Sector Investing

[ReturntoSender]

From Briefing.com: Close Dow -84.31 at 10557.63, S&P -6.89 at 1231.02, Nasdaq -15.09 at 2145.26: The market closed lower across the board, as soaring oil prices, which accompanied 12% runs in both gasoline and natural gas, left investors even more nervous ahead of tomorrow afternoon's widely expected Fed rate hike...

Without market-moving data on either the corporate or economic fronts, traders' focus on the aforementioned bearish cues prompted broad-based consolidation in the wake of Friday's rally, closing nine out of ten economic sectors lower. Prices across the energy complex opened higher and relentlessly surged over the course of the day amid reports that Tropical Storm Rita, which is now forecasted to be a level three hurricane, could disrupt refineries along the Gulf coast. Adding to supply concerns and renewing buying interest in crude futures was the fact that, contrary to previous speculation, OPEC's delayed decision may not result in increased output... The stand-offish stance that market participants had adopted ahead of the latest rate debate outcome was therefore underpinned by energy's action, which renewed inflation worries and added to even more uncertainty related to the potential of upcoming Q3 profit warnings...

With respect to individual sectors' performances, a lack of leadership, aside from Energy's unsurprising leap as oil prices ($67.39/bbl +$4.39) surged 7.0%, characterized the session and held the indices underwater for its entirety... The Financial sector served as the most substantial drag, as the group represents over 20% of the S&P and closed with a 0.9% loss... Technology, comprising 15% of the broader market and sitting just behind Financials in terms of influence, posted a 0.7% decline, driven largely by a 1.4% sell-off in semiconductor...

Industrials (-1.4%) erased last session's gain more than twice over, and closed the day as the session's hardest hit area, as oil's surge weighed heavily on the sector's transportation components... Crude's upside momentum also took a toll on the Consumer Discretionary sector, which, despite better than expected Q1 (Aug) earnings from Nike (NKE 83.45 +4.99) and a strong Q3 report from Carnival Corp (CCL 50.78 +1.75), sported a 1.3% decline at the close. Bear Stearns' downgrade on eBay (EBAY 36.94 -0.16) and disappointing Q4 (Oct) guidance from Apollo Group (APOL 69.93 -3.84), did not help matters...

Utilities, while submerged all day, remained the best of the laggards, as the high divided-yielding issues were likely helped by the recovery effort in Treasurys. Bonds climbed for the first time in four sessions as fed funds futures now show a 90% chance that the Fed will raise rates again (to 3.75%) tomorrow. The yield on the 10-year note (+6/32) fell to 4.24% as the Fed's next tightening became a bit clearer; but, at the same time, it remains well above the 4.0% mark chalked on Sept. 1...DJTA -1.21, DJUA +0.26, DOT -0.83, Nasdaq 100 -0.84, Russell 2000 -0.71, SOX -1.40, S&P Midcap 400 -0.55, XOI +2.23, NYSE Adv/Dec 1045/2212, Nasdaq Adv/Dec 1018/1996

9:53AM Seaspan (SSW) UBS initiates NEUTRAL. Target $21. With a current dividend yield of 8.3%, most of it tax-deferred, and with significant growth potentials, firm believes the co represents one of the best investing propositions in shipping today. They expect the co to benefit from its relatively low cost of capital and remain active in the acquisition front, capitalizing on the recent trend by container operators of leasing, rather than directly owning vessels, in order to retain financial flexibility.
9:53AM RCN (RCNI) Fulcrum upgrades Neutral to BUY. Target $26 to $28. Fulcrum upgrades RCNI citing: 1) valuation; 2) MegaCable adds greater potential value; 3) the generally increasing comfort level with the idea that already industry-leading ARPUs of $102 can continue to increase with the further penetration of what the co labels "emerging triple play" mkts where ARPUs are more than 30% lower than "mature triple play" mkts; and 4) cost-cutting outlook could last beyond 2006.

9:52AM Dominion (D) Citigroup upgrades Hold to BUY. Firm also raises their forecast due to strong upward movement in commodity prices. They think near-term ests benefit from their assumption of front-end loaded growth in their production forecast. Firm believes this systematic approach insulates them from both a potential moderation in commodities and from the co's historically disappointing track record in meeting expectations.

