodity price increases has also begun to narrow. The diffusion index that we have constructed from the eighteen individual components of the Journal of Commerce index has fallen to 80, after being at 100 for four consecutive months (when every individual price in the index had increased over the preceding six months). While the current reading of 80 is still high, the decline from 100 indicates that upward pressure on commodity prices is becoming less widely spread.
The Baltic dry index, a measure of ocean shipping charges, has receded from the astronomical highs reached earlier in 2004. While its current reading still points to continuing upward pressure on shipping-related prices, the recent decline implies that pressures are moderating.
The price of steel scrap, which is thought to be one of Fed Chairman Greenspan’s preferred inflation indicators, has leveled off, but remains at record highs.
Some cautions on our forecast of mild inflation:
• There is substantial inflation uncertainty – there’s no history on how prices in a floating-exchange rate environment react after a deflation.
• Even mild inflation is bad, reducing the growth outlook relative to what it would have been in a more constructive reflation. However, mild inflation is better than faster inflation.
• U.S. monetary policy will still be accommodative even as the Fed raises rates, given the very low starting point. Hence, the upcoming inflation is likely to be persistent.
• Some indicators are still showing accelerating inflation, including: the ISM diffusion index, the Philly Fed’s indicators of prices paid and prices received (both at new near-term highs), the PPI and the CPI. These reflect the weakness of the dollar in late 2003 and will be responsive over time to the Fed’s new stance.
Financials . . . CIBC upgrades Morgan Stanley to Outperform from Sector Perform, as they think the co is better positioned than its competitors for a rising rate environment, Discover's outlook is improving, and its current valuation is depressed. Target is $65.
Oil & Gas . . . The NY Times reports that the president of the Organization of the Petroleum Exporting Countries said Thursday that there was little the group could do to lower fuel prices anytime soon, because OPEC's oil production quotas were not the main problem. His remarks contradicted statements last week by Saudi Arabia calling for increases in the quotas to ease price pressures. Purnomo Yusgiantoro said that the recent sharp rise in retail prices for gasoline and other fuels was "due to factors beyond OPEC's scope." In a meeting with reporters Thursday morning, Mr. Purnomo said that speculation, geopolitics and structural problems in the United States gasoline market were to blame for the run-up in pump prices in America. Even so, he said, representatives of OPEC members will meet informally this weekend at an oil industry conference in Amsterdam to consider Saudi Arabia's proposals for raising production quotas by 1.5 mln barrels a day.
Transports . . . Frontier Airlines cut to Market Perform from Outperform at Raymond James. The downgrade is primarily due to the recent rise in fuel prices to around $41 per barrel for crude oil, firm is lowering its EPS forecast for FRNT as follows: from $0.11 to $0.05 in 1st quarter 2005; from $0.30 to $0.15 in 2nd quarter 2005; from $0.20 to $0.10 in 3rd quarter 2005; and from $0.11 to $0.01 in 4th quarter 2005. This forecast reflects an average price per barrel for crude oil of around $40 per barrel in 1st quarter 2005 and assumes that fuel prices will be around $37per barrel in 2nd quarter 2005 and remain around $35 per barrel for 3rd quarter 2005 and 4th quarter 2005. Given firm's sharp reduction in FRNT's fiscal 2005 EPS forecast from $0.72 to $0.31, which reflects a 38% YOY decline in earnings.
Barron's Online highlights Continental Airlines, which said this week it would raise fares, but that may not give it enough additional revenue to offset rising jet fuel prices. The price of crude oil has risen 11% over the past month to roughly $41 per barrel. Meanwhile, jet fuel prices have shot up to $1.17 per gallon. According to the article, there may be more stormy weather ahead. "Fuel prices are more than likely to go higher," says Robert W. Mann, an independent airline analyst. "The issue really is, airlines have run through hedge positions and have been unable to replace [contracts] at ... rational prices." Mr Mann thinks $1.15-per-gallon jet fuel will be the new annual average price. That's 77% higher than the historical average of 65 cents per gallon. Continental announced this week it would raise ticket prices between $20 and $40 per round-trip flight. But if other airlines don't follow it, those higher fares won't stick. That's why the airline still may need to lay off some workers and get wage and benefit concessions from employees. According to the article, the stock does look cheap at 1.9 x trailing-12-months cash flow, compared with a 5-year average of 4.3 x cash flow. And if Continental can wring out costs through job cuts or labor concessions, the stock could perk up. But the co is losing money, and it is producing cash flow per share well below peak levels. Plus, negotiating with unions takes time.
