Redherring: "Don't have that growth removed"
redherring.com
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Rearranged for emphasis & ease of reading.
>>>Stock Screen: Don't have that growth removed
By Lisa Meyer
RedHerring.com, February 08, 2001
Technology investors are getting accustomed to bad news. Telecommunications equipment bellwether Cisco Systems (Nasdaq: CSCO) missed its earnings estimates on Tuesday, and accumulating evidence of an economic slowdown has convinced many investors to dash for the exits, or at the very least, stay on the sidelines.
Still, analysts expect two things: the Fed will continue cutting interest rates, and struggling telecom and PC companies will keep squeezing through their respective bottlenecks. So in the long run, healthy technology stocks will rebound.
But what about the short term?
We think investors should take a second look at depressed technology stocks.
Some should start to bounce back, even during the next couple tough quarters.
After reading a Thomas Weisel Partners report identifying companies that possess two of the greatest current scarcities
-- earnings growth and positive quarterly earnings revisions.
Red Herring decided to run a stock screen for companies that have the potential to weather the short-term economic slowdown.
We used Thomson Financial/Baseline, a stock analysis database.
THE CRITERIA
We first searched for companies in the telecommunications and technology sectors that had reported earnings for their latest period since the beginning of the year.
We screened for those that beat expectations for earnings growth during the latest period by at least 2 percent.
Plus, we sought firms that have had recent upwards revisions in earnings:
...the consensus estimates for the current quarter must have increased at least 2 percent over the last six weeks,
...while estimates for the full year must have been raised by at least 2 percent over the last three months.
To make sure we were in fact finding high-growth stocks,
... we required the expected earnings growth rate for 2001 to be at least 30 percent.
And in order to make sure that these stocks weren't too expensive, we screened for those trading at a price-to-earnings growth ratio
-- calculated by dividing the company's price-to-earnings ratio for 2001 earnings estimates by its estimated long-term growth rate -- no higher than 1.5.
Finally, to weed out smaller companies, we set a market capitalization minimum of $500 million.
Data was current as of February 7.
An even dozen companies made it through the screen:
... Art Technology Group (Nasdaq: ARTG),
... Broadcom (Nasdaq: BRCM),
... Cabot Microelectronics (Nasdaq: CCMP),
... Informix (Nasdaq: IFMX),
... Macromedia (Nasdaq: MACR),
... Polycom (Nasdaq: PLCM),
... Read-Rite (Nasdaq: RDRT),
... Scientific-Atlanta (NYSE: SFA),
... TranSwitch (Nasdaq: TXCC),
... Ultratech Stepper (Nasdaq: UTEK),
... UTStarcom (Nasdaq: UTSI), and
... WebTrends (Nasdaq: WEBT).
For this article, we chose to focus on three of the more promising in the group:
... Broadcom,
... Art Technology, and
...Scientific-Atlanta.
BROADENING HORIZONS
Yes, Broadcom's stock fell 10.5 percent on Wednesday after CEO Henry Nicholas warned of lower revenue growth in the first quarter than the company had originally expected.
The problems that plague networking companies such as Cisco and personal computer manufacturers such as Gateway (NYSE: GTW) have finally caught up with Broadcom.
But the chip maker for cable-modem and digital set-top boxes still benefits from demand in the consumer electronics business.
So we think that any diminished growth resulting from inventory problems in the telecommunications market can be made up in other areas.
"The company's success is due to good management of its core end market and its ability to find new avenues for growth," says Mark Edelstone, an analyst at Morgan Stanley Dean Witter.
By recently acquiring ServerWorks, which supplies circuit boards to server companies, Broadcom expanded its presence in one of the fastest-growing areas in the current market.
But the acquisitions didn't end there. During the past couple of quarters, Broadcom has bought a number of companies, including DSL provider Element 14 and network processor products provider SiByte -- not only penetrating new markets, but also strengthening existing business.
Analysts cheered such moves by increasing Broadcom's consensus estimates for the current quarter by 4 percent during the past six weeks, and 7.4 percent for the year in the past three months.
As of February 7, analysts were expecting first-quarter earnings of 34 cents per share, an 89 percent gain from last year.
