well this is a bit focused...Earnings Warnings Whack the Market Again
By Andrew Bary
Vital Signs | Dow 30
Help us, Alan! That cry welled up from Wall
Street last week after technology stocks got
bashed and the overall market was hurt by a fresh
series of profit warnings from companies as
diverse as Microsoft, Compaq Computer, Chase
Manhattan, Whirlpool, Maytag, General Motors,
Honeywell, Illinois Tool Works, United Parcel
Service, FedEx and Clorox.
With earnings' underpinning for the stock market
starting to crumble, many investors are now
hoping that Federal Reserve Chairman Alan
Greenspan and his fellow central bankers will
quickly ride to the rescue and reduce short-term
interest rates.
Imminent relief probably isn't forthcoming,
however. Most Fed-watchers believe the central
bank will refrain from easing credit conditions at
this week's meeting of the policy-setting Federal
Open Market Committee. But the markets clearly
are betting that come the new year, the Fed will
get into full easing mode. Financial futures
markets now discount a quarter-point rate
reduction at the FOMC's meeting in late January
and another quarter-point cut at the March
meeting. Once the Fed does ease, stocks may rally
sharply despite a weak earnings environment as
investors "look across the valley" to a period of
stronger economic activity and higher profits.
Hurt by the Microsoft and Compaq warnings and
fears that stalwarts like Sun Microsystems will
succumb to reduced corporate technology
spending, the Nasdaq fell 264 points, or 9.1%, to
2,653 in the five sessions. The index, which
declined 75 points Friday, ended the week just 56
points above its November 30 low of 2597 and
down 35% for the year.
The Dow Jones Industrial Average fared better,
falling 278 points, or 2.6%, to 10,434 as losses in
Microsoft, IBM, Home Depot and General
Electric were partly offset by gains in
McDonald's, General Motors, and AT&T. The
index's big drop came Friday, when it fell 240
points. So far this year, the Dow is off 9%.
The S&P 500 declined 4.2% to 1312 in the week
and now is down 10.7% this year.
Byron Wien, chief domestic strategist at Morgan
Stanley Dean Witter, says the market action last
week showed once again how the consensus is
often wrong. "Everyone thought that stocks
would do well if the election got settled. Yet it
was settled with Bush winning and stocks went
down."
Richard Bernstein, chief quantitative strategist at
Merrill Lynch, says stocks are being supported by
a "Greenspan put." This is the perception that the
Fed will protect investors from serious losses in
stocks by cutting rates. That belief was buttressed
by the Fed chairman's recent comments about the
depressing economic effect of reduced equity
financing and troubles in the junk-bond market.
"People believe that there's limited downside and
unlimited upside to the market," Bernstein says.
Given this view, it should come as no surprise
that Street strategists have never been more
bullish based on their recommended asset
allocations.
Goldman Sachs strategist Abby Cohen and UBS
Warburg strategist Ed Kerschner both pounded
the table last week. Cohen said the S&P 500 is
roughly "15% undervalued" while Kerschner
went as far as calling the current situation "one of
the five most attractive opportunities of the past
20 years." The last such opportunity, he says,
came after the 1998 financial crisis. He sees the
S&P 500 topping 1700 by the end of 2001, a
30% rise from current levels.
Kerschner's super-bullish target may be a stretch
because a weakening economy is taking a toll on
corporate profits. To get to 1700 on the S&P,
price/earnings ratios will have to expand --
something that doesn't usually happen when
profit growth is decelerating.
Fourth-quarter profits for the S&P 500 are now
expected to be up just 7%, half the increase
anticipated on October 1, according to First Call.
Given recent profit warnings, that 7% reading
could be high. Retailers, for instance, are
reportedly having a tough Christmas. Analysts
still see 10% profit growth for the S&P next year,
but that projection probably will come down in
the coming months. It's possible that 2001 profits
may be up only 5% next year or even be flat.
If flat earnings seems outlandish, consider that
General Motors, a big contributor to S&P profits,
could see a 50% drop in profits next year, while
Ford's earnings may decline 25%.
Intel's profits
could fall
sharply in
2001 because
it relied
heavily on
investment
gains this
year to boost
its net, and its
kitty of
capital gains
is virtually
exhausted,
according to
an analysis
by Fred
Hickey,
editor of the
High-Tech
Strategist, a
newsletter in
Nashua, New
Hampshire.
