Replies to post #523 on Sector Investing

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From Briefing.com: It wasn't a tech wreck on Tuesday, but clearly, the sector broke down as the Nasdaq fell through support at 1686 - the top end of the June trading range. Unlike before, though, buyers weren't in any rush to defend that level as rising interest rates, a lack of leadership, an inability to benefit from the stronger than expected ISM Services Index, and apprehension ahead of Cisco's (CSCO 18.86 -0.40) earnings report kept them on sidelines.

Suffice it to say, if the initial response to Cisco's fiscal Q4 earnings report is any indication, the sidelines is where buyers are likely to remain on Wednesday.

Although Cisco posted an in-line pro forma profit of $0.15 per share and slightly exceeded the consensus revenue estimate of $4.68 bln, its margin expansion story was dealt a blow as gross, operating, and net profit margins were all down on a sequential basis. Beyond that worrisome consideration, which Briefing.com will elaborate more on in a Story Stock and Stock Brief on Wednesday, Cisco didn't provide any real sense that a meaningful pickup in end demand is imminent.

For Q1 (Oct), revenues are anticipated to be up 2-4% on a sequential basis and gross margins are projected to be in a range of 67-69%. For the just completed quarter, gross margins were 69.9% and revenues were $4.70 bln. Company guidance implies that Q1 revenues should be in the range of $4.80-4.89 bln (consensus $4.81 bln), but even at the high end of guidance, revenues would still be up less than 1.0% from the yr-ago period. The takeaway, which Briefing.com won't argue with, is that Cisco's stock, at 30x est. FY04 earnings before Tuesday started, has gotten ahead of itself. Accordingly, look for valuation concerns to be an oft-cited factor for any weakness in its stock and the broader market.

In absolute terms, Cisco's report wasn't bad, but at the same time, it certainly wasn't strong enough to justify the premium multiple that was accorded the stock. Shares of CSCO were down 5.0% in extended action from where they closed Tuesday's regular session.

Briefing.com, of course, has professed to being cautious about the tech sector's near-term prospects for a while now given the sharp run-up in stock prices since the March lows. In the wake of Cisco's report, the loss of leadership noted above, and the technical deterioration, we remain wedded to the view that the path of least resistance for the time being lies to the downside.-- Patrick J. O'Hare, Briefing.com

5:56PM Tuesday After Hours price levels vs. 4 pm ET levels: The dismal tone of trading in the regular session has carried over into the after hours session, where the S&P futures, at 959, are 6 points below fair value, and the Nasdaq 100 futures, at 1213, are 18 points below fair value. The source of the extended session's malaise is Cisco (CSCO 17.94 -0.92) following the manufacturer of networking and communications products' in line Q4 (July) report.

Specifically, Cisco matched the Reuters Research EPS estimate of $0.15 on revenues that fell 3% to $4.70 bln. Gross margins, however, declined 84 basis points on a sequential basis. The company's guidance was similarly uninspiring, with Q1 (Oct) revenues projected to be up 2-4% on a sequential basis (to $4.80-4.89 bln versus the consensus of $4.81 bln) and gross margins forecasted to be 67- 69%. Competitors of CSCO include the likes of CIEN, EXTR, FDRY, JNPR, NT, and SCMR, and all of the aforementioned are also down in the extended session.

Checkfree (CKFR 21.13 -5.16) stock has also gotten clobbered, although its pullback lies more with the company's Q4 (June) earnings miss and Q1 (Sept) earnings warning. The provider of financial electronic products reported EPS of $0.22, a penny short of the consensus estimate, on revenues that increased 13% to $144.6 mln. Looking to 1Q04 (Sept), management said it expects revenue of $135-140 mln (consensus of $144.5 mln) and EPS of $0.18-0.20 (consensus of $0.22). The company's outlook for FY04, however, was somewhat more reassuring as it said EPS should be $0.93-0.97 (consensus of $0.96).

Strikingly, shares of Prudential (00C 34.60 -0.02) have traded off in tonight's negative session despite the company's much better than expected Q2 (June) report. The financial services conglomerate exceeded the consensus EPS expectation of $0.60 by $0.07. As for FY03 (Dec), Prudential expects solid EPS growth and pegs its forecast at $2.25-2.40, in line with the Wall Street consensus of $2.35.

One stock, though, that has bucked the bearish tone of trading has been WebMD (HLTH 11.23 +0.19). The on-line health advice provider topped the consensus Q2 (June) EPS expectation by a penny, at $0.11, and showed a revenue increase of 8% to $246.5 mln. Q3 EPS was forecasted at $0.11 (consensus of $0.12) and revenues were projected at $257-262 mln, handily above the consensus estimate of $255.9 mln.

