From Briefing.com: 5:49PM Weekly Wrap: Fraulein Maria would have you believe that the beginning is a very good place to start, but with apologies to her, we'll start the weekly recap at the end. That's because Friday's employment report was the focal point all week, so much so that by Thursday the mute button was hit anytime a pundit appeared on TV to discuss it. However, when the headlines on the employment report hit the wires Friday morning, the volume dial got turned up several notches... and so did the equity market's enthusiasm.
There were a few headlines that excited the market. Specifically, they were the ones that indicated nonfarm payrolls in March increased by 308,000 and that there were upward revisions to payroll figures for January and February. That March number was well ahead of the consensus estimate of 120K and it delivered a message that all aspects of the economy are strong. Fittingly, the stock market and the dollar rallied on the news; meanwhile, the Treasury market took a beating. The benchmark 10-yr note fell more than 2 full points, bringing its yield up to 4.15%, or 27 basis points higher than where it started the session.
The jobs report punctuated what had already been a very good week for the market. Prior to Friday, the Dow, Nasdaq, S&P 500, S&P 400, and Russell 2000 were up 1.6%, 2.8%, 2.2%, 3.3% and 3.9%, respectively. The bullish bias was rooted in the belief that the recent market correction had run its course; it was also helped along by some end-of-quarter/start-of-quarter maneuverings by fund managers. At the same time, there was some bullish posturing ahead of the jobs report, but the relatively light volume behind the gains didn't connote a great deal of conviction in that advance. That stands to reason considering expectations were also high ahead of what turned out to be a very disappointing February employment report.
Outside of the jobs report, the other key items of the week included the OPEC meeting and a reshuffling of the components in the Dow. The former occurred on Wednesday, and as had been anticipated, OPEC stuck by its decision to cut production by 1 mln barrels per day, effective April 1. Crude futures for May, though, dropped 3.8% for the week to $34.39/bbl as speculators unwound some of their positions. Additionally, reports that the Bush administration may suspend rules for some states that mandate cleaner burning gasoline provided a measure of relief on the demand side of the equation as such a move would create less need for light sweet crude inventories.
As for the Dow changes, say good-bye to AT&T (T 19.60), Eastman Kodak (EK 25.17), and International Paper (IP 42.67), and hello to AIG Group (AIG 74.30), Pfizer (PFE 36.00), and Verizon (VZ 37.24). The latter three will be added to the Dow Jones Industrial Average effective at the start of trading April 8. Changing the Dow's complexion was done to recognize "...trends within the U.S. stock market, including the continued growth of the financial and health care sectors and the diminishing relative weight of basic materials stocks."
Given the significant percentage gains in the indices this week, there was a litany of winning industry groups. Employment services was among the standouts for obvious reasons, as was the airline group, which benefited from the drop in oil prices. There weren't many laggards of note, but it is certainly worth mentioning that homebuilding was the worst-performing S&P group for the week, shedding 3.62%.
Incidentally, the homebuilding group was up 1.2% for the week before the jobs report, but with the sharp backup in the 10-yr note, it got hammered on Friday amid concerns the jump in rates would crimp demand for new homes. Homebuilders weren't alone in their misery on Friday. Other rate-sensitive areas, like financial and utilities, also suffered.
On the earnings front this week, the news continued to be encouraging. Best Buy (BBY 53.92) and Circuit City (CC 11.19) topped the headlines in that respect as each reported better than expected year-end results. Best Buy, in turn, offered better than expected guidance for FY05, and with a gain of 11.9%, was one of the best-performing stocks for the week.