Food & Beverage . . . CSFB upgrades Kraft Foods to Outperform from Neutral and raises their target to $34 from $32 based on valuation, as firm notes that on either a P/E or EV/EBITDA basis, the stock trades at close to a 17% discount to the group as a whole. While KFT clearly has its fundamental problems, firm believes the price level to its peers is unwarranted.
The market loves protein and foodservice exposure but Hormel is a little too expensive for our value orientation. Hormel had a solid quarter ($0.37 operating versus our $0.34 estimate) already appears in stock. Weak grocery trends (volumes down 6% but against tough comparisons) may stay sluggish if two new chili competitors are aggressive and if price increase is not well received. Strong refrigerated and turkey trends are pleasing to see but investors usually assign a lower multiple to these earnings than to grocery where operating profits were down 22%. Bottom line, we own no Hormel at this time we kick ourselves for not upgrading during Mad
Cow scare right before Christmas. Target price raised to $30 from $29 and 2004 estimate raised from $1.56 to $1.60.
Retail . . . Roth Capital upgrades Restoration Hardware to Buy from Neutral and increases its target to $7.50 from $5 after the company reported April Quarter results last night. Sales increased by 21%, well ahead of the firm's expectations. Comps increased 9% on top of an 11.9% comp in 1st quarter 2003 which indicates the company's changes to merchandising and marketing strategies are paying off. Due to the strength in the direct business, the improved gross margin exhibited during 1st quarter 2004, and the upcoming merchandising initiatives, the firm thinks the future for Resto is beginning to brighten considerably.
Barron's Online highlights Kohl's, which saw its stock lose 14% during the last 12 months. But, according to the article, the worst may be over for Kohl's due to leaner inventories and better products, featuring both private-label and branded goods, and a realignment of its merchandising department. "Kohl's boasts an attractive merchandise selection [and] environment and convenient locations," says Bernard Sosnick, analyst with Oppenheimer. And despite its stumbles last year, Sosnick views Kohl's as "a retailer with a proven growth concept over a long period of time." Barron's Online says the retailer is trying to keep its merchandise fresh for its typical shopper. For example, a clothing line under the moniker of Daisy Fuentes, an actress and model, debuted in March. "New brand introductions are key for any retailer," says Jeff Stinson, an analyst with FTN Midwest Research. "Whether it is private-label or national brands, retailers need to add some newness to the mix. Daisy Fuentes has done that for them." According to the article, Kohl's stock is real bargain, it was almost 32% off its 52-week high and 43% off its 2002 all-time high. And although its P/E ratio is slightly above its projected long-term annual earnings growth rate, it looks cheap by other measures. Fetching about 21x estimated earnings for the FY ending next Jan, it is trading way below its median P/E of 41.7x projected earnings for the last 5 years. It's also selling below its median 2.9x sales for the last 5 years.
Piper Jaffray says it would buy Electronics Boutique on weakness after it reported a strong quarter last night. Same store software comps were positive and used software growth exceeded new during the quarter. The firm thinks the stock's valuation remains attractive with a long-term EPS growth rate of 14%. Its average PE multiple during 2002-2003 was 15.9x forward earnings and its closest competitor GameStop's (GME) comp PE was 16.8x. The firm thinks the stock has pulled back recently with market conditions and lack of headlines, but the fundamentals remain strong.
UBS upgrades Rite Aid to Buy from Neutral following recent price weakness. While Rx sales may lag its peers, this is not new and RAD's excellent mgmt team has continued to execute well at the front end. Furthermore, the co has continued to generate decent cash flow, helping to increase investment in the store base. Recent 4th quarter results showed EBITDA growth of 22% Year Over Year. While this outstanding performance may moderate in the medium term, the firm still feels confident that the co can grow EBITDA by 12-15% in the current year. Analyst feels 1st quarter results, due late June, should confirm continued strong profitability. Price target moves to $5.50 from $6.
Piper Jaffray raises its target on Aeropostale to $31 after the company reported a strong 1st quarter report last night including robust same-store sales growth of 19%, with all merchandise lines performing well. Margins looked good this quarter: gross margin improved 230 basis points to 29.3%, G&A expenses dropped by 70 basis points, for an overall operating margin of 6% (a significant improvement over 2.9% operating margin in 1st quarter 2004).