9:51AM Credence (CMOS) Fulcrum initiates SELL . Target $7.5. Firm believes the co has done an admirable job diversifying itself from being a test subcontractor-centric and mostly a low-to-mid range mixed-signal only test equipment supplier, to having a more balanced product portfolio with greater exposure to the IDMs. At first glance, they say the co appears well positioned with the critical mass necessary to survive the intensely competitive test equipment space. However, they are concerned in the very near term that consensus rev forecasts are likely too aggressive as test subcontractors activity remains muted and a significant previous mkt share loss (IBM's Cell processor for gaming chips) is impacting the ability to relatively outperform their overall anemic semiconductor capital equipment industry growth forecast.

9:51AM UTStarcom (UTSI) Am Tech/JSA Research initiates BUY. Target $14. Amtech initiates UTSI as they believe the co is in the of a financial turnaround, which will be lead by their cellular phone business in 3Q05 and then their IP broadband business in 4Q05. Firm thinks a restructuring which started last quarter should lower OPEX by $40 mln per quarter, and expect the co to return to profits in 2006. With low expectations, a new CFO, significant changes underway in the geographic concentration of sales and type of product, and the stock trading at 0.3X sales, they think significant upside exists

9:50AM Chiquita Brands (CQB) BB&T Capital Mkts upgrades Hold to BUY. Target $32. BB&T upgrades CQB as they believe it is increasingly likely there will be a status quo outcome to the EU banana regime conflict. Firm traveled with CQB mgmt last week, and notes that mgmt seems very committed to improving the North American market through better contract pricing, as well as product innovation. They also left with a more favorable perspective of the Fresh Express acquisition.

9:49AM MicroStrategy (MSTR) Pacific Growth Equities downgrades Over Weight to EQUAL WEIGHT. Pacific Growth downgrades MSTR as their checks indicate a large number of BI customers, including those that deploy multiple tools from MSTR, COGN and BOBJ, are in the final stages of making decisions to standardize on one BI platform. They believe this trend will largely benefit the broader BI platform providers, most notably COGN, followed by BOBJ. While firm believe MSTR has best-in-class technology to handle large data volumes, they believe MSTR's niche focus will limit its ability to serve a full range of BI initiatives. Their checks indicate some customers have already slowed down MSTR deployments to evaluate other products.

4:15PM Grant Prideco (GRP)
40.32 +1.87: With the energy market flush with cash and demand rising, we felt the environment was ripe for the upstream industries from the oil services, to the drillers and the equipment manufacturers. This brought us to the world's largest drill pipe manufacturer, Grant Prideco. With rising drilling activity and a slew of new and/or refurbished rigs coming to market, GRP is well positioned to reap the rewards. We added the stock as a suggested holding to our portfolio for active investors on March 17th. Even with a 71% return in hand, we feel there remains significant opportunities for GRP to drive growth and profits.

All the currents are running in the right direction for this Houston, Texas-based company. It has undergone a transformation over the last few years, restructuring its business in order to perform better in both the bull and bear points in a cycle. Its largest business, Drilling Products, continues to benefit from rising drilling activity. GRP came into the cycle, after several years of oversupply, aimed at leveraging its over fifty-percentage global market share to drive price optimization. It achieved this goal through capacity, technology, and service, instituting a new price book up 8% y/y in August.

Drill pipe demand continues to accelerate driven by depleted customer inventories, rig activity, rig refurbishment and new builds. According to GRP, there are 60-70 refurbished land rigs scheduled, 90 new land rigs on order, 9 new semi-subs on order, and 33 new jack-ups on order. This means more rigs and more demand for drill pipe. GRP estimates the market value of the drill pipe for these new rigs equates to $200 mln with the majority reaching the market in 2006.

GRP's backlog has increased over 400% since the beginning of 2003, including a 20% gain just within the last quarter, to a high of $500 mln. While this is impressive, it is also promising that GRP achieved these numbers not just through increasing footage, which is up 15% from the prior peak, but through pricing, which is up 25%. With the company selling off its production plant last year, a concern was its ability to meet demand given the accelerating rig activity. Management is confident it can gradually ramp up capacity, reaching its prior level of 14 mln feet by the second quarter of 2006 with a modest amount of capex.

