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Friday, June 18, 2004 9:44:44 PM
Stocks rose as a forecast from Solectron, whose clients include Cisco Systems, reassured investors that second-quarter earnings growth will surpass estimates. The S&P 500 added 2 points (+0.3%) to 1135 and is up 2.1 percent this year. The DJIA gained 38 points (+0.4%) to 10,416.. The Nasdaq advanced 3 points (+0.2%) to 1986. For the week, the S&P 500 lost 0.1 percent, its first weekly decline in four. The Nasdaq dropped 0.7 percent. The Dow average added 0.1 percent, gaining for the fourth straight week. About nine stocks rose for every seven that fell on the New York Stock Exchange. Preliminary figures showed some 1.5 billion shares changed hands on the Big Board, 3.2 percent more than the daily average this year and the busiest since May 25. Trading picked up today because of the quarterly expiration of futures and options on stocks and stock indexes. The expiration often requires securities firms to buy or sell shares that had been used to hedge options positions.
Strong Sectors: aluminum, electronic manuf service, steel, airline, gold, auto, aerospace, casino
Weak Sectors: internet, health care distributor
Top Stories . . . The U.S. current account deficit widened to a record $144.9 billion in the first quarter as Americans bought more foreign-made goods, a government report showed.
GlaxoSmithKline, accused in a U.S. lawsuit of withholding findings about the antidepressant Paxil's effect on children, said it will create a public database of all its company-sponsored drug trials.
Viacom, the world's third- largest media company, said it will receive $738 million in cash from a special dividend paid by Blockbuster as part of its split-off from Viacom.
Halliburton fired two consultants, including the former chairman of its Kellogg Brown & Root unit, for violating the company's code of business conduct.
United Airlines parent UAL Corp. may seek new sources of capital and make additional cost cuts, after a U.S. government board rejected a UAL loan guarantee request while leaving open the possibility of reconsidering the bid.
Happy Birthday . . . Paul McCartney is 62.
Quotes of Note . . . ``We are having astounding corporate profits and the outlook is very strong. That will drive the market going forward.'' Doug Cote, who helps manage $40 billion at ING Investment Management. He expects the Standard & Poor's 500 Index to climb 15 percent in 2004.
Gurus . . . John Berry, the financial columnist close to the Fed, says the Greenspan gang has been monitoring the increase in worker compensation as a key to policy. It may be that some of the compensation increase took the form of increased benefit costs, including some large catch-up payments to under-funded pension plans. If so, there could be less momentum for aggressive tightening.
Interesting comments from Deutsche Securities' analyst Fumiaki Sato – who was credited with forecasting a collapse in the semiconductor market during the IT bubble - told Reuters it was time to move out of chip, PC and liquid crystal display (LCD) shares before those stocks plummeted on falling prices and a supply glut.
Earnings . . . The Wall Street Journal notes that the bottom line keeps getting underestimated. As we approach the second-quarter, report projections for the S&P 500 have risen from 15% to 20%. A big reason is that wage demands have been unexpectedly muted and capital spending continues to lag behind cash flow. The extra cash generated returns, contributing to results.
Fund Flows . . . Strategic Insight estimates U.S. investors put about 190 billion into equity funds during the first half. But some fund managers are finding fewer outlets for the cash, and managers of 38 funds have closed the door to new investors thus far this year. That compares with 35 funds for all of last year.
Bad Boys of Wall Street . . . The WSJ reports that the New Hampshire Bureau of Securities Regulation is expected to file civil fraud charges against Morgan Stanley. The suit will accuse the company of having improperly rewarding brokers with noncash incentives, including awards of raw steaks, so they would sell more in-house mutual funds and variable annuities. New Hampshire regulators will seek a $500K fine against Morgan Stanley, according to a draft of a petition expected to be filed in an administrative proceeding. The petition also alleges that a Morgan Stanley broker improperly solicited clients to buy several unregistered "penny stocks." Andrea Slattery, a spokeswoman for Morgan Stanley, said, "We terminated the broker involved in [the penny-stock] case more than three years ago and settled matters with each client who took issue with his conduct." As for the incentive programs, Ms. Slattery added: "Sales contests were something we addressed and resolved with the NASD last year."
Eco Speak . . . The U.S. current account deficit widened in the first quarter to a record $144.9 billion. Economists had expected the current account deficit to expand to $139.5 billion in the quarter from a revised $127.0 billion in the fourth quarter. The current account deficit is the broadest measure of the nation's financial balance with the rest of the world. Foreign capital inflows increased $447.6 billion in the first quarter, offset by capital outflows of $289.3 billion in the quarter. The gap in trade of goods and services widened to $136.9 billion in the first quarter from $125.5 billion in the prior quarter.
Market Comment . . . The most important driver of equities is the changing status of the fundamental backdrop, in our opinion. Still, there are numerous examples in stock market history of industry segments that have suffered significant reversals despite favorable fundamentals. This generally occurs when the favorable outlook becomes the consensus expectation. In other words, how can a stock price go any higher if every single investor is already bullish? The study of short interest trends is a way to gauge consensus sentiment within market segments, as well as a way to avoid the pitfall of being aggressively positioned in an industry or stock that is already a consensus favorite.
The short interest spread is an easy way to gauge investor expectations regarding sector positioning. This spread currently argues that short interest is relatively low in the cyclical sectors and relatively high in the noncyclical areas of the market. In other words, there is a lot more enthusiasm for cyclical segments overall. This comes as no surprise since the economy has been in recovery mode for several quarters. The really interesting development is that the current spread is near its lowest level in six years — levels associated with past turning points in relative performance trends.
A sector-by-sector look at short interest data in the table above reveals further interesting insights. Indeed, the segment with the highest level of short interest relative to S&P 500 short interest (i.e., relative short interest) less its 1998-to-date average (i.e., relative short interest spread) is utilities. The sector with the lowest relative short interest spread is technology. Within cyclicals, the discretionary sector has the highest relative short interest spread, and within noncyclicals, consumer staples has the lowest relative short interest spread.
Using relative short interest as a proxy for sentiment, the utilities sector would appear to be the least popular among the S&P 500 sectors since it has witnessed the largest increase in its relative short interest in recent quarters. Interestingly, the data suggest that almost 8% of S&P 500 shares short are concentrated in utility stocks, despite the fact that the sector represents only 3% or so of the overall market’s capitalization. The relative short interest for utility shares now stands about 2.5% higher than its 1998-to-date average.
The flip side of relative short interest extremes are sectors like technology, telecoms, and materials. The latter currently represents about 3% of the total S&P 500 short interest. Interestingly, short interest for the materials sector has been below its period average for almost two years as investor interest in the group has grown steadily. While the figure is slightly higher than it was in October 2002 at the nadir of the market decline, it still sits at levels considered to represent an optimistic outlook for materials stocks — i.e., there’s
still plenty of optimism for the sector, according to the data!
Analyzing short interest data at the industry group level can yield further insights. At this level, the segment with the highest relative short interest spread is still utilities. Moreover, two more noncyclical segments are among the top five: food & drug retailing and health care equipment & services. Interestingly, a couple of groups from the cyclical space also made the top five. The automobile & components and software & services industry groups also have a high relative short interest spread. These two segments buck the cyclical trend since most of the economic-sensitive areas of the market show lower relative short interest spreads at this time. This could present investors with an opportunity within the cyclical space. All in all, these five groups maintain at least a 1% relative short interest spread.
The five segments with the lowest relative short interest spreads are all economic-sensitive areas of the market. Interestingly, they hail from four separate sectors, but share common ground in that they are all cyclical in nature — e.g., retailing and media from consumer discretionary; commercial services & supplies from industrials; telecommunication services from the telecommunications sector; and technology hardware & equipment from the tech sector. Of these, only the latter two have a relative short interest spread below negative 1%. The segment that really seems to stand out is technology hardware & equipment, where the relative short interest spread is a remarkably low negative 4.41% — a sign of improved optimism for the group!
As we have cautioned with other indicators, short interest data should not be considered a silver bullet investment strategy tool. Still, it provides a good snapshot of the evolution of consensus trends for a sector or stock and can be useful in combination with other tools. The data above would seem to suggest that, compared to recent history, there exists a fairly high level of bullishness for the technology sector, and the hardware segment, in particular. Alternatively, the enthusiasm has yet to spread to the software side of the
technology equation, at least not with regard to short interest trends, perhaps arguing that software is better positioned to handle negative news than hardware is at this stage.