Finally, Weight Watchers (WTW 44.06 +0.76) has also attracted some buying interest following its Q2 (June) report. The provider of weight loss services exceeded the Reuters Research EPS estimate of $0.51 by a penny, and exhibited sales growth of 19% to $258.9 mln. The company, however, cut its FY03 (Dec) EPS guidance to $1.59-1.64 from $1.63-1.71 - the latter, though, still represent an EPS increase of 21-25% from the year-ago result.

For more detail on these, and other after hours developments, be sure to visit Briefing.com's In Play, Earnings Calendar and Guidance pages. -- Heather Smith, Briefing.com
5:53PM Ahead of the Curve: Cisco (CSCO) 17.90 -1.36 (-7%) [Full day change - after-market change is: -0.96 (-5%) ] Cisco reported today, after the close, and met earnings estimates and exceeded revenue estimates. But the stock is off an additional $1 in after-market trading, after falling $0.40 during the day. It is now off a full -7% for the day. Why? Because every significant margin declined. As we pointed out in Tuesday's Ahead of the Curve on the Stock Brief page, the only reason Cisco has been able to support the valuations it has - a PE of 42 and Price/Sales of 7.5 - is that the company has done a great job of expanding margins over the past two years. The margin expansion story is now over. That leaves strong revenue growth as the only real driver for future earnings - and the outlook is still mixed on that score. That means analysts at institutions everywhere are staying late in Manhattan offices calculating new valuation metrics for the stock - the "right price" for the company. When they finish, the reports will be on portfolio manager's desks in the morning. Tomorrow is when those managers act on the reports. With billions in institutional holdings, it will be very interesting to how they react to this story. We will provide the same type of report for you - the Briefing.com reader before the market opens tomorrow morning. Look for an abbreviated analysis on the Story Stock before the open and a full, detailed report on the Stock Brief shortly thereafter. - Robert V. Green, Briefing.com

5:24PM Cisco Systems releases guidance (CSCO) 18.86 -0.40: -- Update -- Revenues are expected to be up 2-4% sequentially. Gross Margins are forcasted to be 67- 69% Operating expenses up 2-3% in terms of dollars.

4:39PM Cisco Systems earnings growth (CSCO) 18.86 -0.40: -- Update -- On the call, management states that future earnings growth will driven by topline growth -- suggests that more acquisitions are ahead.

4:09PM Cisco Systems reports in line (CSCO) 18.79 -0.47: Reports Q4 (Jul) earnings of $0.15 per share, in line with the Reuters Research consensus of $0.15; revenues fell 2.6% year/year to $4.70 bln vs the $4.68 bln consensus.

Close Dow -149.72 at 9036.32, S&P -17.35 at 965.47, Nasdaq -40.50 at 1673.56: Today's session started out poorly and only got worse from there... Volume was light and breadth figures firmly unfavorable, with the Advancers/Decliners line and the Up/Down volume ratio negative by a roughly 2-to-1 margin... Investors refused to bid the market higher due to the sharp rise in interest rates, lack of leadership and technical deterioration, with the S&P 500 failing the supports at 972 (lower end of June/July trading range) and the Nasdaq failing the support at 1695 (30-day exponential moving average)...
Also contributing to the market's negative bias was apprehension ahead of Cisco's (CSCO 18.86 -0.40) Q4 earnings, slated to be reported after the close today... As a result, the major averages closed the session down 1.6-2.4% with the vast majority of sectors, including financial, retail, transportation, biotech, and large-cap technology participating wholeheartedly in the sell-off... Although better-than-expected, the ISM Services report (at 65.1 versus consensus of 58.0) did little to alter the market's negative bias...

Dating back only to July 1997, this report is often dismissed by the market because it has never been tested in a post-recessionary environment... Elsewhere, the bond market also spent the entirety of the session on the defensive, with the 10-year note closing the day down -31/32, with its yield at 4.41%...NYSE Adv/Dec 1017/2237, Nasdaq Adv/Dec 1042/2092

3:24PM Cisco Systems Earnings Preview (CSCO) 18.84 -0.42: -- Update -- Cisco Systems is scheduled to report Q4 results after the close, with consensus ests standing at $0.15 in EPS and $4.68 bln in sales. Merrill Lynch expects the co report in-line EPS, to slightly exceed their rev est of $4.7 bln, and to have a book-to-bill above 1, fueled by improvement in the U.S. enterprise mkt and led by Federal and strength in the SME mkt; in addition, firm believes the mkt will be primarily focused on the co's rev outlook, which should show a 2-3% sequential improvement for Q1 (factoring in the Linksys acquisition). On the other hand, Fulcrum expects CSCO's guidance to be conservative, and expects mgmt to guide Q1 revs to be flat sequentially and to provide a cautious near-term outlook for its core biz while speaking positively of its new opportunities (especially on SANs and service provider space).