Grant is not just a pipe company. Through its acquisition of ReedHycalog, it is the third largest drill bit manufacturer in the world. This division has performed exceptionally well. Revenues at the time of the acquisition were $225 mln, but are now $375 mln. EBITDA, meanwhile, has doubled to $100 mln. GRP has made several acquisitions in the division rounding out its product offering. Lastly, the company's Tubular Technology division is reaping the benefits of deep gas drilling, GOM, and international offshore activity. This segment typically parallels rig activity in the Gulf, but despite lower rigs counts, it has generated higher revenues and profits over the last two quarters. In Q2, operating margins reached a record high of 25%.

GRP's financial picture continues to gain strength with revenues, earnings, and margins reaching new records in the most recent quarter. Further, it has restructured its balance sheet to reduce interest expense and borrowing costs, receiving upgrades from two rating agencies. In Q2, revenues grew 41%, including 60% growth for Drilling Products, 22% in ReedHycalog, and 40% for Tubular Tech. Operating income soared 135%, led by double-digit gains across its entire business with operating margins widening to 22% from 13% in the prior year. For FY05, it forecasts EPS in a range of $1.60-1.65 (consensus $1.66), up from of $0.56 per share. The Reuters Estimate consensus numbers for FY05 and FY06 are $1.66 and $2.23, respectively. This equates to earnings growth of 34%, with the stock trading at 18.1x.

We feel there remains significant upside to earnings, driven by robust demand, debt restructuring, volume growth (20-30%), and price increases (est. 5-10%). Longer-term GRP's new IntelliServ technology, which enables high speed data transmission while drilling, offers a significant opportunity. GRP has considerable earnings leverage built in and we expect returns to match this potential. The stock jumped almost two dollars Monday following an upgrade to Buy from Neutral at Banc of America, which raised its earnings estimate by 20% for FY06. ---Kimberly DuBord, Briefing.com

2:28PM Apollo Group (APOL)

70.39 -3.38: Education stocks drifted lower on Monday after Apollo Group issued preliminary fourth quarter results below analyst expectations and tempered its outlook for the current quarter (Q1) and fiscal 2006. On account of a higher percentage of students enrolled in the new Western International University Axia College - a program of study that has a lower average price point than its other programs - the company said it expects revenue for the most recent quarter to be between $591 and $595 million, down from the previous range of $605 to $620 million and below analysts' target of $609 million.

Apollo also forecast fourth quarter earnings of $0.65 per share, excluding charges - two cents lower than the consensus estimate and its prior guidance of $0.67 per share. The non-cash charges related to conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options are expected to total $20 million, or $0.07 per share. On a comparable basis, the company earned $0.52 per share on revenue of $492.75 million in the same quarter last year.

Separately, the company offered its financial guidance for the fiscal first quarter, projecting earnings of $0.72 per share, excluding the cost of stock options, on revenue between $635 and $640 million. For the full year, earnings are expected to be $3.06 per share with revenue in the range of $2.69 to $2.71 billion. The company said the results include the effect of the impact of Hurricane Katrina and consequently anticipates first quarter profits to be cut by $0.01 per share and fiscal 2006 profits by $0.04. Analysts on average had forecast EPS of $0.73 for the first quarter and $3.06 for fiscal 2006.

In addition, the company expects growth in selling and promotional expenses in the first half of the year to be comparable to that of the second half of fiscal 2005 (~40% growth). As the business conditions continue to shift as a result of heightened regulatory scrutiny and competitive pressures, the cost of retaining students, employees, and faculty has become increasingly cumbersome for the company. As such, the combined effect of declining enrollment growth and higher student acquisition costs have clouded recent earnings visibility.

As a result, shares in Apollo fell sharply during the regular trading session, scraping a low of $67.67 - marking a 9% drop from Friday's close. Reacting in sympathy to Apollo's mixed outlook were other leading post-secondary education companies. Specifically, Career Education Corp. (CECO), DeVry (00), and ITT Educational Services (ESI) saw their stocks trend considerably lower on Monday.