One of the few cyclical groups that stands out as having a high relative short interest at this time is software & services. Indeed, the segment currently represents almost 9% of all S&P 500 short shares. Software & services saw a strong increase in short shares in the wake of the rally in the spring of 2003, and has relative short interest that is nearly two percentage points above its 1998-to-date average. Interestingly, this is largely at odds with the rest of the cyclical space and the technology sector in particular.
The retail group is one area of the cyclical space that seems to fit the typical pattern for economic-sensitive segments. Indeed, the amount of relative short interest is low compared to its historical average. While it has increased slightly in recent months, retail’s relative short interest spread is a low -0.7%. Much like the rest of the cyclical space, this argues that investors have become more comfortable with the outlook for these stocks, thus their enthusiasm for the group has increased. This would make the segment vulnerable to negative news.
Financials . . . Barron's Online highlights SLM Corp., which should benefit from growing demand for degrees that Americans are seeking. The company both originates student loans and purchases loans from other lenders. It then bundles many of these loans into securities which are sold to investors. "They are the dominant player in an industry where the secular trends such as growing demographics and rising tuition are very favorable," says Stuart McDermott, a senior equity analyst with Holland Capital. This year, the co is expected to generate P/E growth of 15% year over year. And while Sallie Mae' stock has gained about 6% this year, 4 percentage points ahead of the S&P's 500, it has underperformed the S&P Consumer Finance Industry Group in the same time period. Concerns about rising short-term interest rates and the presidential election outcome are holding the stock back. But, according to the article, those fears appear largely unwarranted. Higher earnings growth is in the cards because Sallie Mae is gaining market share in an expanding industry. According to the article, the stock trades at a decent valuation too. It is trading at only a slight premium to its 15% long-term growth rate based on next year's P/E multiple. It also sells below its median forward P/E of 19x for the last 5 years, and below its median P/B value of 8.7x for the last 5 years.
Oil & Gas . . . It's anybody's guess where oil prices will be in 12 months, but investment pro John Maloney is convinced they will stay above $30 a barrel. He is betting on Suncor Energy (SU), which extracts crude from Canada's vast oil-sands deposits in Alberta. Many analysts, he notes, see oil falling from $37 now to $26. "But with economic recovery and limited capacity - exacerbated by turmoil in oil-producing nations - that's hard to imagine," says Maloney, who sees the stock, now at $25, hitting $35 to $40 within a year. He sees Suncor earnings $4 a share in 2005 - way above consensus. In 2004, he expects profits of $1.96 a share. Maloney calculates that every $1 rise in the price of oil adds $0.22 a share to Suncor's cash flow. Suncor's oil sands contain estimated reserves of 175 billion barrels - Second only to Saudi Arabia's. He says it costs Suncor $8 a barrel to extract oil from sands, vs $10 or more for the majors. Suncor's output, now at 214,000 barrels a day, has grown at 10% a year over the past decade. Suncor sees it hitting 500,000 in seven years, Maloney notes. In the long run, Suncor is the oil stock to own, asserts oil maven Charles Maxwell of securities firm Weeden. In three years , he says, Suncor "will be No.1 in production growth." Suncor was featured in his column on Nov.18, 2002, when it was at $14.
Transports . . . Legg Mason downgrades Heartland Express to Hold from Buy solely on valuation. Truckload demand remains strong for Heartland while industry capacity continues to be flat-to-down. However, the stock is approaching the firm's target price of $28 with no change to its model assumptions. The firm says the stock remains a core long-term truckload holding and should not disappoint much on the downside. However, investors could be better off buying Werner Enterprises and Marten Transport.
The WSJ reports leaders of Delta Air Lines pilots union have signaled that they were preparing a new concessions offer to try to jump-start wage-cut talks with the airline, after getting new information from the company detailing its financial peril. At the end of a three-day meeting, leaders of the Air Line Pilots Association, which represents 7,200 Delta pilots, said in a message to members that they had adopted a resolution "directing the negotiating committee to attempt to resume negotiations with management." The union's executive council, in its message to members, said it was aware that Delta was "under considerable pressure due to increasing fuel costs and declining yields." A union spokeswoman said the negotiating committee hasn't completed a new offer to the company, but said it would reflect Delta's worsening financial condition. The union said any concessions package would be "contingent upon a comprehensive restructuring of the airline." The union leadership said it met this week with representatives of Delta's creditors in a conference organized by Saybrook Capital, an investment co that is trying to organize Delta's major unsecured creditors. Catherine Stengel, a Delta spokeswoman, said no new talks are scheduled, but added that the airline is "encouraged that ALPA recognizes the need to provide Delta with a significant economic benefit."
The WSJ reports that US Airways, trying to hang on to its customers in the face of growing low-fare competition in Washington, today will roll out cheaper fares with fewer restrictions on 22 routes, including 15 served nonstop from Reagan National Airport. The US Airways Group unit also will offer the lower fares on seven routes served through connections from Reagan National and to all of the same 22 destinations served via connections from Washington's Dulles Airport. New discount carrier Independence Air took wing earlier this week from Dulles and will serve at least five of the same routes by summer's end, with even lower fares than US Airways' new offerings.
Homebuilders . . . Wachovia upgrades KB Home to Outperform from Market Perform in response to strong quarter and inexpensive valuation: 2nd quarter EPS of $2.40 beat firm's estimate of $2.10, courtesy of better homebuilding operating margins. The stock is trading at 6.1x 2004 EPS, 16% cheaper than group. Firm raises F2004 EPS estimate to $10.85 from $10.30 and 2005 estimate to $11.65 from $10.90, assuming higher deliveries and margins; Gives valuation range of $81 to $87.
Education . . . Lehman expects Apollo Group to exceed 3Q04 rev and EPS estimates with $0.02-$0.04 EPS surprise likely, as a result of: 1) operating margins nicely above the 32.0%-32.5% guidance level. 2) Enrollments modestly exceeding 238.4K est. UOPX, in particular, should drive the strong results. 3) APOL guidance is too conservative regarding the roll out of rEsource; However, firm believes that the positive surprise is largely priced into the stock. Lehman also raises 2005 EPS estimate to $2.25 from $2.19 for slightly better margins and higher online growth and price target to $95 from $88.
Harris Nesbitt comments that amended class action lawsuit against Career Education may have more negative impact than others. While there have been a number of class action lawsuits filed against the company, firm believes this one may have more negative impact. This law firm (Goodkind, Labaton, Rudoff & Sucharow) claims to have found 13 'witnesses" consisting of ex-CECO employees who have made these allegations. The stock was weak late yesterday on all sorts of speculation, although recovered somewhat late in the day. Firm expects further weakness this morning. While firm cannot comment on the validity of these allegations, this disclosure will likely once again highlight one of the key risks of investing in this stock (and the sector in general). Firm maintains its Neutral rating and suggests investors use the expected weakness in the group today to focus on some of the quality names such as Apollo Group, University of Phoenix, Education Management, and Strayer.
UBS comments that while it is impossible to gauge how this suit will play out, firm does believe that - given how detailed the allegations in it are - it is likely to exacerbate concerns about the regulatory risks associated with Career Education’s shares. The amended suit details a list of allegations that resulted from interviews with more than dozen of CECO's former employees; firm believes this amendment includes more employee accounts and more allegations than previous versions did. This amendment alleges that CECO engaged in falsifying student records, including enrollment figures, in order to please investors and qualify for federal funding; and manipulation of financial information, including revenues and margins, to the point of violating GAAP. The suit alleges that wrongdoings are pervasive across CECO's network of schools.
Food & Beverage . . . JP Morgan initiates Sara Lee with Overweight and $29 price target as the company's 21% P/E discount to food stocks does not reflect encouraging momentum in the company's food and beverage (F&B) business and signs of improvement in the apparel cycle. The firm sees 5% discount to pure food companies justifiable. Firm believes that although Apparel is dragging down EBIT for 2004, it may boost EBIT for 2005.
