ÿHome DepotWal-MartThe Gap I know from my mail that a lot of you have
been looking for companies that would actually prosper as a result of
the turmoil in Asia. Well, so have I, and based on my efforts so far,
I'm convinced there are such businesses -- they're companies that buy
parts, subassemblies, or finished goods from hard-pressed Asian
suppliers who are more than willing to cut prices, and these companies
then sell finished products into predominantly non-Asian markets. Names
like Home Depot (HD), Wal-Mart (WMT) and The Gap (GPS) spring readily to
mind -- and investors have started to snap up shares in companies like
these. But retailers aren't the only kind of company that fits this
bill. Manufacturers of all kinds, including a strikingly large number of
high-tech manufacturers, are set to benefit from the same deflation of
prices. It's harder to find one of these companies -- you have to work
through the company's manufacturing system to understand what parts of
the finished product are made where. But for that very reason, I think
stocks in manufacturing companies that source in Asia may be the most
profitable way to play the current economic turmoil. And the stock of a
high-technology company that will profit from the upheaval would be
especially attractive, since everyone knows that the slowdown in Asia
will hurt technology companies.
ÿÿSnapshotPress Releases3-year Chart Overview Earnings Estimates News
Wire Financial Statements I think that Compaq Computer (CPQ) fits that
bill exactly. I'll explain why -- in enough detail so you can disagree,
but also so that the example will suggest a road map for how to do this
analysis on other companies that you think are just as -- or even more
-- promising. Compaq is engaged in the kind of brutal price war that
would, in normal circumstances, make me avoid the stock like the plague.
Last Monday, for example, Hewlett-Packard (HWP) announced its line of
$800 personal computers, trumping Compaq, which had grabbed the lead in
the low-priced computer market by being the first to break the $1,000
barrier last February. I sure hope Hewlett-Packard enjoyed its day in
the sun, because come the next morning, Compaq announced its own $800
models. But these aren't normal times, and the price war set me
thinking. Could the collapse in Asia and over-capacity among the
companies that make chips, hard drives and other components have cut
Compaq's costs so deeply in just a year that the company could be making
more money on a system selling for less? If so, that would be
tremendously important for Compaq's bottom line, because the same kind
of savings would make Compaq's higher-priced computers even more
profitable than they were last year.
ÿÿCompaq's new $800 Presario 2240 isn't merely $200 cheaper than the
$1,000 model of last winter -- it's better too. ÿÿÿÿCan Compaq possibly
be making any money at all on this machine? These new $800 machines aren't merely $200 cheaper than the $1,000
models of last winter -- they're better too. Compaq's original Presario
2100, for example, used a Cyrix MediaGX 133-megahertz chip -- no "Intel
Inside" here -- that handled the audio, graphics, and controller
functions normally performed by additional chips. That resulted in
slower graphics performance, but the compromise shaved $100 off the cost
of the box. To save a few dollars more, the Performa came with a
relatively slow hard drive and without any expansion slots. And it was
available only in black. Still, Compaq's engineers had picked their
compromises well, and customers found the machine's ratio of price to
power attractive. Less than a year later, a customer is making far fewer
sacrifices for $200 less. The new Presario 2240, for example, uses a
faster 200-megahertz Advanced Micro Devices K6Mmx chip. The system comes
with 32 megabytes of memory instead of 24, a bigger hard drive (6.5
gigabytes instead of 2), a 56k modem (instead of 33.6), and a
cutting-edge DVD-ROM drive instead of a plain vanilla CD-ROM. Can Compaq
possibly be making any money at all on this machine? Every analyst on
Wall Street knows that the company makes its biggest profits selling
high-power desktop computers and servers to the corporate market. The
company could be willing to cut margins to the bone at the low end of
the market to prevent some competitor from building the volume that
results in manufacturing efficiencies. Compaq, which owns more than 30%
of the personal-computer server market, could afford that tactic. But I
don't think Compaq has to use high-end sales to subsidize its sub-$1,000
business. You've probably read a lot about how the company -- already
the most efficient manufacturer in the personal-computer industry by
many measures -- has cut costs out of its distribution system in its hot
pursuit of Dell Computer (DELL). Those increasing efficiencies certainly
don't hurt Compaq's bottom line -- but the real key to its ability to
make money on an $800 machine lies with the companies that actually make
most of what Compaq puts in its boxes. The industrial giants of the 19th
and early 20th centuries -- U.S. Steel, General Motors, U.S. Leather --
made almost everything that went into their product. U.S. Steel mined
the coal that fired its furnaces. U.S. Leather owned the oak forests
that produced the bark tannin that it used to cure its leather. General
Motors made the batteries that went into a Chevy or Caddy.