Briefing.com recently updated its Market View page. In doing so, we reiterated our moderately bullish outlook for the stock market for the year. The economy is clearly in good shape and the pickup in hiring activity is a key component for sustained growth. That consideration and the strong profit growth expected in Q2 will continue to buttress the market over the near-term, but with burgeoning concerns about inflation and rising interest rates, we expect subsequent gains to be modest in scope and for the S&P to achieve a mid-single digit gain for the year. --Patrick J. O'Hare, Briefing.com
Index Started Week Ended Week Change % Change YTD
DJIA 10212.97 10469.78 256.81 2.5 % 0.2 %
Nasdaq 1960.02 2057.17 97.15 5.0 % 2.7 %
S&P 500 1108.03 1141.74 33.71 3.0 % 2.7 %
Russell 2000 572.92 603.50 30.58 5.3 % 8.4 %
Close Dow +97.26 at 10470.59, S&P +9.63 at 1141.80, Nasdaq +42.16 at 2057.17: The last time the market saw triple digit nonfarm payroll gains it was October 2002, and thus it was appropriate that stocks rallied on the back of today's 308K spike in March nonfarm payrolls... The figure blew past the consensus estimate (+123K) and even the most optimistic of whisper numbers (+200K) and was accompanied by upward revisions to January (to +159K) and February's (to +46K) figures... With few doubts remaining about the strength of the labor market, stocks and the dollar took off, and bonds and gold got crushed...
The latter experienced its largest drop in five weeks - stumbling over $6 to $422.50/oz, while the former saw the yield on the 10-year note spike from 3.91% to 4.14%... Interest-rate sensitive issues were, not surprisingly, the only weaklings in today's equity market as gold and homebuilding both tumbled... Other sectors were basically uniformly up with technology, transportation, and basic material (i.e. economically-sensitive areas) leading the way higher...
Technology additionally benefited from a bullish call out of JP Morgan (advising investors buy a basket of semiconductor equipment stocks - see Briefing.com's In-Play page, a Premium product, for more information) and a report from World Semiconductor Trade that said global chip sales rose by a record 31% year/year in February...SOX +3.7, NYSE Adv/Dec 1761/1568, Nasdaq Adv/Dec 2217/982
8:03AM Sun Microsystems: Microsoft to pay Sun $700 mln to resolve antitrust issues, $900 mln to resolve patent issues (SUNW) 4.19: -- Update -- Co and Microsoft announce they have entered into a broad technology collaboration arrangement to enable their products to work better together and to settle all pending litigation between the two companies. The companies have also entered into agreements on patents and other issues. The agreements involve payments of $700 million to Sun by Microsoft to resolve pending antitrust issues and $900 million to resolve patent issues. In addition, Sun and Microsoft have agreed to pay royalties for use of each other's technology, with Microsoft making an up-front payment of $350 million and Sun making payments when this technology is incorporated into its server products.
7:51AM Sun Microsystems and Microsoft enter into a broad cooperation agreement and settle all outstanding litigation (SUNW) 4.19: --Update-- In press release announcing downside guidace and lay-offs, co also announces that it has entered into a broad cooperation agreement and settled all outstanding litigation. No details were provided.
7:48AM Sun Microsystems guides below consensus, to cut 3,300 jobs (SUNW) 4.19: Company guides below consensus for Q3 (Mar), now sees a loss of $0.06-0.08, ex items, vs Reuters consensus of ($0.03) on revenues of $2.65 bln vs consensus of $2.8 mln. Company will also reduce workforce by 3300, take related charge of $475 mln spread over next several quarters. SUNW also announces it has appointed current Exec V.P. Jonathan Schwartz as C.O.O. and Pres, effective immediately. McNealy will remain Chairman and C.E.O.
7:36AM Monolithic denies complaint alleging trade secret misappropriation (MOSY) 13.39: Co was notified on April 1, 2004 of a complaint filed against it by UniRAM Technology, alleging trade secret misappropriation and patent infringement. UniRAM's complaint asserts that it provided trade secret information to Taiwan Semiconductor Manufacturing Corporation (TSMC) in 1996-97 and speculates that MoSys improperly obtained unspecified trade secrets of UniRAM from TSMC in an unknown manner.
3:37PM Sun microsystems (SUNW) 4.88 +0.69: Sun microsystems and Microsoft (MSFT 25.72 +0.64) announced a ten year agreement that settles patent infringement and unfair competition litigation between the companies and provides for broad technical and product collaboration.
Under the agreement, MSFT pays Sun $700MM to resolve pending antitrust issues and $900MM to resolve patent issues, and the companies pay royalties for use of each other's technologies, with MSFT making an up-front payment of $350MM and Sun making payments when MSFT technologies are incorporated into Sun server products.