Intel is seen
earning $1.65
a share this
year, but
some
analysts
expect it to
produce
profits of just
$1.40 a share
in 2001. That
$1.40
estimate
could prove
optimistic
because it
reflects
still-sizable
investment gains. It's possible Intel's profits could
fall below $1.30 in 2001. Intel shares fell 1.50 to
32.50 last week, well below their September high
of 75. Intel may look inexpensive based on this
year's profits, but investors have to remember that
2000 profits have been bloated by unsustainably
high investment gains that Intel has insisted on
including in its operating results. Don't be
surprised to see the company try next year to get
Wall Street to focus on its operating profits.
The entire tech sector has benefited from
Intel-style investment gains in 2000, but those
gains could turn into losses in 2001. Just last
week, Compaq said it will recognize a loss on its
investment in Internet incubator CMGI.
And in one sector that's seen strong profits gains
this year, energy, earnings are likely to fall in
2001.
The brokerage industry should reap less
bountiful profits next year. Morgan Stanley Dean
Witter, for instance, is estimated to have earned
over $5 billion in its fiscal year just ended, an
amount that will prove very tough to top in 2001.
The consensus is for Morgan to beat its expected
fiscal 2000 profits of $5 a share in 2001, but it's
conceivable that the bellwether brokerage firm
may earn $3.50 a share or less, which would still
represent a healthy 20%-plus return on equity.
The investment community, despite warnings
from brokerage executives like Goldman Sachs
chief executive Henry Paulson, has persisted in
viewing the securities industry as capable of
consistently generating 30% returns on equity, an
unsustainably high level of profitability given the
industry's huge equity base and vulnerability to
market declines.
The factors cited by Chase Manhattan last week in
its profit warning -- lower trading revenues,
investment losses and high compensation
expenses -- also are affecting the brokers.
This week, Morgan Stanley and Goldman Sachs
are expected to report lower profits for their fiscal
fourth quarters, ending in November. The actual
results could be even worse than the current
consensus, which calls for Morgan to earn $1.29
a share, down from $1.42 a year ago, and for
Goldman to post net of $1.38 a share, down from
$1.54 a year ago.
Morgan Stanley was off 5.25 last week to 68.88;
Goldman Sachs also dropped 5.25, to 86.69, and
Merrill Lynch fell 6 to 63.68. Some Morgan
Stanley insiders now are saying privately that the
stock's record high of 110, reached in September,
might not be challenged for quite a while.
There's continued buzz on the Street that the $10
billion purchase of Donaldson Lufkin & Jenrette
by Credit Suisse First Boston is not going well.
Given the exodus of talent from DLJ and the mess
in the junk-bond market, some think that DLJ,
which has earned an estimated $500 million after
taxes this year, will be lucky to contribute $150
million to Credit Suisse next year.
Citigroup, which had been relatively unscathed
by the fallout lately in the banking and securities
industries, finally got hit last week, falling 3.50 to
48. Citigroup's fans figure that Sandy Weill, the
company's chief executive, will find a way to
deliver in tough times. But it's worth noting that
Citigroup is involved in banking, securities, credit
cards and consumer lending -- all difficult areas
now. Citigroup's Salomon Smith Barney division
has been a big source of profit growth this year,
but it is feeling the same pressures as Morgan
Stanley and Goldman. It'll be interesting to see if
Citigroup can hit the current fourth-quarter profit
estimate of 67 cents, which is up 20% from last
year's 56 cents. If Citigroup can deliver when
rivals falter, it will only burnish Weill's reputation
as one of the greatest Wall Street executives ever.
interactive.wsj.com
The Trader, Part 2
The Trader, Part 1
Microsoft's profit warning dominated the
market Friday with shares of the software giant
falling 6.31 to 49.19 after hitting a new 52-week
low of 47.75. Microsoft now is down 57% this
year, which has clipped an amazing $375 billion
from its market value. Microsoft's decline alone
accounts for about 30% of the S&P 500's drop
this year.
Given the
implosion
in the
personal-computer
market,
Microsoft's
news
wasn't a
big
surprise,
especially
since the
new profit
guidance
isn't dramatically lower than before. But investors
were in no mood to be charitable. Microsoft said
it sees current-quarter profits of 46-47 cents a
share, compared with the consensus of 48 cents,
and it guided down estimates for its fiscal year
ending in June to about $1.81 a share from $1.87.
If it hits the new guidance, Microsoft's profits will
be up just 6% in the current fiscal year.
There has been plenty of focus lately on the
impact on Intel's profits from investment gains,
but Microsoft also has benefited from gains taken
on its $20 billion portfolio of equity and other
investments. During its last fiscal year, Microsoft
realized an estimated $1.6 billion in gains, worth
around 20 cents a share.