Year-to-date, Apollo shares are down over 13%. Given the counter-cyclical nature of Apollo, combined with rising competition, investors' optimism for the stock has been subdued by concerns of slowing revenue and enrollment growth. Although the concerns are not solely company specific, light enrollment growth and margins remain a significant overhang on performance in subsequent quarters. In addition, the magnitude of Apollo's premium valuation is unwarranted and exacerbates the current cautious sentiment. The company currently trades at 23x the FY06 EPS estimate of $3.06, compared to 14x for CECO and 18x for ESI. --Richard Jahnke, Briefing.com

11:25AM Nike (NKE)

83.70 +5.24: Nike's shares were first out of the gate Monday morning in what can only be described as a strong start to its fiscal year. The world's largest athletic shoe company's profits rose 32% on sales growth of 8.4%, surpassing expectations by a whopping $0.19! Additionally, Nike reported impressive future orders for footwear and apparel, scheduled for delivery from September through January of 2006, totaling $4.9 bln - up 11%.

Nike's ability to keep pace with consumers worldwide continues to drive growth. For the first quarter, Nike reported net income of $432.3 mln, or $1.61 per share, up from $326.8 mln or $1.21 per share a year earlier. The bears will point to assistance from lower SG&A and tax rate, along with $10 mln in other income. Nonetheless, this was a high quality result setting the bar a bit higher for the rest of the fiscal year. Footwear continues to propel Nike's overall business with total revenues coming in at $3.86 bln, up 8.4% y/y and 4% q/q. Future orders growth by region is 12% in the US, 4% in Europe, 15% within Asia Pacific region, and 32% in the Americas.

For the quarter, US sales rose 8% to $1.5 bln with footwear gaining 11% to $1 bln. Apparel and equipment sales grew marginally to $386 mln and $92.3 mln, respectively. European sales grew 4% ex-currency. Nike gained traction in the apparel market, improving inventory levels with sales up 6% to $435.2 mln. Footwear grew 3% to $685.1 mln. In Asia, apparel sales outpaced footwear, up 19%, with total sales, excluding currency, up 10%.

What we have always liked about Nike is its consistent execution, not only in driving the top line, but also in driving the bottom line through continued improvements in productivity and efficiency. Gross margins in Q1 expanded by 100 basis points to 45.3%. A substantial portion of the gain was derived from lower SG&A expenses, which were down to 28.6% of sales from 30.1% last year. Management noted the improvement was in part due to the change in timing of marketing expenses (i.e. Summer Olympics). We would note SG&A cost control has become a new priority for the company. As of the quarter end, global inventories were up 11% to $1.9 bln. Cash and short-term investments increased from $1.3 bln last year to $1.9 bln. The Beaverton, Oregon-based company purchased 1.8 mln shares worth $151 mln under its 4-year $1.5 bln repurchase program.

The competitive field has become more challenging with Adidas and Reebok (RBK) joining forces, but they will have a difficult race as Nike has outpaced Reebok both in sales and profits over the last two years. To wit, Nike's future sales speaks to its strong revenue growth trends ahead with management forecasting high-single digit growth for the year. The bulls took Nike's shares by the horns this morning, sending its stock up almost six dollars. We think Nike will remain on the winning team due to its market-leading innovation, multi-dimensional offering in both performance and lifestyle products, unequalled marketing prowess, and operational efficiencies all driving returns. Additionally, there are many catalysts for Nike with key sporting events coming up on the global calendar, starting with the Winter Olympics in Turin, Italy, and the World Cup in Germany next June. ---Kimberly DuBord, Briefing.com

11:16AM Carnival Corp. (CCL)

49.57 +0.54: Despite lingering concerns about rising fuel costs, Carnival Corp. reported third quarter earnings that surpassed Wall Street's expectations, but noted that Hurricane Katrina, which devastated the Gulf Coast in late August, will have some impact on fourth quarter results. The Miami, Florida-based company said it earned $1.15 billion, or $1.41 per share, during the quarter - six cents ahead of the average analyst estimate of $1.35 per share - as higher ticket prices and onboard revenues helped offset an increase in net cruise costs. The results exclude one-time charges totaling $45 million, or $0.05 per share - $23 million related to a billing from the British Merchant Navy Officers Pension Fund (MNOPF) and $22 million for an investment write-down. In the same period last year, the company earned $1.03 billion, or $1.22 per share.

