Gentlemen,
FYI:
TECHNOLOGY: CQ1 EPS PREVIEW: PC MARKET LOOKING UP
07:32am EST 27-Mar-00 Morgan Stanley\DW (Munson, Gillian 212-761-6070) AAPL
-A SOLID FUNDAMENTAL START TO THE YEAR
Good stock performance and healty fundamentals have starting C2000 off on a
good foot.
-MATCHED WITH GOOD STOCK PERFORMANCE
Almost every stock we track rose in the last month and many also have had
good C2000 YTD performance. Disk drive stocks have been the biggest recent
winners.
-MACRO VIEW ON PCS REMAINS POSITIVE
We think the PC market is more healthy this year than it has been in the
last 3 years. We are are recommending all three PC-oriented stocks we cover,
AAPL, CPQ and DELL.
-EXPECT MORE UPSIDES THAN DOWNSIDES THIS QUARTER
We believe that the environment will cause there to be more upside surprises
in our coverage than in the previous eight quarters.
Investment summary and conclusion:
CQ1:00 started off a bit tough in the PC Hardware and Data Storage. The
demand snapback that was expected in January did not unfold and for many
companies the quarter started off slow. However, US momentum picked up in
February and European demand picked up in March. Asia, where acceptance of
the Internet is on a roll, appeared strong throughout the quarter to us.
Even with the challenges facing the industry, CQ1 went relatively well for
our companies (in part due to conservative expectations). We do see some
risk but generally expect more upside than downside potential.
We also believe that the companies we cover will project an optimistic
outlook on their CQ1 conference calls. We believe that this will be
particularly true for the systems vendors (Apple, Compaq and Dell) and for
the enterprise storage players.
Industry Overview - CQ1
We believe that PC Hardware units fell roughly 9% Q/Q in CQ1 to 29MM units
(up 15% Y/Y). This is slightly less Q/Q seasonality than in the past but a
tad more than expected at the beginning of the quarter. We continue to
believe that the PC environment is improved over the past two years. We
think that the industry will enjoy mid-teens Y/Y unit growth matched with
relatively tame pricing pressure. This should drive the first double-digit
revenue growth year in almost three.
In the Enterprise Data Storage market, we continue to see tremendous roll
outs of capacity. We believe that we have just begun to see the tip of the
icebeg in terms of the volume of data that will be driven by Internet
adoption. We believe that this will drive a multi-year opportunity for the
leaders in this space.
In disk drives, the quarter was a bit of an anomaly in that dynamics while
influenced by PCs were not as difficult as the PC market. While PC demand
was a tad lighter than expected, disk drive unit shipment trends appear
strong, with relatively tame pricing on the desktop. We suspect that this is
a result of some rollover of better-than-expected demand from CQ4:99. In the
enterprise, new competitors continued to make the pricing environment tough.
In almost all cases, disk drive companies are attempting to position
themselves away from their core disk drive operations and to highlight
additional efforts they might have in place to grow in new businesses (most
have network attached storage NAS efforts). We suspect that there continues
to be excess supply in the disk drive business and expect that there may be
some more pricing pressure before the industry environment improves.
Company Analysis - CQ1
Adaptec - CQ1 EPS est. $0.49 Outperform
We continue to rate Adaptec shares Outperform. We don't expect a lot of
upside to our Adaptec estimates this quarter due to the issues that impacted
the PC market at the end of CQ4 and the beginning of CQ1. We are forecasting
EPS of $0.49 (up 35% Y/Y and down 6% Q/Q) on revenue of $213MM (up 20% Y/Y
and up 1% Q/Q). The First Call estimate is $0.49.
Adaptec suffers from negative PR related to market perception of the Fibre
Channel ramp in PC servers. As shown in Figure 5 below, Fibre channel will
grow over the next few years, but SCSI should also remain a growth business.
Adaptec's high PC server market share should help it have a strong demand
ramp in CQ2 and CQ3 as Windows 2000 servers roll out.
Adaptec is expected to report EPS on April 27.
Apple Computer - CQ1 EPS est. $0.80 Outperform
We continue to rate Apple shares Outperform. We believe that the stock
represents a solid value in the PC space and believe the company's outlook is
solid. We think that Apple can continue its track record of solid EPS
upsides.