ÿIntelAdvanced Micro DevicesCyrix/National Semiconductor ÿÿPlummeting
microprocessor prices alone have cut $143 out of the cost of Compaq's
product even as the company improved what it sells. In comparison -- and I don't mean this as a slight in any way -- Compaq
is more a packager than a manufacturer. The company takes
microprocessors from Intel (INTC) or Advanced Micro Devices (AMD),
graphic chips from S3 (SIII), disk drives from Quantum (QNTM) and turns
them into computer systems. When the prices of those very sophisticated
raw materials drop, so do Compaq's costs. And right now the prices of
those items are sinking like stones. Some of this has nothing to do with
the Asian crisis. For example, the hot competition between Intel,
Advanced Micro, and Cyrix/National Semiconductor (NSM) is almost
entirely the function of technology cycles in the microprocessor
industry compounded by slowing demand for personal computers. (See my
last column, "The Two Faces of Intel," for more on that battle.) The
falling price of microprocessors accounts for most of the $200 price cut
in Compaq's offerings all by itself. In the first quarter of 1997, an
Intel Pentium MMX 166 chip -- one faster than the Cyrix chip Compaq used
in the Presario 2100 -- sold for $356. Right now the same chip goes for
$112, according to Lehman Brothers. The faster 233-megahertz chip sells
currently for $213. Figuring that Intel's competitors have cut prices at
about the same speed as the industry leader, plummeting microprocessor
prices alone have cut $143 out of the cost of Compaq's product even as
the company improved what it sells. But the Asian crisis is pitching in
to cut Compaq's costs too. Compaq itself does very little manufacturing
in the countries hit hardest by the currency crisis. Its factories are
located in Houston, Scotland, Brazil, Singapore, and China. The latter
two nations have managed to escape the worst of the Asian currency
devaluation so far, so I don't expect that Compaq will get big cost
savings from its own manufacturing.
ÿWestern DigitalQuantumSeagate ÿÿCompaq may be in the enviable position
of being able to grab market share from less efficient manufacturers by
aggressive pricing. To measure the real effect of Asia, you've got to look at Compaq's
suppliers. Western Digital (WDC), a major supplier of disk drives, makes
its products in California, Singapore, and Malaysia. (Malaysia's ringgit
is down more than 40% against the dollar in the past 12 months.)
Competitor Quantum Corp., headquartered in Milpitas, Calif., actually
has farmed out all of its manufacturing to Japan's Matsushita-Kotobuki
Electronics. That's produced a double price cut from a falling yen --
down 10% against the dollar in the past 12 months -- and from the
plummeting baht and ringgit, since Matsushita-Kotobuki, like many
Japanese companies, has moved substantial parts of its manufacturing to
Southeast Asia. Seagate (SEG) makes all of its drives in Southeast Asia.
The disk-drive companies were swimming in over-capacity even before the
Asian slowdown. That produced major price cuts, especially at the low
end of the market (1.2- and 1.6-gigabyte hard drives) as these companies
tried to move inventory quickly to make room for more profitable 6.4-
and 9.3-gigabyte components. But the cash crunch that has hit Korean
manufacturers is likely to drive prices even lower as companies such as
Samsung and Hyundai look for sales at any price as long as they'll bring
in dollars. The savings from dropping prices in hard drives -- about $30
a machine, I calculate -- aren't the end of the story either. Memory
prices have collapsed. The new Presario uses a graphics accelerator from
S3 with major Asian content. And on and on. I don't think Compaq is
making a killing on each $800 machine that it sells, but thanks to these
price trends I believe the company isn't selling the product at a loss
either. In fact, I think Compaq may be in the enviable position of being
able to grab market share from less efficient manufacturers by
aggressive pricing of a feature-loaded machine and still be making more
money on its cheapest system than it was a year ago.
ÿCompaq That's the fundamental case for buying Compaq now. The technical
case argues for a bit of patience. Currently, Compaq's stock takes a
pounding whenever any technology company announces bad news. Shares are
stuck in a relatively narrow trading range of $56 to $62. I don't think
that Compaq will make much of a move higher until we're through the
steady dose of bad news that January earnings announcements are likely
to bring. Since 14% of its sales go to Asia, we could even see bad news
from Compaq in this period, before the mathematics of lower costs kicks
in. I'm going to watch the stock carefully for a while before adding it
to Jubak's Picks. Given the red ink I'm expecting to see running in the
streets in the next few weeks, I think I'll sit on the sidelines like
Madame LeFarge and stick to my knitting. ÿ |