JP Morgan initiates ConAgra with Underweight as CAG's valuation does not properly reflect the company's below average execution risk now that co is entering a more challenging phase, where improving operational efficiencies, better integrated marketing and distribution practices, and margin enhancing product innovation should be the key drivers of EPS growth after successful transformation from a commodity-oriented business to a packaged food company of branded value-added products.
Piper Jaffray is seeing some evidence that low-carb mania is beginning to wane. Unfortunately, this could also reduce the sales potential on American Italian Pasta's (PLB) new low-carb pasta product introduction. The firm has heard from several retailers that customer acceptance has been just "so-so." The firm lowers its target to $34 from $38, reflecting a reduced near-term earnings outlook but retaining a multiple of 17x.
The WSJ reports that Archer-Daniels-Midland agreed to pay $400 million to settle a nearly nine-year-old civil suit alleging it rigged prices of a corn sweetener. The plaintiff class, a group of about 2,000 companies that includes PepsiCo and Coca-Cola, used an ADM sweetener called high-fructose corn syrup in their products. The group alleged that ADM conspired with other manufacturers in the highly concentrated corn-milling industry to illegally inflate high-fructose corn syrup prices in the early 1990s, costing them $1.4 bln.
Restaurants . . . Peet's Coffee cut to Neutral from Outperform at Harris Nesbitt as stock has neared $25 target.
Piper upgrades CBRL Group to Outperform from Market Perform despite yesterdays weak comp disclosure. The firm views the recent sales erosion as due to tougher industry comparisons, the initial gas price sticker shock, and the company's recent bad publicity. The firm does not anticipate these three to fuel further erosion in sales. Instead, they expect the format's enduring consumer appeal and solid execution to help revive comps to more normal levels. In firm's view, despite the erosion in their EPS estimates, the stock's valuation reflects further comp store sales erosion. Next Friday, mgmt will host its first analyst meeting in 7 years. Although the firm does not anticipate any major announcements, they expect investor confidence to improve following the meeting. 2004 EPS estimate moves to $2.30 and revenue estimate to $2.39 billion, 2005 EPS estimate goes to $2.65 and rev estimate to $2.585bn.
Retail . . . Pacific Growth initiates Abercrombie & Fitch with Overweight rating based on: 1) The improved, fashion right product offering at all 3 ANF concepts should translate into positive same-store sales, stronger margins and increased earnings growth. 2) Significant store growth opportunities at Hollister. Firm's EPS estimates are $2.52 for 2004 and $2.93 for 2005.
Viacom and Blockbuster announce terms of separation. The transaction would involve Viacom's distribution of its interest in Blockbuster through a "split-off" exchange offer to VIA.B stockholders. BBI also announced that, prior to the commencement of the exchange offer, BBI anticipates paying a pro rata special cash distribution of $5 per share, or a total of approximately $905 million based on the number of shares currently outstanding, to all stockholders, including VIA.B. As the owner of approximately 81.5% of BBI's outstanding shares, VIA.B anticipates receiving a cash payment of $738 million in the distribution, which, as to VIA.B, will be free of income taxes.
RFID . . . Lehman out saying RFID update from Wal-Mart suggests that rollout is on track, including favorable results from Dallas pilot facility. That said, the company expects to be 'live' in North Texas by January 2005 (top 137 suppliers), in addition to six distribution centers and 250 Wal-Mart stores by June '05. In following, and given that Avery will participate in the rollout as a primary converter (at the very least), the firm believes that confirmation of Wal-Mart's intention to stick with the previously disclosed timelines should be a positive for the stock. Lehman is sticking with their Overweight rating $72 target.
Media . . . The WSJ reports that each spring, the nation's big broadcast-television networks tout their coming prime-time schedules and go fishing for advance ad dollars. The event, known as the "upfront," is a highly competitive contest for rev and bragging rights, and the broadcast networks quietly release their data to the media. The dollar figures and percentages of increase or decrease are treated as a meaningful way to keep score, not only to compare networks but also to divine the health of the media industry and even the state of the economy at large. And the total money involved is huge, this year's take by the six major networks is believed to be in the neighborhood of $9.5 billio. "It's a number that is anything the networks say it is, quite frankly," says Larry Spiegel, a principal at the Richards Group. What's more, upfront numbers indicate commitments to spend money in the future. But as the TV season winds on, these early promises have been overtaken by ad dollars spent later on in what is known as the "scatter" market. The only networks to post upfront gains this year were Viacom's CBS and UPN. CBS secured about $2.4 billion in commitments, up from about $2.2 billion in 2003. UPN secured about $350 million in ad commitments, up from $250 million in 2003.
Hotel & Leisure . . . Carnival Corporation's 2nd quarter results beat expectations, reporting $0.41 vs. our estimate and Street consensus of $0.35. Net revenue yields increased 13.2% in the quarter on a pro forma basis, ahead of +10-12% guidance, and ahead of expectations of +11.0%. Occupancy was lower than expected, but was offset by much higher on-board per diems and much lower net cruise costs per available berth day, which declined slightly versus expectation of roughly a 2% increase. Management indicated that both occupancy and pricing for 3rd quarter has been strong. As a result, CCL guided 3rd quarter and full year yields each to be up 6-8% (aided by currency translation). Unit costs were reiterated to be flat to up 2% for the full year, reflecting expected cost synergies. Full-year EPS guidance is now $2.10 to $2.20, up from $2.05-2.15 and compared to consensus of $2.13. Analysts are raising 2004 estimate to $2.17 from $2.11 to reflect management's yield and expense guidance. Given the outlook for the remainder of 2004 and the continued positive implications for 2005, analysts are letting some of this year's strength flow through to 2005 and are thus raising our estimates slightly to $2.57 from $2.54. Given Carnival's visibility and positive outlook for the remainder of the year, we think 2nd half earnings risk is fairly limited, and thus the main reason for the pop in the stocks today. However, we believe the next real move in the stocks will come with better visibility and comfort with 2005. We don't think we're there yet.
Electronics . . . JP Morgan initiates TiVo with an Underweight due to 1) Less expensive, more fully featured offerings will emerge over the next several years that would slow TiVo's growth substantially, and pressure the stock. 2) DirectTV, responsible for 55% of company's total subscribers and nearly three-quarters of net additions in the April Quarter, is likely in the 2005 to 2007 time frame to shift its DVR sales focus to a less expensive, more integrated DVR offering based on technology from News Corp.-controlled vendor NDS. 3) Cable companies are ramping up sales of cheaper, more fully featured DVR services. 4) Over time, consumer electronics makers will begin selling non-subscription DVRs that will be effective alternatives to TiVo.
IT Services . . . AG Edwards initiates IBM with a Buy and $105 price target, citing: 1) IBM is the biggest IT services company in the world, with a 2003 market share of 8%, and also has a top three position in worldwide market share for software and each major segment of computer hardware. 2) Through the entire downturn of the last three years, IBM has had more than a billion dollars in net income from continuing operations in every qtr. 3) IBM has been awarded more patents than any other US company in each of the last 11 years, leading to belief that IBM has more intellectual property in the combined fields of computers, semiconductors and electronic materials that any other company in the world.
EMS . . . Jabil Circuit upped to Strong Buy from Outperform at Raymond James. The upgrade follows yesterday's 13% decline following disappointing guidance for the August quarter; believes the market's excessive reaction to this relatively minor shortfall was unwarranted. The firm emphasizes that it believes the issues responsible for the shortfall are temporary and not indicative of any underlying strategic weakness; the aforementioned startup costs are expected to impact margins for only the next three to six months; firm would expect a healthy rebound thereafter. Price target of $31 is based on 25x firm's 2005 estimate of $1.25.
Baird upgrades Solectron to Outperform from Neutral based on solid revenue trends, improved operational metrics, significantly lower net debt, progress with divesting businesses, and attractive valuation. Firm raises EPS ests for 2004 and 2005 to $0.01 from $0.00 and to $0.23 from $0.18, respectively; Increases price tgt to $8 from $7.
Solectron reported net sales of $3.04 billion, up 5.3% sequentially and 29.0% year over year on a continuing operations basis. Proforma EPS was $0.01 excluding charges, $0.01 above consensus, and up $0.03 sequentially. Net sales was inline with First Call consensus and 1.3% above estimates of $3.0 billion.