After the close, Nordstrom reported 1st quarter 2004 EPS of $0.48 vs. $0.20, above the consensus of $0.43. Earnings per share were much better than the original company plan of $0.23 to $0.28, driven by strong sales, lower markdown levels, buying and occupancy leverage and expense leverage. Results included an $0.08 per share charge for early retirement of debt. Same-store sales were up 13.2%, beating the original plan of 4-6% comps. Inventory continued to be well controlled, with inventory per square foot down 8.6% at quarter-end. Looking ahead, the plan is for 2nd quarter 2004 EPS of $0.70 to $0.74 based on 4%-6% comps and full year 2004 EPS of $2.42 to $2.46 based on 4%-6% comps. This compares to full-year 2004 EPS guidance given at the beginning of the year of $2.02-$2.08 based on a 1-3% comp. Analysts are raising estimates as follows: 2nd quarter 2004 EPS to $0.74 from $0.62, 20Y04 EPS to $2.50 from $2.27 and FY05 EPS to $2.80 from $2.50. We are assuming 6% comps in 2nd quarter 2004, in line with the plan for a 4%-6% increase and projected full year 2004 same-store sales of 6.1%, slightly higher than company plan.
Gap Stores 1st quarter 2004 sales rose 9.4% to $3.7 billion, with comps of 7% vs.12% LY. The top line was driven by same store sales growth of 21% at Banana Republic, 9% at Old Navy, and 5% at Gap Domestic. Strong product assortments and effective marketing put some fire power in the top line! The 1st quarter 2004 gross margin rose 490 bps to 43.0% driven by merchandise
margin expansion and the leverage of fixed costs in COGS. The 1st quarter 2004 SG&A ratio rose 150 bps to 28.0% due to marketing initiatives and premiums paid for early debt retirement. GPS's operating margin rose 340 bps to 15.0%. GPS now targets a 2004 operating margin at the low end of its mid-teen guidance range (13.5%-16.4%), a year faster than expected. This accelerated timeframe is being driven by more regular price selling and higher markdown margins - its merchandising, marketing, and operating strategies are gaining more traction. While GPS raised its SG&A guidance (see details below), the considerable gross margin expansion it has realized in recent quarters will continue, serving as an offset. As such, anlaysts are maintaining 2004 and 2005 EPS estimates of $1.40 and $1.55, respectively. This translates into annual EPS growth of 28% in 2004 and 10% in 2005.
Medical Devices . . . CIBC spoke with Boston Scientific management, given concerns on Wall Street about the Taxus drug-eluting stent involving the balloon sticking issue. In the company's words "there are no issues with any of their stents." Share gains in the coronary stent market also support its comments. The co may have as much as 75% US coronary stent share at this juncture. The firm's industry checks have told it that "Taxus VI will put to bed any concerns about overlapping stents in longer and more complex coronary lesions," implying the data will be good. Data will be presented on 5/25 at the Paris Course (PCR) medical conference, the largest interventional cardiology conference in Europe.
SunTrust Robinson Humphrey upgrades Conceptus to Neutral from Reduce, as they believe there are a handful of catalysts (combined with 7.5 million shares short) that could limit downside and potentially drive the stock higher in the near-term. The firm says the co should receive FDA approval for a 3-year enhanced effectiveness claim (of 99.8%) for labeling on its Essure device in the very near future; the co has submitted the additional data needed for the JNJ enhanced labeling revision, and they believe the approval will come by the end of June; and firm expects JNJ to begin launching the product right after the enhanced labeling claim is granted.
Drugs . . . Bernstein downgrades AstraZeneca to Market Perform from Outperform, as the stock is trading at a 10% premium to peers on 2005 EPS despite earnings growth for 2005-08 that is just in-line with the industry. The firm says their prior Outperform rating was premised on the potential of Crestor, Iressa, and Exanta, but with these stories now understood, firm sees investors becoming increasingly concerned with post-2005 growth when there is no pipeline heir apparent.
JP Morgan is out positive on Sepracor saying that following the 21% decline from its April 26 one-yr high, they would be buying the shares. Firm attributes the weakness to insider selling, the approach of the late-May/early-June response to the Estorra approvable letter, and strangely lingering confusion about the 6-month turnaround they expect for a Class II resubmission. Post-APA, they continue to remain exceedingly bullish on the "second coming" of the insomnia market, although investors seem to still underestimate the size. With rates of prevalence as high as 30% of the normal population, underdiagnosis of the condition, firm projects at least 25% CAGR for the insomnia market to grow from $1.8 billion in 2003 to $5.3 billion in 2008. Also, there seems to be an underappreciation of the timeline slippage on Estorra's competitor, indiplon, as Pfizer/Neurocrine need to take extra time to reorganize the NDA filing strategy. Firm reiterates that SEPR is one of their top picks for 2004.