We believe that Apple could have the biggest upside this quarter among the PC
companies we cover. We are forecasting EPS of $0.80 (up 33% Y/Y) on revenue
of $1.96B (up 28% Y/Y and down 17% Q/Q). The First Call estimate is $0.80.
We believe the company enjoyed strong demand in CQ1, particularly at the high
end. Mix should benefit both revenue and margins. We suspect that Apple has
a lot of incremental new products in its pipeline which will drive a positive
outlook.
Apple is expected to report EPS on April 19 after the market close.
Avid Technology - EPS est. ($0.06) Neutral
From a stock perspective, Avid shares represent a future on the company's
ability to drive growth with its Internet efforts. We think that it is early
to determine if this is a growth driver or rather a natural extension of the
product line. We continue to rate the shares Neutral.
We don't expect much upside to Avid's CQ1. We believe that Avid continues to
be in a turnaround mode. The company is repositioning its product line and
is in the lull before its big trade show, the National Association of
Broadcasters (NAB). We are forecasting EPS of ($0.06) on revenue of $108MM
(down 3% Y/Y and down 3% Q/Q). The First Call estimate is ($0.07).
No reporting date has been set yet.
Brocade (co-covered with George Kelly) - EPS est. $0.06 (normalized and
taxed, $0.08 reported) (April) Strong Buy
We believe that Brocade is an attractive pure play on the storage networking
market. We think Brocade is starting to pull away from its competitive pack.
The company gained share last quarter even through we expected some share
loss given the number of competitors in the market.
We believe that Brocade will have a solid upside this quarter. We are
forecasting EPS of $0.06 (up from ($0.01) last year) on revenue of $53MM (up
403% Y/Y). The First call mean is $0.08, reported.
No reporting date has been set yet.
Compaq - EPS est. $0.17 Outperform
We continue to believe that new management is an agent for positive change at
Compaq. We also believe that the company will benefit from three key drivers
this year: a more rational PC demand and pricing environment, the Windows
2000 upgrade cycle, and the upgrade cycle for the Wildfire AlphaServer (
Unix).
We believe that Compaq has limited upside this quarter. The company has
already indicated that the quarter started off slow in January and we believe
that an inventory readjustment at Inacom (post Compaq's acquisition of
Inacom) and a slow pickup post Y2K in Europe may be negatives to the overall
numbers. However, our channel checks (particularly in the U.S.) continue to
be very encouraging, and we believe that the company will be able to point to
momentum entering CQ2 on its earning conference call.
We are forecasting EPS of $0.17 (up 3% Y/Y and Q/Q) on revenue of $9.7B (up
3% Y/Y and down 8% Q/Q). We suspect that Compaq's enterprise group did well
in the quarter and that the company will be able to show some progress
towards better profits in PCs. The First Call mean is $0.16.
No reporting date has been set yet.
Dell Computer - EPS est. $0.16 (April) Outperform
We continue to rate Dell shares Outperform. We believe that the next leg in
the shares needs to be driven by investors gaining a better understanding of
what Dell's longer-term strategy might be. The company's estimate revision
from FQ4 have set it up to have easier hurdles to jump which should be a
positive for the stock near-term.
For CQ1 (end April), we believe that Dell is benefiting from a solid PC
market environment, the timing of its quarter (January industry weakness has
already been factored into FQ4) and the ramp of enterprise products as a
percentage of the mix. We believe that the company has a good chance of
beating EPS estimates for CQ1.
We are forecasting CQ1 (April) EPS of $0.16 (up 1% Y/Y and flattish Q/Q) on
revenue of $7B (up 27% Y/Y and up 3% Q/Q). The First Call estimate is $0.16.
No reporting date has been set. Dell plans to host an Analysts' meeting in
New York on April 6.
Quantum DSS - EPS est. $0.28 Neutral
We continue to rate DSS shares Neutral. We believe that investors will stay
in a we believe it when we see it mood with regard to the shares for a while.
While the company's storage systems businesss (tape systems and SNAP NAS
servers) are interesting, they are not likely enough to offset the weaker
than expected revenue trends in the core tape drive business. Clearly DSS is
a profitable entity but we think that the organic issues/concerns with DLT
are enough to hold the shares back for the time being.
We are not expecting a lot of upside from DSS this quarter. We are
forecasting EPS of $0.28 (down 16% Y/Y and down $0.02 Q/Q) on revenue of
$344MM (down 12% Y/Y and down 6% Q/Q). The First Call mean is $0.28.