Sun also announced job cuts totaling 3,300 employees. Management expects to record a total charge of approximately $475MM over the next several quarters for the workforce reductions, including approximately $200MM in Q3. The workforce reductions could save the company $200-350MM in annual operating expenses.
Management guided for Q3 GAAP EPS of ($0.23-0.25) on revenue of $2.65B (-5.0% Y/Y) vs. Reuters Research consensus at ($0.03) on $2.831B. The GAAP loss includes the $200MM charge and charges of approximately $350MM for an increase in the valuation allowance for deferred tax assets. Pro-forma EPS is expected to be ($0.06-0.08). Cash flow from operations is expected to exceed $300MM.
Prior to today's announcement, Sun shares were down over 22% from the Q2 review (Story Stocks, January 16, 2004), when we advised investors to wait for a 25-30% pull-back before considering Sun as a leveraged play on a recovery in enterprise spending. We stated then that upside is capped until SUNW management takes more aggressive action to reduce expenses and/or delivers sales growth at least in the high single-digits.
The headcount reductions and alliance with MSFT are significant steps to those ends, and mark the emergence of a new Sun. The alliance is expected to help drive product innovation and interoperability, and is a necessary and strategic response to the rising threat that Linux poses to both Sun and MSFT. Sun has, with one stroke, blunted Linux and secured valuable beachhead against competitors. Likewise, this agreement reinforces MSFT's position against Linux and are likely to help pacify regulators.
Sun shares are, based on our inverted EVA / DCF model, priced for sustained upper teens revenue growth assuming steady Y/Y improvement to 13% operating margin.
Improving global economic and corporate spending environment support growth expectations at least in the near-term. Operating margin expectations are consistent with Sun's historical operating performance and may be conservative in view of the leaner operating model implied by today's announced workforce reductions. Cost reductions coupled with the MSFT windfall will help Sun to be much more price and technology competitive.
Shares trade at a discount to a broad group of industry comps. The following table shows price multiples and Y/Y growth rates for SUNW and MSFT compared against peers in the computer systems & peripherals, software & programming and semiconductor components groups.Company *P/SG Ratio **P/OPG Ratio P/S Y/Y Revenue Growth
TTM 2004E 2005E TTM 2004E 2005E
Sun microsystems (SUNW) 0.9 (44.1) 1.5 1.4 1.4 (6.9%) (1.1%) 6.1%
Microsoft (MSFT) 3.9 18.4 8.1 7.7 7.2 11.3% 11.4% 7.5%
IBM (IBM) 1.2 12.9 1.8 1.7 1.6 9.8% 7.5% 6.1%
Hewlett Packard (HPQ) 0.6 17.5 0.9 0.9 0.8 18.4% 7.5% 6.3%
Dell (DELL) 1.5 19.0 2.1 1.8 1.6 17.1% 16.7% 15.3%
Apple Computers (AAPL) 1.0 75.9 1.5 1.3 1.2 15.4% 21.6% 9.0%
Red Hat (RHAT) 12.9 n/a 33.0 22.3 14.5 37.6% 46.8% 53.9%
Intel (INTC) 3.4 16.8 6.0 5.2 4.7 12.6% 14.9% 11.2%
Computer Systems & Peripherals 1.0 18.5 1.4 10.1%
Software & Programming 2.8 33.8 5.0 6.1%
Semiconductor Components 2.8 55.9 4.5 14.6%
Blended 1.8 29.3 2.7 10.0%
*P/SG Ratio: Trailing 12 month (Price / Sales) / Growth ratio as of March 26, 2004.
**P/OPG Ratio: Trailing 12 month (Price / Operating Income) / Growth ratio as of March 26, 2004.
For Sun and Microsoft, UWin is quite simply a formula for survival and success. We would buy SUNW, and continue to accumulate MSFT over time on weakness. Refer to the October 23-24, 2003 and January 23, 2004 Story Stocks on MSFT for investment summary.--Ping Yu, Briefing.com
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