• The computing and storage (28.9% of revenues) segment fell 2% sequentially. We believe the sequential weakness might have been driven by Solectron disengaging from certain underperforming programs in the segment. Next quarter we expect Solectron’s computing and storage segment to increase sequentially as demand improves going into the second half of the year.
• Networking was up 1% sequentially and the segment accounted for 21.0% of sales, down from 21.8% last quarter. Cisco, Solectron’s largest customer, saw growth of 3.7% sequentially, outpacing the rest of the segment and likely above Jabil’s flat growth with Cisco in the quarter. Solectron’s higher-end Cisco programs continue to perform well and we expect them to be up next quarter.
• Communications revenues (19.3% of sales), which include both wireline and wireless infrastructure customers, were up 12% sequentially. The majority of the strength was on the wireless infrastructure side with key customers such as Motorola, Ericsson, Lucent, and Nortel. Motorola had a particularly strong quarter for Solectron rising double digits sequentially.
• The consumer products segment (19.8% of sales) rose 2% sequentially as a result of the strong set-top box demand for Pace Micro offset with a decline in the ramp of its NEC 3G handsets. As a result, NEC dropped below 10% of sales in the quarter.
• Sales to the automotive sector rose 23% or $16 million as demand bounced off a seasonally weak quarter and the industrial segment rose 38% due to strength with Solectron’s semiconductor & test customers which are seeing improving demand.
Network Equipment . . . RBC Capital says its sources indicate that executive management of Cisco and Nortel met yesterday to exchange an open dialogue following the Canada Telecom Summit. While not privy to what was discussed, the firm believes a partnership between the companies may make sense across several levels. Cisco's current mix of enterprise to service provider remains about 70%/30% while Nortel's mix is the exact opposite. Furthermore, both companies share similar service provider networking visions -an IP/MPLS core and multi-service edge. The firm believes no large acquisitions are pending and that it will take several months for a formal agreement to be announced, if at all. Nevertheless, the two companies have begun a dialogue and the firm expects progress to be made over the next several quarters.
Morgan Stanley upgrades Corning to Overweight from Equal Weight. The firm notes that stock has only appreciated 5% since the beginning of the year, with 15%+ upside from current levels to firm's DCF fair value estimate of $14.
Morgan Stanley downgrades Motorola to Equal Weight from Overweight and reduces tgt to $20 from $25. Firm believes 1st quarter margin performance, particularly in handsets, will be difficult to sustain, particularly since firm expects the competitive environment to intensify.
Goldman Sachs says its view following reports from two of Cisco's contract manufacturers and firm's channel checks suggest a continued healthy ramp in switching. While contract manufacturer Jabil cited a weaker than expected outlook in its business with CSCO, this was clearly a Jabil-specific issue related to inventory and product mix. Solectron, another manufacturer for CSCO, reaffirmed firm's view with its results last night in which CSCO's sales to Solectron were at the high end of our expectations.
UBS has a cautious view on the mobile phone sector heading into 2nd half 2004 due to the likelihood for slowing industry growth and increased pricing pressure as numerous new products are launched in 2nd half 2004. UBS notes industry volumes should exceed 600m this year based on strong 1st quarter 2004 results and modest sequential growth through the year. UBS believes several recent negative data points from the component food chain reflect several industry trends which include: adjustments to component inventory levels by OEMs ahead of new product introductions, slowing sequential industry volume growth, and share shifts in China towards multinational vendors.
CNET News reports Thomas Campana died June 8 at the age of 57, a day after an appeal got under way in a high-profile patent infringement case launched by his company, NTP, against RIM and its renowned BlackBerry device. Campana was co-founder and president of NTP, and the co-inventor of patented technology the company is seeking to protect. According to the article, people close to NTP downplayed speculation that Campana's death could open the door to a quick settlement in the case.
Semiconductor Equipment . . . WR Hambrecht says recent selling pressure on semi equipment stocks may continue in response to a slight decline in the industry book:bill to 1.11:1 from 1.13:1 (and a front-end B:B of 1.09:1 vs. 1.12:1) on slightly higher sales. SEMI's monthly equipment order figures for May were flat with April and in line with expectations. Process equipment orders for May Quarter were up 20% from February Quarter, and 129% from a year ago. Back-end order growth figures were similar month/month and quarter/quarter and rose 88% from a year ago. The firm believes that the flattening of orders is mainly seasonal and look for renewed order growth (and a rally in the stocks) by autumn in response to continued strength in electronics demand and semiconductor production. The industry's normal seasonality and the transitional between technology nodes are only temporary and are creating an excellent buying opportunity in these stocks.
Semiconductors . . . Deutsche Bank says Micron's 3rd quarter could provide an upside surprise, which might boost the stock in the near term. However, given its expectations for DRAM contract ASPs to decline into 2H04, and the company's poor competitive position, the firm sees limited attractiveness in the stock. The firm reits its Hold and $16 target. The stock remains uncompelling, although the company's current 1.5x NTM P/S & 1.6x TTM P/B are well below former peaks of 7.8x & 4.1x (mid-cycle 2.2x & 2.7x). However, the company's lack of competitiveness vs. peers (with similar valuations) limits the stock's attractiveness.
Boxmakers . . . Dell President Kevin Rollins plans to cut computer-printer prices in half and shave as much as 20 percent from the cost of printer supplies as he challenges Hewlett-Packard in its most-profitable market. "Our customers are telling us they've just been paying too much for ink and toner," Rollins said. "It's frankly the most expensive liquid on the planet." Rollins is crafting plans to use what he calls "the Dell effect" to muscle in on a market that Hewlett-Packard Chief Executive Carly Fiorina relies on to supply almost 70 percent of her company's profit. DELL's plans to bring down prices in the printer market aren't new. Nevertheless, watch for potential reaction in Lexmark and Hewlett-Packard.
Software . . . Needham upgrades Progress Software to Strong Buy from Buy after the company reported last night. Firm says the co continued to chug along in its May Quarter. The database related businesses each turned in somewhat better than expected. Sonic outperformed its peers, but continued to see long sales cycles as the Enterprise Service Bus technology transitions from early adopter to mainstream customers. The firm believes the stock is valued too inexpensively relative to its growth prospects.
First Albany downgrades Red Hat to Neutral from Buy as the stock has risen to the $20s from $12 in December. The firm is concerned by some quarterly metrics that makes it fairly valued until the firm can answer some newly surfacing questions. The firm is disappointed that RHAT's 1st quarter revenue of $41.6 million missed the consensus of $43 million. The revenue miss stemmed from a back-end-loaded quarter on the direct side, and disappointing indirect channel results. This is forcing the firm to reexamine its expectations for growth in RHAT's indirect channel; and that more back-end-loading of the direct business could mean MSFT's competitive response is lengthening RHAT's sales cycles.
CSFB increases Red Hat estimates. The firm raises 2005 estimate to $0.27 from $0.25. Based on higher estimated attach rates and operating margins. The firm revises 2006 to $0.63 from $0.56, and DCF target price to $27 from $25. The firm would be buyers on reduced expectations.
Lehman comments that NPD results through the end of May indicate that sales of Symantec retail products are up 80% year/year QTD, tracking ahead of firm's estimate for 48% year/year growth for consumer revenue for June. Based on current momentum, believes company is on pace to meet or exceed firm's 1st quarter consumer revenue estimate of $247 million.
Adobe reported solid 2nd quarter results with revenue of $410 million, exceeding the consensus estimate of $405 million. The upside was a result of better than expected performance of Intelligent Documents (Acrobat), which posted 26% year-over-year growth, and about $6 million in upside. CSFB out raising their 2004 EPS estimate despite the inline 2nd quarter based on continued strength of the CS upgrade. New F2004 EPS estimate is $1.62, up from $1.55, and 41% EPS growth. Firm would accumulate the stock in the low $40s in anticipation of a more constructive environment towards the end of year when they believe investors will begin to anticipate a blockbuster product year in 2005. Smith Barney out saying that, while numbers once again exceeded Street estimates, the quarter didn't feel as strong as the first quarter when all segments were up sequentially and at rates much greater than they had anticipated. Firm is raising their estimates but maintains Hold rating, noting they would be more interested in the shares below the $40.00 level.