Hotel & Leisure . . . Goldman Sachs downgrades Alliance Gaming to In-Line from Outperform in order to make room for Starwood Hotels as an Outperform-rated stock. Considering that AGI has missed slot sales expectations the last two quarters, firm does not expect the stock to show significant appreciation until the co reports results in August and investors' confidence is restored.
Goldman Sachs raises their view of the Lodging sector to Attractive from Neutral, and upgrades Starwood Hotels to Outperform from In-Line; with the economy accelerating (even with fed tightening) and some pent up demand, firm expects more business travelers to hit the road. Also, firm's latest proprietary forecast suggests RevPAR growth will average 6% per year through 2006. Firm also points out that both MAR and HLT should be attractive to new investors in an improving lodging environment.
Telecom . . . The Federal Communications Commission has pulled back its approval of a plan backed by Nextel Communications Inc. to secure valuable new airwaves on which to transmit its phone traffic, sources close to the commission said. This week, FCC Commissioner Michael K. Powell pulled his vote supporting the 1.9 gigahertz exchange, effectively extending negotiations and increasing the possibility that Nextel may be forced to take the less-desirable frequencies it says it will not accept, sources close to the FCC said.
AmTech suggests investors avoid "buying the pullback" on Nextel but look to "lighten into strength." NXTL's version of the plan is to clean up the 800MHz band in order to reduce harmful interference of public safety radio communications calls for replacement spectrum in the 1.9GHz band. In return, the company would then pay for the public safety's relocation costs as well as giving up some of its own spectrum in the 800MHz band. It now appears more than likely that the FCC will rule that NXTL can NOT switch to the valuable 1.9GHz spectrum. Instead, the co may be forced to use the 2.1GHz band (which would create higher costs for phones). Both sides of the debate are still locked firm in their positions. However, FCC Chairman Powell has just switched sides and indicated his desire to complete the FCC's decision by the end of the month.
The WSJ's "Heard on the Street" column highlights Global Crossing, which saw its shares tumble by 27% three weeks ago after executives startled investors with word that the telecom provider expects to restate 2003 results and withdrew its 2004 earnings forecast, sparking the Nasdaq to consider delisting the stock. But possible troubles ahead doesn't scare Mexican billionaire Carlos Slim Helu, who became the latest big-time investor to buy up a serious chunk of Global Crossing shares. Mr. Slim, who has invested heavily in the telecom business, said he may increase his stake to nearly 20%, according to the article, citing filings he made with regulators in several states. Mr. Slim and his family currently own a 9.9% stake in the co. Word of the possible higher stake comes just a week after Richard Rainwater, the Texas investor, said he also had been buying up shares after the stock's recent stumble, and days after Global Crossing sewed up a key $100 mln bridge loan from Singapore Telemedia Pte Ltd., the biggest investor in the co. "The Slim buying doesn't change anything," says Romeo Reyes, a telecom analyst at Jefferies & Co., who has an "underperform" rating on the stock. "The business has gotten progressively worse since they've come out of bankruptcy."
IT Services . . . Wedbush Morgan initiates coverage of RSA Security with a Buy rating and $21 target. The firm believes that the identity management market is the fastest growing market in the security industry and will benefit from spend dollars shifting to internal security and infrastructure. The firm believes that RSAS is getting its house in order after a stumble a few years ago, and they believe the cash cow SecurID product will give the co the leverage to expand into new product lines, such as ClearTrust, which now has its own dedicated sales force.
Storage . . . Thomas Weisel says that McData's revenue is likely bottoming creating a favorable risk / reward after the co reported last night. The firm notes that non-EMC revenues were up an encouraging 30% year/year (EMC sales down 29% year/year). Renewed growth depends on stabilization at EMC and success of new products. While competition is not going away, the firm thinks a successful ramp in Nishan (2nd quarter/3rd quarter) and launch of Sanera (3rd quarter/4th quarter) - combined with likely stabilization at EMC due to FICON and Nishan - positions the company for renewed growth.
