barron's trader col...
EMC Warns and Techs Swoon
By Andrew Bary
Vital Signs
Stocks fell back into a funk last week following a series of profit
disappointments that were capped by warning from former technology
stalwart EMC.
The Dow Jones Industrial Average tumbled 227 points Friday to 10,252,
bringing its loss for the week to 250 points, or 2.4%. The Nasdaq got
clocked in the holiday-shortened week, dropping 156 points, or 7.2%, to
2004, including a 76-point setback Friday. The S&P 500 was off 2.8% to
1190.
Wall Street has alternately focused on the potential for higher corporate
profits in 2002 stemming from the Federal Reserve's aggressive easing actions
this year and a seemingly constant stream of punk earnings news. This past
week, the poor profit reports dominated as Federated Department Stores,
Advanced Micro Devices, EMC and British telecommunications equipment
maker Marconi warned of weak second-quarter profits, prompting analysts
to cut their estimates for 2001 and 2002.
"The bear case for the economy got reinforced," says Byron Wien, chief
domestic strategist at Morgan Stanley. Wien noted that employment data for
June released Friday morning showed a larger-than-expected drop in payroll
jobs of 114,000 and an uptick in the jobless rate to 4.5% from 4.4% in May.
Wien says that while the April lows are apt to hold, he doesn't see much
appreciation potential for stocks in the second half, in contrast to bullish
strategists like Goldman Sachs' Abby Jospeh Cohen, who sees the S&P
reaching 1550 by year-end-30% above current levels.
The EMC news late Thursday rocked the tech sector Friday and prompted a
drop of more than eight points in EMC's stock, which finished the week at
21.60, down 7.65. IBM and Sun Microsystems, both hardware makers, fell
sharply Friday in sympathy with EMC as IBM declined 5.60 to 106.50 and
Sun gave up 1.49 to 13.68. EMC, the leading producer of data-storage
systems, warned that its second-quarter profits would total four-to-six cents,
far short of the consensus estimate of 17 cents, and that revenues would total
$2 billion in the period, below the projected $2.3 billion.
EMC had been one of the tech Fab Five in late 1999 and early 2000 along
with Oracle, Cisco Systems, Sun Microsystems and Nortel Networks, and it
was the last to feel the effects of the tech spending slowdown. EMC peaked
at 105 in September and traded as high as 80 in January. As recently as late
2000, EMC partisans figured that the company was a cinch to earn $1 a
share this year, up from last year's 79 cents, and that optimism lasted into the
first quarter.
Yet Street analysts now see EMC generating profits of just 35-40 cents this
year, and some cut their 2002 projections to around 50 cents from 80 cents.
EMC has dominated the market for high-end data-storage systems, but its
lush profits margins, which hit 60% in the second quarter last year, attracted a
slew of competitors. Michael Dell, the chief executive of Dell Computer,
which has been moving into the storage area, reportedly has called EMC
"Excessive Mark-Up Corp."
The EMC news highlighted both the risks for bargain hunters in the tech
sector and the industry's high operating leverage. EMC's revenues in the
just-concluded quarter were $300 million below expectations -- not a huge
amount, but virtually all that decline affected its bottom line as profit estimates
fell to about a nickel from 17 cents. One of the less-heralded dangers in the
tech sector is margin compression as rivals in increasingly crowded fields like
data storage, telecommunications equipment and even software vie for a
dwindling amount of business.
Ross Margolies, manager of the Salomon Brothers Capital fund, says all the
investors trying to pick the low point in tech stocks and the inflection point in
their businesses may be in for a rude surprise. The revenue and profit base, he
says, may be so low at the bottom that the stocks may not move up when the
recovery does come. Many semiconductor companies are experiencing 50%
revenue declines from year-ago levels. "Once people realize that these
companies aren't going to have 50% recurring annual growth off the bottom,
they're going to be disappointed," he says.
Margolies also argues that the EMC debacle and all the other tech disasters
underscore the industry's economic sensitivity, which argues against premium
price/earnings multiples. "If you want to buy cyclical companies, you ought to
consider Federated Department Stores or Alcoa, which have dominant
positions and far lower valuations."
The EMC blowup also suggests that investors should look at tech companies'
price/sales ratios, which are derived by dividing market value by annual
revenues. Sectors with high price/sales ratios, such as software and data
storage, tend to- have high margins. Just look at Microsoft's monopolistic
90% gross margins. Yet high-margin companies tend to attract numerous
rivals, although none so far have threatened Microsoft.
The accompanying table shows the current
price/sales ratios of some major tech companies
and the 10-year average. Microsoft, Oracle and EMC trade above their
10-year averages and are potentially vulnerable to narrowing margins or P/E
compression. Hewlett-Packard, Compaq and Gateway have low price/sales
ratios and trade below their 10-year average. They would appear to have less
risk than their more highly valued peers. If major tech stocks traded at their
10-year averages, Compaq, H-P and Gateway would rise, while Microsoft,
Oracle, Intel and EMC would fall. Cisco trades for around six times sales,
below its 10-year average of 11 and a peak of 35 in early 2000. The average
tech company tracked by Merrill Lynch trades for 4.5 times trailing 12-month
sales, slightly above the 10-year average. |