TIBCO reported a strong second quarter last night that was even better than the summary numbers indicated, as EPS was negatively affected by extraneous items, reducing earnings by a penny. Even more impressive was the outlook, as guidance implies upside to current estimates when we attempt to exclude anticipated Staffware financials. TIBCO offers a compelling value at current levels. It is benefiting from favorable changes to its relationship with its previous parent company, Reuters, as evidenced by the robust performance of the financial services vertical. Analysts are raising estimates to reflect greater growth than we had anticipated and to account for the Staffware acquisition.
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Strong Sectors: aluminum, electronic manuf service, steel, airline, gold, auto, aerospace, casino
Weak Sectors: internet, health care distributor
Top Stories . . . The U.S. current account deficit widened to a record $144.9 billion in the first quarter as Americans bought more foreign-made goods, a government report showed.
GlaxoSmithKline, accused in a U.S. lawsuit of withholding findings about the antidepressant Paxil's effect on children, said it will create a public database of all its company-sponsored drug trials.
Viacom, the world's third- largest media company, said it will receive $738 million in cash from a special dividend paid by Blockbuster as part of its split-off from Viacom.
Halliburton fired two consultants, including the former chairman of its Kellogg Brown & Root unit, for violating the company's code of business conduct.
United Airlines parent UAL Corp. may seek new sources of capital and make additional cost cuts, after a U.S. government board rejected a UAL loan guarantee request while leaving open the possibility of reconsidering the bid.
Happy Birthday . . . Paul McCartney is 62.
Quotes of Note . . . ``We are having astounding corporate profits and the outlook is very strong. That will drive the market going forward.'' Doug Cote, who helps manage $40 billion at ING Investment Management. He expects the Standard & Poor's 500 Index to climb 15 percent in 2004.
Gurus . . . John Berry, the financial columnist close to the Fed, says the Greenspan gang has been monitoring the increase in worker compensation as a key to policy. It may be that some of the compensation increase took the form of increased benefit costs, including some large catch-up payments to under-funded pension plans. If so, there could be less momentum for aggressive tightening.
Interesting comments from Deutsche Securities' analyst Fumiaki Sato – who was credited with forecasting a collapse in the semiconductor market during the IT bubble - told Reuters it was time to move out of chip, PC and liquid crystal display (LCD) shares before those stocks plummeted on falling prices and a supply glut.
Earnings . . . The Wall Street Journal notes that the bottom line keeps getting underestimated. As we approach the second-quarter, report projections for the S&P 500 have risen from 15% to 20%. A big reason is that wage demands have been unexpectedly muted and capital spending continues to lag behind cash flow. The extra cash generated returns, contributing to results.
Fund Flows . . . Strategic Insight estimates U.S. investors put about 190 billion into equity funds during the first half. But some fund managers are finding fewer outlets for the cash, and managers of 38 funds have closed the door to new investors thus far this year. That compares with 35 funds for all of last year.
Bad Boys of Wall Street . . . The WSJ reports that the New Hampshire Bureau of Securities Regulation is expected to file civil fraud charges against Morgan Stanley. The suit will accuse the company of having improperly rewarding brokers with noncash incentives, including awards of raw steaks, so they would sell more in-house mutual funds and variable annuities. New Hampshire regulators will seek a $500K fine against Morgan Stanley, according to a draft of a petition expected to be filed in an administrative proceeding. The petition also alleges that a Morgan Stanley broker improperly solicited clients to buy several unregistered "penny stocks." Andrea Slattery, a spokeswoman for Morgan Stanley, said, "We terminated the broker involved in [the penny-stock] case more than three years ago and settled matters with each client who took issue with his conduct." As for the incentive programs, Ms. Slattery added: "Sales contests were something we addressed and resolved with the NASD last year."
Eco Speak . . . The U.S. current account deficit widened in the first quarter to a record $144.9 billion. Economists had expected the current account deficit to expand to $139.5 billion in the quarter from a revised $127.0 billion in the fourth quarter. The current account deficit is the broadest measure of the nation's financial balance with the rest of the world. Foreign capital inflows increased $447.6 billion in the first quarter, offset by capital outflows of $289.3 billion in the quarter. The gap in trade of goods and services widened to $136.9 billion in the first quarter from $125.5 billion in the prior quarter.
Market Comment . . . The most important driver of equities is the changing status of the fundamental backdrop, in our opinion. Still, there are numerous examples in stock market history of industry segments that have suffered significant reversals despite favorable fundamentals. This generally occurs when the favorable outlook becomes the consensus expectation. In other words, how can a stock price go any higher if every single investor is already bullish? The study of short interest trends is a way to gauge consensus sentiment within market segments, as well as a way to avoid the pitfall of being aggressively positioned in an industry or stock that is already a consensus favorite.
The short interest spread is an easy way to gauge investor expectations regarding sector positioning. This spread currently argues that short interest is relatively low in the cyclical sectors and relatively high in the noncyclical areas of the market. In other words, there is a lot more enthusiasm for cyclical segments overall. This comes as no surprise since the economy has been in recovery mode for several quarters. The really interesting development is that the current spread is near its lowest level in six years — levels associated with past turning points in relative performance trends.
A sector-by-sector look at short interest data in the table above reveals further interesting insights. Indeed, the segment with the highest level of short interest relative to S&P 500 short interest (i.e., relative short interest) less its 1998-to-date average (i.e., relative short interest spread) is utilities. The sector with the lowest relative short interest spread is technology. Within cyclicals, the discretionary sector has the highest relative short interest spread, and within noncyclicals, consumer staples has the lowest relative short interest spread.
Using relative short interest as a proxy for sentiment, the utilities sector would appear to be the least popular among the S&P 500 sectors since it has witnessed the largest increase in its relative short interest in recent quarters. Interestingly, the data suggest that almost 8% of S&P 500 shares short are concentrated in utility stocks, despite the fact that the sector represents only 3% or so of the overall market’s capitalization. The relative short interest for utility shares now stands about 2.5% higher than its 1998-to-date average.
The flip side of relative short interest extremes are sectors like technology, telecoms, and materials. The latter currently represents about 3% of the total S&P 500 short interest. Interestingly, short interest for the materials sector has been below its period average for almost two years as investor interest in the group has grown steadily. While the figure is slightly higher than it was in October 2002 at the nadir of the market decline, it still sits at levels considered to represent an optimistic outlook for materials stocks — i.e., there’s
still plenty of optimism for the sector, according to the data!
Analyzing short interest data at the industry group level can yield further insights. At this level, the segment with the highest relative short interest spread is still utilities. Moreover, two more noncyclical segments are among the top five: food & drug retailing and health care equipment & services. Interestingly, a couple of groups from the cyclical space also made the top five. The automobile & components and software & services industry groups also have a high relative short interest spread. These two segments buck the cyclical trend since most of the economic-sensitive areas of the market show lower relative short interest spreads at this time. This could present investors with an opportunity within the cyclical space. All in all, these five groups maintain at least a 1% relative short interest spread.
The five segments with the lowest relative short interest spreads are all economic-sensitive areas of the market. Interestingly, they hail from four separate sectors, but share common ground in that they are all cyclical in nature — e.g., retailing and media from consumer discretionary; commercial services & supplies from industrials; telecommunication services from the telecommunications sector; and technology hardware & equipment from the tech sector. Of these, only the latter two have a relative short interest spread below negative 1%. The segment that really seems to stand out is technology hardware & equipment, where the relative short interest spread is a remarkably low negative 4.41% — a sign of improved optimism for the group!
As we have cautioned with other indicators, short interest data should not be considered a silver bullet investment strategy tool. Still, it provides a good snapshot of the evolution of consensus trends for a sector or stock and can be useful in combination with other tools. The data above would seem to suggest that, compared to recent history, there exists a fairly high level of bullishness for the technology sector, and the hardware segment, in particular. Alternatively, the enthusiasm has yet to spread to the software side of the
technology equation, at least not with regard to short interest trends, perhaps arguing that software is better positioned to handle negative news than hardware is at this stage.
One of the few cyclical groups that stands out as having a high relative short interest at this time is software & services. Indeed, the segment currently represents almost 9% of all S&P 500 short shares. Software & services saw a strong increase in short shares in the wake of the rally in the spring of 2003, and has relative short interest that is nearly two percentage points above its 1998-to-date average. Interestingly, this is largely at odds with the rest of the cyclical space and the technology sector in particular.