Total revenues for the third quarter increased 10.9% year/year to $3.61 billion, driven by a 5.2% increase in cruise capacity and significant growth in cruise net revenue yields. As a result of higher ticket prices, on board revenue, and, to a lesser extent, higher occupancy, net revenue yields increased 6.2% compared to the same quarter last year.

Net cruise costs rose 7.4% versus last year. The increase was primarily due to a 36% increase in fuel prices and the $23 million MNOPF contribution. Excluding these costs, the company's net cruise costs increased a more modest 1.4%, mostly as a result of higher dry-dock amortization expense.

Regarding the results for the third quarter, Carnival said that "robust demand for cruise vacations continued into our seasonally strong summer period. Significant improvements in pricing, particularly for our North American brands, more than compensated for increases in fuel costs, resulting in higher profits and another record third quarter."

At the same time, the company tempered its forecast for the fourth quarter. It said that Hurricane Katrina caused it to cancel one of its voyages and to shorten two others. Furthermore the company redirected two ships - the Conquest and the Sensation - to other homeports. The conquest was relocated to Galveston, Texas, while the Sensation, along with two other ships are being chartered by the U.S. government to be used in the recovery effort. As a result of the disruption to operations and related costs, Carnival expects fourth quarter earnings in the range of $0.39 to $0.41 per share with an increase in net revenue yields of 4.5% to 5.5%, compared to last year. According to Reuters Estimates, analysts are expecting EPS of $0.42 on revenue of $2.51 billion.

Carnival also noted that it is on pace to post a 20% gain in EPS for the full year. Earlier in the month, the company said that Hurricane Katrina could reduce fiscal year earnings by approximately $0.01 to $0.03 per share. Therefore, the implied EPS guidance is $2.64 to $2.67, compared to the average analyst estimate of $2.69.

Notwithstanding the impact of rising fuel costs - which has largely been factored into the stock - and the residual effects of Hurricane Katrina, strong demand continues to drive performance for the world's largest cruise operator. Although shares have traded down about 1% since Katrina hit, underperforming the broader market, the company's long-term fundamental outlook remains favorable, based on the belief that bookings and pricing trends will continue to increase. At current prices, the stock is trading at 18.9x the FY05 EPS estimate of $2.69. --Richard Jahnke, Briefing.com

9:02AM Page One - Down Open as Oil Ticks Up

Futures indicate a lower open. It is a slow news day. Oil therefore steals the headlines.

Oil is up $1.10 to $64.10 a barrel. There are more storms heading for the Gulf, and OPEC may not raise output as previously seemed likely.

The media obsession with the all things bad (including much of the financial media) has led them to overlook good news. Most significantly, third quarter earnings forecasts are up, despite Katrina.

Current estimates for third quarter operating earnings growth are up to 17%. This is an extremely impressive number. A month ago, the forecasts were at 15%. Second quarter operating earnings were up 14%, and that was rightly recognized as a very good performance.

Granted, third quarter estimates may come down in the weeks ahead if earnings warnings pick up. Some companies will have problems due to Katrina. But estimates always prove low as well, so a final gain at or above 17% is likely.

The strong trend in earnings is undeniable.

One obsession is with inflation fears. It is anticipated that inflation will pick up as a result of Katrina. These fears are overdone. Core inflation starts at a very low level. Over the past five months, core CPI is up at less than a 1% annual rate. Energy prices may soon level off. There are risks here, but assuming the worst is usually wrong.

This morning's Big Picture column makes the argument for a fourth quarter market rally. The P/E levels have dropped this year due to strong earnings growth amidst a flat market. With the top in interest rates around the corner, continued strong earnings growth can now lead to stock market gains rather than P/E compression. The article looks at sectors that might benefit.

There are no major mergers this morning. There are no economic releases. Nike reported strong earnings, but there is little other corporate news. The big event this week is the Fed policy meeting tomorrow. The earnings and economic calendars are light. The market will be watching for earnings warnings, particularly any that note a Katrina impact. -- Dick Green, Briefing.com