It's true that estimates will likely come down somewhat now that Mr. Nicholas has issued cautious comments regarding the quarter (which means that if we ran this screen again next week, Broadcom might not make the cut), but we still think bad news is priced into the stock at this point.
Trading at 54 times its estimated 2001 earnings, only slightly higher than its long-term growth rate of 50 percent, Broadcom seems to be a reasonable buy.
The stock, now trading at $82.81, has already taken a big beating since hitting a high of $274.75 last August on fears of a slowdown in growth.
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VALUABLE ART
Despite worries that an economic slowdown would decrease IT spending, 74 percent of chief information officers surveyed last month by Morgan Stanley said they have yet to reduce their budgets.
Interestingly enough, these CIOs also said that if they had to cut spending, network equipment, security software, and e-commerce initiatives would be last on their lists.
Such priorities put Art Technology, a provider of Internet customer-relationship management and e-commerce software applications, in a good position.
Not only is the company in the right domain, it also provides an architecture many corporations now seek in order to standardize purchasing processes: J2EE compliant, or pure JavaScript.
"Art Technology also has done a great job in training partners and system integrators on its products," adds Ian Morton, an analyst at J.P. Morgan H&Q.
Art Technology is expanding its footprint not only domestically, but also internationally.
The company added 131 new customers in its recent quarter, including The American Heart Association, Ford (NYSE: F), publishing company Meredith Corporation (NYSE: MDP), and Lloyd's of London.
Such customer wins helped Art Technology post earnings in its most recent quarter of 10 cents per share, beating analyst expectations by 2 cents.
The current quarter looks to be shaping up just as well: consensus estimates have increased 14 percent in the past six weeks. And consensus estimates for this year rose 8.3 percent during the last three months.
The stock is by no means cheap, trading at 64 times 2001 earnings estimates.
Investors have already rewarded Art Technology handsomely for its strong results. The stock has nearly doubled in the last month.
But when you consider that earnings are expected to grow 167 percent this year and the fact that the stock is trading at 1.3 times its long-term growth rate of 50 percent, we think the high multiple is justified and that the stock still has room to run, especially since the company has earnings momentum on its side.
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BOXES ARE BOOMING
Scientific-Atlanta's strong fundamentals also put it in a good position for the short and the long term.
The company, which manufactures cable set-top boxes, is taking advantage of a recent switch in focus among cable operators from digging trenches to lay fiber to providing customers with equipment.
Increasing competition between cable operators and direct broadcast satellite TV also has helped Scientific-Atlanta. In order to remain competitive, cable operators must upgrade their services with digital set-top box systems.
This upgrade cycle should last several years, according to a report by Peter Ausnit, an analyst at Deutsche Banc Alex. Brown.
Mr. Ausnit also writes that Scientific-Atlanta will increase its current quarterly production of 1.3 million units to 1.5 million by the end of the company's fiscal third quarter of 2001 (ending in March).
Indeed, the demand for such equipment is strong: the U.S. digital cable market is expected to nearly double in 2001, to 17.5 million homes -- each with 1.3 digital set-top boxes, according to Mr. Ausnit's report.
Scientific-Atlanta's only current fault is its inability to keep up with that demand.
During the last five quarters, the company has booked more digital set-top box sales than it could deliver, creating a backlog that exceeded 2.1 million units at the end of 2000.
Still, revenue increased 69 percent in its latest quarter, helping to fuel a 112 percent increase in net income. Scientific-Atlanta earned 42 cents per share, compared with 20 cents a year earlier.
And the outlook continues to look good, as the consensus earnings estimate for the first quarter has increased by 7.9 percent during the past six weeks.
Consensus estimates for the year rose 5.9 percent in the past three months. Analysts expect the company to post earnings growth of 81 percent this year, yet the stock trades at just 32 times 2001 earnings estimates.
Scientific-Atlanta is also trading at just a slight premium to its expected long-term growth rate of 25 percent.
So even though the news doesn't seem to be getting better for technology companies anytime soon, several companies are still expected to post solid gains in earnings in these challenging times.<<< |