2:03PM CTI Molecular cut to Neutral from Strong Buy at First Albany (CTMI) 13.85 -2.03: -- Update -- Firm believes CTMI shares could trade in a range of $12-$15 until competitive pressures alleviate.

1:44PM Research In Motion takeover speculation (RIMM) 25.51 -2.57: -- Update -- RIMM has seen some significant volatility since last Friday as various takeover rumors buffet the stock. Merrill Lynch theorizes that an HPQ takeover of RIMM would make some strategic sense, as HPQ has focused on the wireless data space and owning the BlackBerry would offer them instant traction in the business segment; also, HPQ's Indigo acquisition was about the same size as RIMM, and would broadly fit the definition of a small acquisition. On the other hand, UBS views an HPQ acquisition of RIMM as unlikely, saying it would be ill−timed (see 9:32 comment); firm believes that RIMM's mgmt would likely only consider selling the co as a fallback position if its marketing efforts were unable to capitalize on its technology assets, yet since Feb 2002 RIMM has essentially doubled its distribution channels, subscriber base, rate of subscriber growth, and quarterly rev; in addition, RIMM should be profitable for the first time this qtr excluding provisions for the NTP patent violation case.

9:42AM CTI Molecular cut to Neutral at BofA Sec (CTMI) 13.98 -1.90: -- Update -- The downgrade from Buy follows this morning's earnings warning. Firm cutting its FY04 est to $0.69 from $0.80 and reducing price target to $14 from $27.

ATI Tech (ATYT) 11.68 -1.20: Wedbush Morgan downgraded to Hold from Buy based on valuation as well as increasing competition from INTC in notebook integrated chipsets and NVDA in integrated chipsets for both desktop and notebook; firm expects INTC's mkt share to increase significantly next spring in integrated notebooks, and are now more convinced about the probability that NVDA will enter a license agreement with INTC to sell integrated chipsets for desktops and notebooks.

Rudolph Tech (RTEC) 18.24 -2.12: Fahnestock downgraded to Neutral from Buy; while it believes the co is poised to grow somewhat faster than the overall equipment industry, firm is concerned over the shares' rich valuation, weak orders, and a concentrated customer base; 6-month target is $14, and 12-18 month target is $22.

http://finance.yahoo.com/mp/q?tqnt

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Technical Analysis: Breakdown
by Paul Shread

http://stocks.internetnews.com/close/article/0,1785,1701_2244971,00.html

August 5, 2003 - Today clearly went to the bears. The Nasdaq and Dow (first two charts below) broke some pretty key support levels, the 1685 shelf on the Nasdaq and the Dow's March channel line. That 1685 level on the Nasdaq is now resistance, and support levels are 1656, 1625 and 1600. On the Dow, support is 9000, 8950 and 8871, and resistance is 9050, 9100, 9150 and 9200. The S&P (third chart) has major support at 962, and 950 is below that. Resistance is 983-989. There was heavy put-buying again today, but it wasn't much help this time. Short-term stochastics are approaching levels where a bounce is possible, but the technical damage today suggests more downside ahead.

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The U.S. Government Borrows $24 Billion

http://www.financialsense.com/Market/wrapup.htm

The borrowing demands of the U.S. government have put a tremendous amount of pressure on the financial markets. Today the U.S. Treasury sold $24 billion in 3-year Treasury Notes, which worked as a massive vacuum on the markets by sucking in all available capital. With the huge offering of 3-year notes, money came out of stocks and bonds across the board. According to CBS MarketWatch, “U.S. 3-year Treasury note sale sees lackluster demand. The bid-to-cover ratio, a measure of demand, came in at a weaker-than-expected 1.32 versus 1.96 at the last sale in May.” Investors were not exactly lined-up to buy treasuries, but there were at least enough buyers to absorb the debt, albeit at the expense of further declines in bonds of all maturities and a big acceleration in falling stock prices.

Now that the offering of three-year debt is out of the way, tomorrow our government will borrow an additional $18 billion in five-year notes and then on Thursday another $18 billion will be borrowed using 10-year treasury debt. This is big, big money that the government MUST borrow. If they are not able to borrow the money from investors, they must either do without, or effectively print the necessary money out of thin air. The alternative to borrowing the money would be for the government to simply cease operations, as they would have no money left in their checking account.

Today’s Markets

The Dow Jones Industrial Average fell 149 points today or 1.6% to close at 9,036, the S&P 500 was tagged for a loss of 17 points or 1.8%, and the Nasdaq Composite took the biggest hit by falling 40 points or 2.4% to close at 1,673. You can say goodbye to NASDAQ 1,700 for the time being since Cisco just reported hitting their expected numbers without breaking any records. Cisco’s net sales for the fourth quarter of fiscal 2003 were $4.7 billion, compared with $4.8 billion for the fourth quarter of fiscal 2002, a decrease of 2.6%. In the prior quarter Cisco’s sales were $4.6 billion, so the current quarter is still relatively flat. They are going to need stronger growth going forward if they plan to continue sporting a P/E ratio of 41. Cisco closed down 40 cents today at $18.86, but has fallen an additional 63 cents in after hours trading to $18.23.