McData's 1st quarter results and guidance did nothing to make the analyst community feel any better regarding the stock. 1st quarter results came in-line with consensus estimates but 2nd quarter guidance disappointed yet again with the co giving revenue guidance of $92-100 million with an operating EPS loss of ($0.02) to breakeven. MP Securities out noting that of McDATA's greater than 10% customers, IBM posted the worst decline, dropping 26% Quarter/Quarter (after a strong January quarter) while EMC declined by 18% Quarter/Quarter. With the stock trading at approx 47x firm's 2005 EPS estimate, but at a low LTM P/S, they believe the stock will perform in-line with the market. First Albany out downgrading the shares to Underperform from Neutral saying the disappointing revenue trends are primarily the result of two factors: the relative weakness of corporate IT spending at the high end (particularly in the U.S.) and the lengthening of sales cycles especially for large deals due to increased competitive pressure from Cisco (and, to a lesser extent, Brocade). In light of reduced visibility, lack of near-term catalysts, increased competition, and uncertainty regarding various transitions, they think the stock will continue to underperform. The company's cash per share of $1.80 provides some downside protection, although they note that net cash per share is only $0.14.
Network Equipment . . . Raymond James comments that following a prolonged absence, Motorola appears to have cracked into Sprint PCS with the V60v handset. While this is likely a relatively small financial opportunity, all sales to Sprint represent incremental upside to Motorola's handset business. Firm continues to be encouraged by momentum in the company's new product initiatives, and expects healthy trends to continue going forward. Based on a mid-20s multiple of 2005 EPS, firm's price target is $28. This suggests the stock trading at approx 1.7x forward revenues, in-line with peers.
Smith Barney upgrades Tellabs to Buy from Hold, as they view the company's proposed acquisition of AFCI as a good deal. The firm thinks there are nice synergies between AFCI's access and TLAB's transport and data products, and believes that TLAB has the service and support organization to push AFCI products into more accounts in greater volumes. Also, AFCI's products should provide a growth driver for TLAB, and should also give TLAB greater entry into the IOC market for transport and data products.
Merrill Lynch upgrades ADC Telecom to Buy from Neutral based on earnings momentum. The firm expects EPS to grow substantially over the next few years, and says the acquisition of Krone could help the company grow the high-margin connectivity biz and improve gross margin 40-43% by increased volumes in similar product space. The firm also believes the co is in the process of divesting its loss-making billing software and cable businesses, which could bring down operating expenses to a run-rate of $90 million/qtr. Target is $3.20.
Morgan Stanley downgrades Nokia to Underweight from Equal-Weight due to their increased conviction in the company's structural problems. The firm's market share model suggests that NOK's market share drops to 28% by 2008, and with an increasingly price sensitive and lower growth market. The firm's EPS now show a five-year growth rate of -6.6%. In addition, firm says that a Russian market research contact suggests NOK has dropped from #1 to #3 (though NOK does not agree) in Russia -- a key emerging market -- with product, distribution, and marketing issues. Firm also says that valuation is not compelling on an intrinsic value or sum of the parts basis.
Goldman Sachs cut its fair value and earnings forecasts on mobile phone giant Nokia on expectations that growth in the handset market will slow. Goldman said it did not expect Nokia to regain its market share. The bank cut its fair value to 11.5 euros from 13, and its 2004 earnings per share estimate to 0.65 euros from 0.70 euros, keeping its recommendation at "in-line".
Network Equipment Report . . . New market share data from the Dell’Oro Group on the enterprise and carrier routing markets were released last night. Cisco gained roughly 1% market share in the overall routing market up to 81% as its overall router sales increased 6% sequentially. Juniper’s share remained essentially flat, inching up 30 bps to 11%.
Within the carrier core routing market, Juniper saw strength in high-end core routing, where its revenues grew 10% sequentially, boosting its market share to 34% from 31% in the December quarter. Juniper’s T-Series high-end core routers continue to gain ground against Cisco, as Cisco has not yet introduced its competing high end HFR core router. Cisco’s high-end core routing revenues grew 2%, but the company lost 2% market share to Juniper. Pricing in the core router
market remains favorable for both Cisco and Juniper, and each saw mid-single digit sequential price increases.
New market share numbers for Avici, on which we initiated coverage last night, confirmed what the company said when it reported March quarter results. Avici’s market share dropped to 2.5% from 4.7%, as both new chassis shipments and line card shipments declined. Avici should deliver stronger results in the June quarter as recent contract announcements move to the initial phases of deployment. Procket, a private start-up competitor in the core routing market, shipped 20 routers in the quarter. It appears Procket is beginning to gain some initial traction in the core router market, though it is still in the very early stages. Procket’s 29 chassis shipments over the past six months are even with Avici’s level of shipments over the past year.
