hickey on tech
That High-Tech Balloon Is Going Ssssssssss
Published: July 11, 2004
THE warnings from technology companies came fast and furious last week, cuffing investors who had bought their shares on hopes of super earnings generated in a hot economy. Individual investors and hedge funds alike had piled into tech stocks and enjoyed the ride through 2003, convinced that 2004 results would justify the shares' soaring prices.
But with software companies like Siebel Systems and Veritas Software, hardware companies like Unisys and computer resellers like the CDW Corporation and Ingram Micro Inc. cautioning that their businesses softened in the second quarter, the sound of air escaping a balloon is more than detectable.
Inquiring investors want to know: Is this a blip, or is the second-quarter slowdown the beginning of a longer-term malaise in tech?
Fred Hickey, editor of The High-Tech Strategist in Nashua, N.H., and a technology stock analyst who knows the industry down to its nittiest and grittiest, says the setbacks in the sector are just beginning.
Investors may have been lulled into thinking that the second-quarter results at tech companies would be sunny because reports of shortfalls had been relatively rare.
Companies typically alert investors to problems late in a quarter, but by June 30, that front was quiet. "Normally the third month in a quarter belongs to the confessors," Mr. Hickey said. But at the end of June, he added "there were more positive preannouncements than negative."
Nevertheless, two signs point to problems ahead for technology stocks, he said. First, semiconductor shares, which often lead the action in tech stocks, have gone into a nose dive. The semiconductor stock index, known as the SOX, is down 11.2 percent this year, and spot prices of computer chips are forecasting further declines.
But the biggest trouble spots on Mr. Hickey's horizon are the ballooning inventories on tech companies' balance sheets. Already rising in the first quarter, these inventories will probably show a surge for the second quarter, he said, because few tech companies appear to have cut production in recent months.
Investors may not have noticed how inventories have grown at some of their favorite technology concerns. After all, balance sheets are boring; income statements make for much jazzier reading. And comparing balance-sheet items in quarterly reports requires some work: most show only assets and liabilities from the current and previous quarter, not from the same quarter during the previous year.
IN the first quarter of 2004, inventories jumped 21 percent to 61 percent, year over year, at such tech stalwarts as Dell, Cisco Systems, Intel and Texas Instruments. And that was when the economy was cooking. So Mr. Hickey expects inventories to show a surge for the second quarter. When inventories rocket, profit margins are hurt. Hefty write-downs are another common result.
The sales shortfalls at some technology companies will become most evident in the third quarter, Mr. Hickey said, making for some very ugly earnings comparisons from the same period in 2003. Back then, tax rebates were propelling consumers into the stores and gross domestic product soared 8 percent, annualized. Computer notebook sales in the third quarter of 2003, for example, were up 60 percent.
But this year, personal computer sales in the United States are growing at rates in the single digits or low teens. PC and notebook sales are also slowing in Europe and are actually declining in Japan.
In addition, the tax rebates, courtesy of the White House, are spent, mortgage refinancings have peaked and rising oil prices are pinching consumers. So it's no wonder that sales of tech gear have slowed.
Mr. Hickey said the inventory situation at some of the nation's biggest technology companies reminds him of late 2000, when demand from nascent Internet companies screeched to a halt. Although it became apparent in March 2000 that the Internet boom, created in part by a profligate Wall Street, was over, the impact of this steep decline in demand did not show up in major suppliers' results until much later that year and in early 2001.
"This industry is hopelessly optimistic," Mr. Hickey said. "They always overproduce."
None of this would matter if technology shares were cheap. But they are not. The price-to-earnings ratio on both Dell and Cisco is 32. Texas Instruments' is 30, and Intel's is 26.
"On June 30, the bulls were extremely long and vulnerable, even though underneath the surface there was a lot of trouble in a lot of places," Mr. Hickey said.
Perhaps the companies issuing early warnings recently will prove to be in the minority by the time all second-quarter results are out. But technology has had a heck of a run in the past year. As they say, nobody ever went broke taking profits.