Another story stock for the day is Costco Wholesale. The volume on Costco shares skyrocketed to over 56 million as the stock gapped-down at the open and continued falling $6.90 on the day for a close of 30.06, a loss of over 18%. Costco’s sales numbers were up 12% over the same period last year, but they couldn’t drive the higher sales to the bottom line. According to Richard Galanti, CFO, “Despite the satisfactory sales results, a combination of lower-than-planned gross margins, continuing escalation of costs associated with employee healthcare and workers’ compensation expenses, and increased initiatives to improve customer service and speed checkout at the front-end all led to reduced expectations for our fiscal fourth quarter results.”

These problems are not unique to Costco. Higher costs with little pricing power at retail have hurt the bottom line earnings. Guidance for near-term quarterly results has been reduced. This theme should hold true as we move through the second half of the year. I can tell you from first-hand experience that Costco is a buttoned-down company that runs their business with a very high degree of discipline. If they are having trouble controlling operating costs, I can assure you that it is consistent across Corporate America. Most U.S. corporations have been controlling costs by laying-off workers. In today’s headlines Challenger, Grey & Christmas, a Chicago based employment firm, said that employment reduction announcements rose 43% in July to 85,117 versus 59,715 announced layoffs in June. Keep taking away the consumers’ jobs and the second-half recovery is sure to be a flop.

Energy Moves Higher

One of the biggest contributing factors to higher costs that are reducing companies’ earnings is the rise in energy prices. Today crude oil was up another 38 cents to close at $32.22 per barrel, unleaded gas was up almost 3% on inventory concerns, and natural gas added 6.5 cents today to close at $4.695 per BTU. The bombings in Indonesia added to concerns over U.S. oil imports. Again, as we move through the second half of the year let’s watch for a recovery in corporate earnings. Without earnings, we are in for a nasty decline this fall…or are the ides of October coming early this year?

Back To What Matters

The only thing that matters this week is the selling of the government debt. Treasury prices have been plummeting, and with all of the additional supply this week, prices could continue to decline. The second factor that hurt bonds today was the release of the Service Sector Index by the Institute for Supply Management. The index of non-manufacturing businesses had a reading of 60.6 in June and was expected to decline to a reading of 58 when the surprise number came in today at 65.1. This is the highest level for the index since it began back in July of 1997. Also note that the service sector of our economy represents 85% of our total economy. So we get the highest reading in six years for 85% of our economy, and the stock market goes down 2% on the good news.

What matters is the selling of the debt. That is it. Everything else revolves around the fact that our government can not continue operating without borrowing more money. Once the money is borrowed it will surely be spent right into the economy, otherwise the economy would be in contraction. One of the big problems is that the money will be spent on implements of war (i.e., bombs and bullets) that won’t add a thing to your quality of life, or even add earnings to the companies that you own in your portfolio. Yes, the borrowed money will show up in the GDP numbers which will depict a growing economy, but the growth is not real growth to build upon, it is growth by temporary government spending via massive borrowing.

It comes as no surprise to me that stocks are taking a hit just when the economy is supposedly improving. It’s easy for the Wall Street Spinsters to say that bond prices are getting killed because the economy is improving, but where is the follow-through from stocks? When the government needs to borrow $60 billion in one week, everything else must be pushed to the back burner until the debt is sold. Last Friday I stated that the markets were being conditioned to buy Treasury paper. Bonds were already oversold (we thought) to make the yields more attractive for this weeks’ auction, and stocks have gotten ahead of themselves, so money could easily come out of stocks to buy the Treasury paper. The coverage on the sale of the 3-year notes was thin today. We will just have to watch and see how things go tomorrow and Thursday as they auction the rest of the debt paper.

I have increased my short positions for the overall stock market and am patiently waiting to find the near-term bottom for bonds to play the bounce. Precious metals are in a holding pattern until the debt is sold. In fact, gold investors were put on notice last Friday in the late-day take-down right before the close. Silver investors got a hand slap today with silver losing ground, but the stocks held up well. I read the metal bashing as someone saying, "Don't even think of buying gold and silver until all the debt is sold. We can't let the metals rise because it will show weakness in our paper." Everyone will know the precious metals bull market is real when the price of the metals goes up in all currencies. With the current stresses on the global monetary system, precious metals are a very nice way to feel some security in the preservation of wealth.

© 2003 Mike Hartman
August 5, 2003