The retail group is one area of the cyclical space that seems to fit the typical pattern for economic-sensitive segments. Indeed, the amount of relative short interest is low compared to its historical average. While it has increased slightly in recent months, retail’s relative short interest spread is a low -0.7%. Much like the rest of the cyclical space, this argues that investors have become more comfortable with the outlook for these stocks, thus their enthusiasm for the group has increased. This would make the segment vulnerable to negative news.
Financials . . . Barron's Online highlights SLM Corp., which should benefit from growing demand for degrees that Americans are seeking. The company both originates student loans and purchases loans from other lenders. It then bundles many of these loans into securities which are sold to investors. "They are the dominant player in an industry where the secular trends such as growing demographics and rising tuition are very favorable," says Stuart McDermott, a senior equity analyst with Holland Capital. This year, the co is expected to generate P/E growth of 15% year over year. And while Sallie Mae' stock has gained about 6% this year, 4 percentage points ahead of the S&P's 500, it has underperformed the S&P Consumer Finance Industry Group in the same time period. Concerns about rising short-term interest rates and the presidential election outcome are holding the stock back. But, according to the article, those fears appear largely unwarranted. Higher earnings growth is in the cards because Sallie Mae is gaining market share in an expanding industry. According to the article, the stock trades at a decent valuation too. It is trading at only a slight premium to its 15% long-term growth rate based on next year's P/E multiple. It also sells below its median forward P/E of 19x for the last 5 years, and below its median P/B value of 8.7x for the last 5 years.
Oil & Gas . . . It's anybody's guess where oil prices will be in 12 months, but investment pro John Maloney is convinced they will stay above $30 a barrel. He is betting on Suncor Energy (SU), which extracts crude from Canada's vast oil-sands deposits in Alberta. Many analysts, he notes, see oil falling from $37 now to $26. "But with economic recovery and limited capacity - exacerbated by turmoil in oil-producing nations - that's hard to imagine," says Maloney, who sees the stock, now at $25, hitting $35 to $40 within a year. He sees Suncor earnings $4 a share in 2005 - way above consensus. In 2004, he expects profits of $1.96 a share. Maloney calculates that every $1 rise in the price of oil adds $0.22 a share to Suncor's cash flow. Suncor's oil sands contain estimated reserves of 175 billion barrels - Second only to Saudi Arabia's. He says it costs Suncor $8 a barrel to extract oil from sands, vs $10 or more for the majors. Suncor's output, now at 214,000 barrels a day, has grown at 10% a year over the past decade. Suncor sees it hitting 500,000 in seven years, Maloney notes. In the long run, Suncor is the oil stock to own, asserts oil maven Charles Maxwell of securities firm Weeden. In three years , he says, Suncor "will be No.1 in production growth." Suncor was featured in his column on Nov.18, 2002, when it was at $14.
Transports . . . Legg Mason downgrades Heartland Express to Hold from Buy solely on valuation. Truckload demand remains strong for Heartland while industry capacity continues to be flat-to-down. However, the stock is approaching the firm's target price of $28 with no change to its model assumptions. The firm says the stock remains a core long-term truckload holding and should not disappoint much on the downside. However, investors could be better off buying Werner Enterprises and Marten Transport.
The WSJ reports leaders of Delta Air Lines pilots union have signaled that they were preparing a new concessions offer to try to jump-start wage-cut talks with the airline, after getting new information from the company detailing its financial peril. At the end of a three-day meeting, leaders of the Air Line Pilots Association, which represents 7,200 Delta pilots, said in a message to members that they had adopted a resolution "directing the negotiating committee to attempt to resume negotiations with management." The union's executive council, in its message to members, said it was aware that Delta was "under considerable pressure due to increasing fuel costs and declining yields." A union spokeswoman said the negotiating committee hasn't completed a new offer to the company, but said it would reflect Delta's worsening financial condition. The union said any concessions package would be "contingent upon a comprehensive restructuring of the airline." The union leadership said it met this week with representatives of Delta's creditors in a conference organized by Saybrook Capital, an investment co that is trying to organize Delta's major unsecured creditors. Catherine Stengel, a Delta spokeswoman, said no new talks are scheduled, but added that the airline is "encouraged that ALPA recognizes the need to provide Delta with a significant economic benefit."
The WSJ reports that US Airways, trying to hang on to its customers in the face of growing low-fare competition in Washington, today will roll out cheaper fares with fewer restrictions on 22 routes, including 15 served nonstop from Reagan National Airport. The US Airways Group unit also will offer the lower fares on seven routes served through connections from Reagan National and to all of the same 22 destinations served via connections from Washington's Dulles Airport. New discount carrier Independence Air took wing earlier this week from Dulles and will serve at least five of the same routes by summer's end, with even lower fares than US Airways' new offerings.
Homebuilders . . . Wachovia upgrades KB Home to Outperform from Market Perform in response to strong quarter and inexpensive valuation: 2nd quarter EPS of $2.40 beat firm's estimate of $2.10, courtesy of better homebuilding operating margins. The stock is trading at 6.1x 2004 EPS, 16% cheaper than group. Firm raises F2004 EPS estimate to $10.85 from $10.30 and 2005 estimate to $11.65 from $10.90, assuming higher deliveries and margins; Gives valuation range of $81 to $87.
Education . . . Lehman expects Apollo Group to exceed 3Q04 rev and EPS estimates with $0.02-$0.04 EPS surprise likely, as a result of: 1) operating margins nicely above the 32.0%-32.5% guidance level. 2) Enrollments modestly exceeding 238.4K est. UOPX, in particular, should drive the strong results. 3) APOL guidance is too conservative regarding the roll out of rEsource; However, firm believes that the positive surprise is largely priced into the stock. Lehman also raises 2005 EPS estimate to $2.25 from $2.19 for slightly better margins and higher online growth and price target to $95 from $88.
Harris Nesbitt comments that amended class action lawsuit against Career Education may have more negative impact than others. While there have been a number of class action lawsuits filed against the company, firm believes this one may have more negative impact. This law firm (Goodkind, Labaton, Rudoff & Sucharow) claims to have found 13 'witnesses" consisting of ex-CECO employees who have made these allegations. The stock was weak late yesterday on all sorts of speculation, although recovered somewhat late in the day. Firm expects further weakness this morning. While firm cannot comment on the validity of these allegations, this disclosure will likely once again highlight one of the key risks of investing in this stock (and the sector in general). Firm maintains its Neutral rating and suggests investors use the expected weakness in the group today to focus on some of the quality names such as Apollo Group, University of Phoenix, Education Management, and Strayer.
UBS comments that while it is impossible to gauge how this suit will play out, firm does believe that - given how detailed the allegations in it are - it is likely to exacerbate concerns about the regulatory risks associated with Career Education’s shares. The amended suit details a list of allegations that resulted from interviews with more than dozen of CECO's former employees; firm believes this amendment includes more employee accounts and more allegations than previous versions did. This amendment alleges that CECO engaged in falsifying student records, including enrollment figures, in order to please investors and qualify for federal funding; and manipulation of financial information, including revenues and margins, to the point of violating GAAP. The suit alleges that wrongdoings are pervasive across CECO's network of schools.
Food & Beverage . . . JP Morgan initiates Sara Lee with Overweight and $29 price target as the company's 21% P/E discount to food stocks does not reflect encouraging momentum in the company's food and beverage (F&B) business and signs of improvement in the apparel cycle. The firm sees 5% discount to pure food companies justifiable. Firm believes that although Apparel is dragging down EBIT for 2004, it may boost EBIT for 2005.
JP Morgan initiates ConAgra with Underweight as CAG's valuation does not properly reflect the company's below average execution risk now that co is entering a more challenging phase, where improving operational efficiencies, better integrated marketing and distribution practices, and margin enhancing product innovation should be the key drivers of EPS growth after successful transformation from a commodity-oriented business to a packaged food company of branded value-added products.
Piper Jaffray is seeing some evidence that low-carb mania is beginning to wane. Unfortunately, this could also reduce the sales potential on American Italian Pasta's (PLB) new low-carb pasta product introduction. The firm has heard from several retailers that customer acceptance has been just "so-so." The firm lowers its target to $34 from $38, reflecting a reduced near-term earnings outlook but retaining a multiple of 17x.
