For all the negative chatter on analysts, it is time to give it up for the boys at Salomon. Jon Joseph was able to look over all the current period problems at the longer-term and upgrade the sector, when it looked very very bleak. Now I realize that as I commend them for their move, I risk calling a top tick in the tech sector but if I am cognizant of that and state it here, I am hoping it won't be true...
Today's comment on VTSS (by Jon's sidekick Clark Westmont) sums it up:
-- SB: VTSS: Upgrading to Buy --
07:49am EDT 19-Apr-01 Salomon Smith Barney (Clark Westmont 415-951-1886) VTSS
SALOMON SMITH BARNEY
Vitesse Semiconductor (VTSS)
VTSS: Upgrading to Buy 1S (Buy, Speculative)
Mkt Cap: $5,921.6 mil.
April 19, 2001 SUMMARY
* We are changing our rating on Vitesse Semiconductor
SEMICONDUCTORS (VTSS-$30) from 2H (Outperform, High Risk) to 1S
Clark Westmont (Buy, Speculative).
415-951-1886 * It is well known that near-term business conditions
clark.westmont@ssmb.com are very difficult, as the company's earnings release
on Monday demonstrated.
* However, based on a variety of data points, we
believe Vitesse's earnings will bottom within the
next three to six months, and orders will likely
bottom within the next three months.
* We are upgrading the stock from Outperform to Buy
to reflect the recovery in earnings power the company
will likely produce later this year and beyond. We
are increasing our risk rating from High Risk to
Speculative to reflect the uncertainty surrounding
near-term earnings. Our price target has been lifted
from $27 to $36.
FUNDAMENTALS
P/E (9/01E) 71.3x
P/E (9/02E) 73.0x
TEV/EBITDA (9/01E) NA
TEV/EBITDA (9/02E) NA
Book Value/Share (9/01E) $5.72
Price/Book Value 5.4x
Dividend/Yield (9/01E) $0.00/0.0%
Revenue (9/01E) $634.8 mil.
Proj. Long-Term EPS Growth 40%
ROE (9/01E) 1428.0%
Long-Term Debt to Capital(a) NA
VTSS is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA . RECOMMENDATION
Price (4/18/01) $30.65 Current Rating 1S
52-Week Range $94.06-$15.94 Prior Rating 2H
Shares Outstanding(a) 193.2 mil. Current Target Price $36.00
Convertible No Previous Target Price $27.00
EARNINGS PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
9/00A Actual $0.14A $0.13A $0.17A $0.21A $0.64A
9/01E Current $0.25A $0.10A $0.04E $0.06E $0.43E
Previous $0.25A $0.10A $0.04E $0.06E $0.43E
9/02E Current $0.07E $0.10E $0.12E $0.15E $0.42E
Previous $0.07E $0.10E $0.12E $0.15E $0.42E
9/03E Current NA NA NA NA NA
Previous NA NA NA NA NA
First Call Consensus EPS: 9/01E $0.45; 9/02E $0.47; 9/03E NA
Calendar Year EPS: 12/00A $0.75; 12/01E $0.27; 12/02E $0.56; 12/03E NA
OPINION
We are upgrading Vitesse Semiconductor from Outperform to Buy to reflect the
recovery in earnings power the company will likely produce later this year and
beyond. We are increasing our risk rating from High Risk to Speculative to
reflect the uncertainty surrounding near-term earnings. Our price target has
been increased from $27 to $36.
In general, we believe Vitesse is making significant progress in diversifying
its product base to reduce its dependency upon the competitive PHY market. In
particular, the company has shown increasing strength in the emerging markets
for network processors and switch fabrics, segments that are very early in a
move to off-the-shelf standard products of the sort designed by Vitesse. While
we understand that June will be down another 10-25% sequentially, we believe
that these strengthening new product areas when combined with a future upturn
in demand for PHY products positions the company well in the second half of the
year. On a fundamental basis, we believe that Vitesse's earnings are likely to
trough in the June or September 2001 quarter.
Consider factors that are 'new' in 2001
Over the last four months, not a week has passed without a fresh round of bad
news from the communications supply chain: weak end-market demand, excess
customer inventories, weak carrier balance sheets, cats and dogs sleeping
together, total mayhem. We believe the glory days of 1999 and 2000 are
probably never to be repeated, and there is no question that there are
significant inventory and demand issues to be worked through. However, we
believe the communications business collapse has an overshoot element to it,
partly because of macroeconomic uncertainty and partly due to seasonal effects.