Analysts now expect Microsoft to reap as much as
$2 billion in gains in the current fiscal year, worth
24 cents a share. That estimate could prove
optimistic given the rout in technology stocks.
Even if Microsoft can realize $2 billion in gains,
there's a strong case to be made that they should
be excluded from its operating profits. After all,
equity gains are unsustainable and largely
discretionary.
Strip out the projected gains and Microsoft trades
for around 30 times projected fiscal 2001 profits,
above its stated P/E of 27 based on $1.81
estimates.
William Epifanio, an analyst at J.P. Morgan,
remains bullish on Microsoft because of its
monopolistic market position and relatively
modest P/E. He also points to the company's
balance sheet, which probably is the best in
Corporate America. Microsoft has cash of $25
billion in addition to its $20 billion in
investments. The cash and investments are worth
nearly $9 a share. The company, moreover, has
been generating about $3 billion of free cash each
quarter, Epifanio says. Microsoft also could get
some help in its antitrust fight from President-elect
Bush.
PepsiCo's partisans have a lot to cheer about this
year with the stock up 38% to 48.82 in a rocky
market. Archrival Coca-Cola, on the other hand,
has seen its shares fall 8% to 53.50, way below its
1998 peak of 90. Coke was off nearly eight points
last week.
Pepsi, the subject of a favorable Barron's cover
story last spring ("Chipping Away," June 12),
soon may hit another milestone -- a higher
price/earnings multiple than Coke's. Pepsi fetches
around 30 times projected 2001 profits of $1.65 a
share, while Coke commands 31 times estimated
2001 earnings of $1.70 a share. Given the
narrowing P/E gap, some investors are tempted to
switch to Coke from Pepsi, but Bill Pecoriello, the
beverage analyst at Sanford Bernstein, says Pepsi
remains the better bet.
"There's still execution risk with Coke in 2001,"
Pecoriello says, noting that he recently cut his
2001 profit estimate for the beverage giant to
$1.70 a share from $1.74. Coke is expected to
earn about $1.45 a share this year.
The bullish argument for Coke has been that the
company, whose profits this year are expected to
be little changed from those in 1996, will finally
break out in 2001 and generate mid-teens profit
growth.
But Coke is
struggling in
the U.S. Its
global
bottling
network
remains
under
pressure, and
it continues to
be
outmaneuvered
by Pepsi in
non-carbonated
beverages,
the source of
virtually all
the industry's
growth.
Pecoriello
notes that
Pepsi now
has the No. 1 water brand, Aquafina, the No.1
iced tea, Lipton, and it will have the top sports
drink, Gatorade, when it completes its purchase of
Quaker Oats. Coke is aiming to be more
responsive to local tastes around the world, but it
risks cannibalizing its major soda brands.
Coke is due to report its global volume trends
Wednesday for the fourth quarter, and the
numbers may not be impressive. Pecoriello
recently cut his volume forecast to 3.8% from
4.5%, noting that U.S. volume may be up just 1%
despite aggressive Grinch-related promotions.
Another potential headache for Coke may come
next year if its U.S. bottlers roll out a low-priced
bottled water that will compete against Coke's
Dasani brand.
For a company with stagnant profits in recent
years and a challenging outlook, Coke still
commands a relatively high multiple.
It's ironic in a year in which major indexes have
declined that asset-management companies have
been among the stock market's strongest
performers with an average gain of over 50%.
One of the biggest winners has been Neuberger
Berman, whose shares have more than tripled to
77.50. The entire group has been helped by
merger activity and continued takeover
speculation. Neuberger, which went public only
last year, has been mentioned prominently as a
potential seller.
Yet some think Neuberger's stock is overpriced,
and that it will be tough for the company to find a
buyer willing to pay much more than 75.
Neuberger has one of the highest valuations in the
group, trading for 27 times projected 2000 profits
of $2.86 a share and 24 times estimated 2000
profits of $3.20 a share. The typical asset manager
trades for around 20 times estimated 2000 profits.
T. Rowe Price, at 40, fetches just 19 times
estimated 2000 earnings, while Franklin
Resources, at 34.50, commands less than 15 times
estimated 2000 profits. With a market value of
nearly $4 billion, Neuberger commands a hefty
7% of assets and 10 times book value.
The company's market value isn't much less than
that of T. Rowe Price, which has more than triple
Neuberger's assets and a much broader franchise.
If the mania for asset managers cools and
Neuberger doesn't sell out, its stock could easily
fall to 50 next year. |