The WSJ reports that Archer-Daniels-Midland agreed to pay $400 million to settle a nearly nine-year-old civil suit alleging it rigged prices of a corn sweetener. The plaintiff class, a group of about 2,000 companies that includes PepsiCo and Coca-Cola, used an ADM sweetener called high-fructose corn syrup in their products. The group alleged that ADM conspired with other manufacturers in the highly concentrated corn-milling industry to illegally inflate high-fructose corn syrup prices in the early 1990s, costing them $1.4 bln.
Restaurants . . . Peet's Coffee cut to Neutral from Outperform at Harris Nesbitt as stock has neared $25 target.
Piper upgrades CBRL Group to Outperform from Market Perform despite yesterdays weak comp disclosure. The firm views the recent sales erosion as due to tougher industry comparisons, the initial gas price sticker shock, and the company's recent bad publicity. The firm does not anticipate these three to fuel further erosion in sales. Instead, they expect the format's enduring consumer appeal and solid execution to help revive comps to more normal levels. In firm's view, despite the erosion in their EPS estimates, the stock's valuation reflects further comp store sales erosion. Next Friday, mgmt will host its first analyst meeting in 7 years. Although the firm does not anticipate any major announcements, they expect investor confidence to improve following the meeting. 2004 EPS estimate moves to $2.30 and revenue estimate to $2.39 billion, 2005 EPS estimate goes to $2.65 and rev estimate to $2.585bn.
Retail . . . Pacific Growth initiates Abercrombie & Fitch with Overweight rating based on: 1) The improved, fashion right product offering at all 3 ANF concepts should translate into positive same-store sales, stronger margins and increased earnings growth. 2) Significant store growth opportunities at Hollister. Firm's EPS estimates are $2.52 for 2004 and $2.93 for 2005.
Viacom and Blockbuster announce terms of separation. The transaction would involve Viacom's distribution of its interest in Blockbuster through a "split-off" exchange offer to VIA.B stockholders. BBI also announced that, prior to the commencement of the exchange offer, BBI anticipates paying a pro rata special cash distribution of $5 per share, or a total of approximately $905 million based on the number of shares currently outstanding, to all stockholders, including VIA.B. As the owner of approximately 81.5% of BBI's outstanding shares, VIA.B anticipates receiving a cash payment of $738 million in the distribution, which, as to VIA.B, will be free of income taxes.
RFID . . . Lehman out saying RFID update from Wal-Mart suggests that rollout is on track, including favorable results from Dallas pilot facility. That said, the company expects to be 'live' in North Texas by January 2005 (top 137 suppliers), in addition to six distribution centers and 250 Wal-Mart stores by June '05. In following, and given that Avery will participate in the rollout as a primary converter (at the very least), the firm believes that confirmation of Wal-Mart's intention to stick with the previously disclosed timelines should be a positive for the stock. Lehman is sticking with their Overweight rating $72 target.
Media . . . The WSJ reports that each spring, the nation's big broadcast-television networks tout their coming prime-time schedules and go fishing for advance ad dollars. The event, known as the "upfront," is a highly competitive contest for rev and bragging rights, and the broadcast networks quietly release their data to the media. The dollar figures and percentages of increase or decrease are treated as a meaningful way to keep score, not only to compare networks but also to divine the health of the media industry and even the state of the economy at large. And the total money involved is huge, this year's take by the six major networks is believed to be in the neighborhood of $9.5 billio. "It's a number that is anything the networks say it is, quite frankly," says Larry Spiegel, a principal at the Richards Group. What's more, upfront numbers indicate commitments to spend money in the future. But as the TV season winds on, these early promises have been overtaken by ad dollars spent later on in what is known as the "scatter" market. The only networks to post upfront gains this year were Viacom's CBS and UPN. CBS secured about $2.4 billion in commitments, up from about $2.2 billion in 2003. UPN secured about $350 million in ad commitments, up from $250 million in 2003.
Hotel & Leisure . . . Carnival Corporation's 2nd quarter results beat expectations, reporting $0.41 vs. our estimate and Street consensus of $0.35. Net revenue yields increased 13.2% in the quarter on a pro forma basis, ahead of +10-12% guidance, and ahead of expectations of +11.0%. Occupancy was lower than expected, but was offset by much higher on-board per diems and much lower net cruise costs per available berth day, which declined slightly versus expectation of roughly a 2% increase. Management indicated that both occupancy and pricing for 3rd quarter has been strong. As a result, CCL guided 3rd quarter and full year yields each to be up 6-8% (aided by currency translation). Unit costs were reiterated to be flat to up 2% for the full year, reflecting expected cost synergies. Full-year EPS guidance is now $2.10 to $2.20, up from $2.05-2.15 and compared to consensus of $2.13. Analysts are raising 2004 estimate to $2.17 from $2.11 to reflect management's yield and expense guidance. Given the outlook for the remainder of 2004 and the continued positive implications for 2005, analysts are letting some of this year's strength flow through to 2005 and are thus raising our estimates slightly to $2.57 from $2.54. Given Carnival's visibility and positive outlook for the remainder of the year, we think 2nd half earnings risk is fairly limited, and thus the main reason for the pop in the stocks today. However, we believe the next real move in the stocks will come with better visibility and comfort with 2005. We don't think we're there yet.
Electronics . . . JP Morgan initiates TiVo with an Underweight due to 1) Less expensive, more fully featured offerings will emerge over the next several years that would slow TiVo's growth substantially, and pressure the stock. 2) DirectTV, responsible for 55% of company's total subscribers and nearly three-quarters of net additions in the April Quarter, is likely in the 2005 to 2007 time frame to shift its DVR sales focus to a less expensive, more integrated DVR offering based on technology from News Corp.-controlled vendor NDS. 3) Cable companies are ramping up sales of cheaper, more fully featured DVR services. 4) Over time, consumer electronics makers will begin selling non-subscription DVRs that will be effective alternatives to TiVo.
IT Services . . . AG Edwards initiates IBM with a Buy and $105 price target, citing: 1) IBM is the biggest IT services company in the world, with a 2003 market share of 8%, and also has a top three position in worldwide market share for software and each major segment of computer hardware. 2) Through the entire downturn of the last three years, IBM has had more than a billion dollars in net income from continuing operations in every qtr. 3) IBM has been awarded more patents than any other US company in each of the last 11 years, leading to belief that IBM has more intellectual property in the combined fields of computers, semiconductors and electronic materials that any other company in the world.
EMS . . . Jabil Circuit upped to Strong Buy from Outperform at Raymond James. The upgrade follows yesterday's 13% decline following disappointing guidance for the August quarter; believes the market's excessive reaction to this relatively minor shortfall was unwarranted. The firm emphasizes that it believes the issues responsible for the shortfall are temporary and not indicative of any underlying strategic weakness; the aforementioned startup costs are expected to impact margins for only the next three to six months; firm would expect a healthy rebound thereafter. Price target of $31 is based on 25x firm's 2005 estimate of $1.25.
Baird upgrades Solectron to Outperform from Neutral based on solid revenue trends, improved operational metrics, significantly lower net debt, progress with divesting businesses, and attractive valuation. Firm raises EPS ests for 2004 and 2005 to $0.01 from $0.00 and to $0.23 from $0.18, respectively; Increases price tgt to $8 from $7.
Solectron reported net sales of $3.04 billion, up 5.3% sequentially and 29.0% year over year on a continuing operations basis. Proforma EPS was $0.01 excluding charges, $0.01 above consensus, and up $0.03 sequentially. Net sales was inline with First Call consensus and 1.3% above estimates of $3.0 billion.
• The computing and storage (28.9% of revenues) segment fell 2% sequentially. We believe the sequential weakness might have been driven by Solectron disengaging from certain underperforming programs in the segment. Next quarter we expect Solectron’s computing and storage segment to increase sequentially as demand improves going into the second half of the year.
• Networking was up 1% sequentially and the segment accounted for 21.0% of sales, down from 21.8% last quarter. Cisco, Solectron’s largest customer, saw growth of 3.7% sequentially, outpacing the rest of the segment and likely above Jabil’s flat growth with Cisco in the quarter. Solectron’s higher-end Cisco programs continue to perform well and we expect them to be up next quarter.