The macroeconomic uncertainty is widely recognized but hard to quantify.
Hopefully, the Fed action of the last several months will resolve that issue.
In our view, the seasonal effect is less well recognized by chip investors but
somewhat easier to quantify.
In the past several years of telecom spending growth, communications equipment
sales during the March quarter have often been flat or only slight down
compared to that of the December quarter of the just completed year (i.e.,
sequentially flat or slightly down). This is despite the fact that the March
quarter is typically the lightest quarter of the new year for telecom spending.
For example, U.S. Department of Commerce data for communications equipment
shipments shows Q1 of 2000 was down less than 1% from Q4 of 1999.
In a year when telecom spending contracts, however, the seasonal effects can
become dramatic. Assume that Q1 of a typical year accounts for 22% of the
annual budget and Q4 accounts for 28% (in fact, DOC data shows that Q1-Q4 of
2000 split spending 23%, 25%, 25% and 27%, respectively). In a year like 2001
when the annual outlay for communications equipment might fall by 15% compared
to the prior year, Q1 of 2001 could be down 20-35% sequentially from Q4 of
2000. However, spending should seasonally be sequentially flat to up every
subsequent quarter of the year. That would help to drain inventories and
establish a more stable order environment. Indeed, there are indications from
Altera and others that some signs of firming in North America are already
appearing. We believe those type of data points are likely to spread over the
next several months. Although June is likely to be a very tough quarter, a
bottom in earnings declines will likely be set in within the next six months.
There is a bad news/good news element to this seasonality. The bad news is,
wireline communications IC sales will likely gain a more seasonal reputation
than in the past two or three years. Fundamentally, this may heighten earnings
volatility and will increase the importance of accurately forecasting next
year's telecom spending before the end of each year. On a stock basis, it will
likely affect the P/E multiples investors are willing to pay. The good news
is, part of the current tough sales environment can be explained by
seasonality, and companies will adjust to running their operations in synch
with the seasons.
Investment opinion
We do NOT want to downplay the well-known effects of inventory overhang and an
uncertain business climate. We also remain concerned about future pricing
pressures in the communications industry. Our increase in the risk rating from
High Risk to Speculative reflects those hazards.
However, assuming the 22-25-25-28 rule holds true, it is plausible that telecom
spending by Q4 2001 will be 27% higher than in Q1-01. That move from here to
there should feel like heaven to investors, in our opinion. Over the next six
months, investors (and the industry) are likely to get a clearer picture of who
the survivors are on a product basis, what earnings power is possible, and what
are the real spending prospects for 2001 and 2002.
Specifically to Vitesse, sales in June are already expected to be down 55% from
December, which should factor in a fair amount of telecom spending weakness and
supply chain inventory corrections. With investor expectations already so
fundamentally dire for March and June, additional bad news in the short-term
may have limited stock effect. In addition, we believe our operating margin
model for 2002 may prove overly pessimistic (we are modeling 21.6% for next
fiscal year compared to 36% for last fiscal year).
Vitesse is also a high beta stock (literally 2.41), and we believe many
portfolio mangers may use it to try to play catch-up with the overall stock
market rally. This may dampen the valuation sensitivity in the short run.
We are increasing our price target from $27 to $36, assuming the stock can
justify a 40-50x P/E multiple against the company's potential earnings power as
we exit calendar 2002. We would not be surprised to see the stock trade well
above that level if the twinkling of stabilization begins to spread. However,
there is downside risk back into the low-20's if stabilization remains elusive.
ADDITIONAL INFORMATION AVAILABLE UPON REQUEST
Securities recommended, offered, or sold by SSB: (i) are not insured by the
Federal Deposit Insurance Corporation; (ii) are not deposits or other
obligations of any insured depository institution (including Citibank); and
(iii) are subject to investment risks, including the possible loss of the
principal amount invested. (c) Salomon Smith Barney Inc., 2000. All rights
reserved. Any unauthorized use, duplication or disclosure is prohibited by law
and may result in prosecution. Please refer to ticker SSBDISCL for important
Salomon Smith Barney Disclaimer information.
Clark Westmont 415-951-1886
First Call Corporation, a Thomson Financial company.
All rights reserved. 888.558.2500
Symbols:
US;VTSS
Source FC - First Call Research Notes
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