In the edge routing market, Cisco’s 2% sequential growth was enough to push its market share up 3% to 74%. Juniper also gained market share slightly by roughly 50 bps to 14.2%. The biggest share drop in the market came from Nortel, whose revenues declined nearly 40% to $22 million (primarily from its Shasta product and Backbone Node router lines), leading to a 3% decline in market share. Nortel’s results in this business have been choppy over the past year, and this is
a relatively small piece of Nortel’s overall portfolio.
Cisco, Lucent, and Alcatel each posted slight 1-2% market share gains against Nortel in the WAN switch market. The combined effect led to a 4% market share decline for Nortel. Cisco, Lucent, and Alcatel each posted essentially flat revenues—an incremental positive given the typical seasonal decline in the March quarter—while Nortel saw a more severe than normal seasonal decline of 19% to $169 million.
Cisco saw 15% sequential growth in low-end enterprise routing and 5% in mid-range enterprise routing, two markets where it continues to dominate with over 90% market share. Pricing remained fairly stable overall—midsingle digit price increases in low-end routers, but an unexpected 8% sequential decline in mid-range ASPs. Mid-range routing ASPs can fluctuate based on the mix of routing modules sold in the quarter, but we had expected new module sales to lead to more stable mid -range ASPs. Given the record level of mid-range chassis shipments—nearly 50,000 chassis in the quarter, the highest level over the past decade—it would appear that Cisco is building its installed base, and add-on module sales will come further down the road.
Semiconductor Equipment . . . Thomas Weisel downgrades Ultratech to Peer Perform from Outperform. There are two reasons for increased caution on the near-term revenue potential: (1) the company's revenue growth trajectory in the current semi equipment upturn does not appear to be keeping pace with its peer group, and (2) the recent decision by INTC to adopt multiple smaller cores in its processors creates increased uncertainty around the timing of potential adoption of UTEK's laser processing technology by the semi industry.
Semiconductors . . . Based on its belief that overall business conditions remain robust, Morgan Stanley raises its estimates for Broadcom. Its 2004e EPS has been increased to $1.32 from $1.25, while 2005e has been raised to $1.50 from $1.40. These are above consensus of $1.29 and $1.47, respectively. This has been driven by expectations for faster revenue growth and better margins, and the firm believes that additional upside potential remains likely.
Morgan Stanley initiates coverage of Conexent with an Overweight rating and $6 target. The firm sees CNXT as an attractive value idea in their semi universe, and foresees a higher multiple on earnings as the co monetizes certain assets, deleverages its balance sheet, and delivers merger-related synergies.
Analysts positive following strong results and guidance from Marvell Tech. July Quarter guidance for 10% revenue growth came in much better than consensus forecast for 5% growth and whisper number of 7-9%. Western Digital's transition to SoC technology contributed significantly to MRVL's storage revenue growth during the quarter. MRVL also benefited from gigE IC ramps at Cisco and other OEMs during the April Quarter. Merrill Lynch out raising their 2004 EPS estimate from $1.40 to $1.53 and 2005 EPS estimate from $1.71 to $1.84 saying they believe MRVL has strong growth opportunities in several new markets in 2005. They expect to see a notable increase in the company's WLAN IC sales later this year from product ramps in a new gaming platform. Firm also continues to be encouraged about power management, which management believes could account for $100+ million in sales in 2005. They are currently modeling only about $35 million from power management in 2005, which means there is potential for significant upside to estimates. Firm is reiterating their Buy rating and $52 target.
The WSJ reports a small Canadian-based computer company has filed a $500 million patent lawsuit against Intel. In a lawsuit filed in U.S. District Court on Thursday, All Computers Inc. alleges that Intel violated patent laws by using the company's patented circuitry in its Pentium processors without a license. Although All Computers is suing for $500 million, attorneys for the co said under patent laws as much as $1.5 billion in damages could be awarded, if the infringement was deliberate. "It's probably one of the largest patent infringements in the U.S. or the world's history because of the volume of sales and the types of products," said William E. Levin of Laguna Beach, Calif., an attorney representing All Computers. "We expect it will have a big impact on the computer industry as a whole." The circuitry controls the frequency of input of the processors, said his partner, Edward F. O'Connor. "Virtually every computer in the world utilizes this technology."
Software . . . BMO Nesbitt Burns upgrades Business Objects to Market Perform from Underperform based on valuation, as the stock now reflects disappointing 1st quarter results. Price target is $26.
Microsoft and Oracle announced a software development agreement on Thursday, signaling an improved relationship between the two corporate database software market rivals. Software developers will be able to work with Microsoft's tools to write programs for Oracle's databases under the accord.
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