DSS is expected to report EPS on April 25.
Quantum HDD - EPS est. $0.05 Neutral
We continue to rate HDD Neutral. However, dynamics in the desktop disk drive
space (where HDD has most of its revenue) were stable in the quarter, which
should help the company show a potential upside. The company continues to
make moves into the low end of the high end. We believe that its efforts are
causing pricing pressure in that space.
We believe that HDD is likely to show some upside this quarter. We are
forecasting EPS of $0.05 (upfrom a loss of $0.01 last year, down from a
profit of $0.06 per share last quarter). Our revenue estimate is $826MM
(down 10% Y/Y and down 7% Q/Q). The First Call mean is $0.04.
Quantum HDD is expected to report EPS on April 25.
Read-Rite - EPS est. ($0.92) Neutral
We continue to rate Read-Rite shares Neutral. Read-Rite is still working its
way back from its all-time high loss per share of $1.61 in CQ3:99.
On the positive side, the company was upbeat about new customer and program
qualifications at our Systems and Semiconductor conference in Laguna Niguel
in early March. However, the recording heads market is still one of the
toughest parts of the disk drive market and one that is still oversupplied.
Moreover, Read-Rite's revenue performance has been tough to forecast at best.
Given what have been good desktop disk drive demand trends this quarter, we
believe that Read-Rite could have some upside this quarter. We are
forecasting EPS of ($0.92), vs. ($0.39) last year, on revenue of $137MM (down
33% Y/Y and up 20% Q/Q). The First Call mean is ($0.81).
No reporting date has been set yet.
SeaChange - EPS est. $0.02 Neutral
Seachange is in a hot sector right now, which is reflected in the stock in
our view.
We believe that SeaChange could have some upside this quarter. We are
forecasting EPS of $0.02 (up from $0.00 a year ago) on revenue of $22MM (up
4% Y/Y and up 2% Q/Q). The First Call mean is $0.01.
No reporting date has been set yet.
Seagate - EPS est. $0.14 Outperform
We continue to rate Seagate shares Outperform. The stock has had a strong
run this quarter, primarily on investor realizations that the company has
real value in its disk drive business and its investment holdings. We
continue to believe that Seagate is very focused on investor value.
We believe that it is unlikely that Seagate will have an upside surprise this
quarter based on fundamental market conditions its disk drive holdings. It
is possible that some sales of equity holdings could help push interest
income up and drive at least in line EPS. Our concern for the numbers comes
from the intense pricing pressure we see in the high end of the disk drive
market owing to the entrance of Quantum HDD at the low end and the continued
pressure from Fujitsu at the high end. Still, Seagate is focused on its
longer-term story in disk drives and is making the proper investments to
drive technology leadership.
We are forecasting EPS of $0.14 (down 72% Y/Y, flattish Q/Q) on revenue of
$1.6B (down 9% Y/Y flat Q/Q). The First Call mean is $0.14.
No reporting date has been set.
Western Digital - EPS est. ($0.37) Neutral
Western Digital is rated Neutral. The stock has had a big move this quarter
based on the better fundamentals in the desktop disk drive business and the
company's efforts to expand into adjacent market spaces such as NAS (with its
Connex business). We are concerned that the enthusiasm is warranted but that
it might overly discount for the future at this point. We continue to be
concerned about core disk drive fundamentals in the spring and rate WDC
Neutral.
We believe that Western Digital could have some upside this quarter based on
the relatively tame pricing environment in desktop disk drives, WDC's primary
market. We are forecasting EPS of ($0.37) (vs. ($0.68) in CQ1:99) on revenue
of $564MM (down 16% Y/Y and up 1% Q/Q). The First Call mean is ($0.42).
No reporting date has been set yet.
Valuation
Generally, the stocks in our group traded well during the quarter. Almost
every stock we track has gone up over the last 30 days in line with strong
market performance. We continue to see momentum back in the PC stocks and we
get the sense that investors are more willing to look positively at our group
in general.
On the disk drive side, multiple stocks are up over 100% in the last 30 days. Here we are concerned that the promise of new products and a better supply demand balance may be a little overdone. We would be cautious in this space. In our opinion, the cheapest two disk drive related stocks are Quantum HDD and Read-Rite at this point.
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