• Communications revenues (19.3% of sales), which include both wireline and wireless infrastructure customers, were up 12% sequentially. The majority of the strength was on the wireless infrastructure side with key customers such as Motorola, Ericsson, Lucent, and Nortel. Motorola had a particularly strong quarter for Solectron rising double digits sequentially.
• The consumer products segment (19.8% of sales) rose 2% sequentially as a result of the strong set-top box demand for Pace Micro offset with a decline in the ramp of its NEC 3G handsets. As a result, NEC dropped below 10% of sales in the quarter.
• Sales to the automotive sector rose 23% or $16 million as demand bounced off a seasonally weak quarter and the industrial segment rose 38% due to strength with Solectron’s semiconductor & test customers which are seeing improving demand.
Network Equipment . . . RBC Capital says its sources indicate that executive management of Cisco and Nortel met yesterday to exchange an open dialogue following the Canada Telecom Summit. While not privy to what was discussed, the firm believes a partnership between the companies may make sense across several levels. Cisco's current mix of enterprise to service provider remains about 70%/30% while Nortel's mix is the exact opposite. Furthermore, both companies share similar service provider networking visions -an IP/MPLS core and multi-service edge. The firm believes no large acquisitions are pending and that it will take several months for a formal agreement to be announced, if at all. Nevertheless, the two companies have begun a dialogue and the firm expects progress to be made over the next several quarters.
Morgan Stanley upgrades Corning to Overweight from Equal Weight. The firm notes that stock has only appreciated 5% since the beginning of the year, with 15%+ upside from current levels to firm's DCF fair value estimate of $14.
Morgan Stanley downgrades Motorola to Equal Weight from Overweight and reduces tgt to $20 from $25. Firm believes 1st quarter margin performance, particularly in handsets, will be difficult to sustain, particularly since firm expects the competitive environment to intensify.
Goldman Sachs says its view following reports from two of Cisco's contract manufacturers and firm's channel checks suggest a continued healthy ramp in switching. While contract manufacturer Jabil cited a weaker than expected outlook in its business with CSCO, this was clearly a Jabil-specific issue related to inventory and product mix. Solectron, another manufacturer for CSCO, reaffirmed firm's view with its results last night in which CSCO's sales to Solectron were at the high end of our expectations.
UBS has a cautious view on the mobile phone sector heading into 2nd half 2004 due to the likelihood for slowing industry growth and increased pricing pressure as numerous new products are launched in 2nd half 2004. UBS notes industry volumes should exceed 600m this year based on strong 1st quarter 2004 results and modest sequential growth through the year. UBS believes several recent negative data points from the component food chain reflect several industry trends which include: adjustments to component inventory levels by OEMs ahead of new product introductions, slowing sequential industry volume growth, and share shifts in China towards multinational vendors.
CNET News reports Thomas Campana died June 8 at the age of 57, a day after an appeal got under way in a high-profile patent infringement case launched by his company, NTP, against RIM and its renowned BlackBerry device. Campana was co-founder and president of NTP, and the co-inventor of patented technology the company is seeking to protect. According to the article, people close to NTP downplayed speculation that Campana's death could open the door to a quick settlement in the case.
Semiconductor Equipment . . . WR Hambrecht says recent selling pressure on semi equipment stocks may continue in response to a slight decline in the industry book:bill to 1.11:1 from 1.13:1 (and a front-end B:B of 1.09:1 vs. 1.12:1) on slightly higher sales. SEMI's monthly equipment order figures for May were flat with April and in line with expectations. Process equipment orders for May Quarter were up 20% from February Quarter, and 129% from a year ago. Back-end order growth figures were similar month/month and quarter/quarter and rose 88% from a year ago. The firm believes that the flattening of orders is mainly seasonal and look for renewed order growth (and a rally in the stocks) by autumn in response to continued strength in electronics demand and semiconductor production. The industry's normal seasonality and the transitional between technology nodes are only temporary and are creating an excellent buying opportunity in these stocks.
Semiconductors . . . Deutsche Bank says Micron's 3rd quarter could provide an upside surprise, which might boost the stock in the near term. However, given its expectations for DRAM contract ASPs to decline into 2H04, and the company's poor competitive position, the firm sees limited attractiveness in the stock. The firm reits its Hold and $16 target. The stock remains uncompelling, although the company's current 1.5x NTM P/S & 1.6x TTM P/B are well below former peaks of 7.8x & 4.1x (mid-cycle 2.2x & 2.7x). However, the company's lack of competitiveness vs. peers (with similar valuations) limits the stock's attractiveness.
Boxmakers . . . Dell President Kevin Rollins plans to cut computer-printer prices in half and shave as much as 20 percent from the cost of printer supplies as he challenges Hewlett-Packard in its most-profitable market. "Our customers are telling us they've just been paying too much for ink and toner," Rollins said. "It's frankly the most expensive liquid on the planet." Rollins is crafting plans to use what he calls "the Dell effect" to muscle in on a market that Hewlett-Packard Chief Executive Carly Fiorina relies on to supply almost 70 percent of her company's profit. DELL's plans to bring down prices in the printer market aren't new. Nevertheless, watch for potential reaction in Lexmark and Hewlett-Packard.
Software . . . Needham upgrades Progress Software to Strong Buy from Buy after the company reported last night. Firm says the co continued to chug along in its May Quarter. The database related businesses each turned in somewhat better than expected. Sonic outperformed its peers, but continued to see long sales cycles as the Enterprise Service Bus technology transitions from early adopter to mainstream customers. The firm believes the stock is valued too inexpensively relative to its growth prospects.
First Albany downgrades Red Hat to Neutral from Buy as the stock has risen to the $20s from $12 in December. The firm is concerned by some quarterly metrics that makes it fairly valued until the firm can answer some newly surfacing questions. The firm is disappointed that RHAT's 1st quarter revenue of $41.6 million missed the consensus of $43 million. The revenue miss stemmed from a back-end-loaded quarter on the direct side, and disappointing indirect channel results. This is forcing the firm to reexamine its expectations for growth in RHAT's indirect channel; and that more back-end-loading of the direct business could mean MSFT's competitive response is lengthening RHAT's sales cycles.
CSFB increases Red Hat estimates. The firm raises 2005 estimate to $0.27 from $0.25. Based on higher estimated attach rates and operating margins. The firm revises 2006 to $0.63 from $0.56, and DCF target price to $27 from $25. The firm would be buyers on reduced expectations.
Lehman comments that NPD results through the end of May indicate that sales of Symantec retail products are up 80% year/year QTD, tracking ahead of firm's estimate for 48% year/year growth for consumer revenue for June. Based on current momentum, believes company is on pace to meet or exceed firm's 1st quarter consumer revenue estimate of $247 million.
Adobe reported solid 2nd quarter results with revenue of $410 million, exceeding the consensus estimate of $405 million. The upside was a result of better than expected performance of Intelligent Documents (Acrobat), which posted 26% year-over-year growth, and about $6 million in upside. CSFB out raising their 2004 EPS estimate despite the inline 2nd quarter based on continued strength of the CS upgrade. New F2004 EPS estimate is $1.62, up from $1.55, and 41% EPS growth. Firm would accumulate the stock in the low $40s in anticipation of a more constructive environment towards the end of year when they believe investors will begin to anticipate a blockbuster product year in 2005. Smith Barney out saying that, while numbers once again exceeded Street estimates, the quarter didn't feel as strong as the first quarter when all segments were up sequentially and at rates much greater than they had anticipated. Firm is raising their estimates but maintains Hold rating, noting they would be more interested in the shares below the $40.00 level.
TIBCO reported a strong second quarter last night that was even better than the summary numbers indicated, as EPS was negatively affected by extraneous items, reducing earnings by a penny. Even more impressive was the outlook, as guidance implies upside to current estimates when we attempt to exclude anticipated Staffware financials. TIBCO offers a compelling value at current levels. It is benefiting from favorable changes to its relationship with its previous parent company, Reuters, as evidenced by the robust performance of the financial services vertical. Analysts are raising estimates to reflect greater growth than we had anticipated and to account for the Staffware acquisition.
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