Michael: The other day I posted that Prudential had reiterated its Strong BUY on COMPAQ. The following is the text of its reasonings. It is worth reading. It concedes that COMPAQ may still have some difficulty with earnings but that is priced into the stock and the trends are all good. This is a long read but worth it. It contains a survey of the market segments.
MARCH MONTHLY MONITOR HIGHLIGHTS
08:04am EDT 7-Apr-99 Prudential Securities (K.ALEXY)
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o PC vendor and channel checks during the month suggest that corporate demand during the month of March has accelerated over February's weaker-than-expected levels. And while seasonal patterns typically suggest a sequential acceleration, we believe that demand is slightly better on a Y/Y basis as well.
o Still, we remain uncertain as to whether this strength will be sufficient to pull through weaker-than-expected results earlier during the quarter (particularly for those companies with a March quarter end), yet view the data as encouraging and representative of a positive inflection point.
o We believe that - much like in the 4Q when the market extrapolated perceived PC strength into 1999 suggesting a stronger-than-expected PC year - recently, sentiment has reversed with the market extrapolating 1Q weakness throughout the year.
o We have not changed our PC unit growth expectations for the year (16% unit growth) and have maintained that while demand "paused" during Q1 for a variety of reasons, the pause was temporary and not reflective of a more sustained slowdown in end demand. We believe March data supports this thesis and that PC stocks are beginning to rebound.
o Our survey of retail salespeople indicated that demand was in line with expectations for the month of March. Inventory levels in the retail channel remained lean and PC ASPs increased during the month, primarily due to the PIII introduction.
o We continue to recommend purchase of Dell, Gateway, and Compaq shares. We believe evidence of a re-acceleration in end demand will serve as a near-term catalyst for the shares. We continue to remain neutral on the disk drive and PC channel stocks.
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PC Demand Themes
After a softer-than-expected February, March demand re-accelerated with both vendor and channel checks noting renewed momentum during the month. It remains to be seen whether or not March demand was strong enough to pull through weakness experienced earlier in the quarter for vendors such as Compaq. And while we continue to expect that there is risk of a revenue and earnings disappointment, we believe this risk is already priced into the stock.
We view the acceleration in March as reinforcement to our thesis that PC demand has not permanently slowed and that the weakness experienced during the first quarter should not be extrapolated to the entire year.
To recap, after a seasonally soft January, demand data from the month of February from both channel and vendor checks indicated weakness vs. seasonal expectations. Our checks indicated weakness in unit volumes - rather than mere pricing pressure - which accounted for the revenue softness during the month.
Our checks further indicated the weakness was generally confined to the business (as opposed to consumer) markets - and was concentrated in the large and medium business segments - despite commentary from Compaq suggesting additional weakness in the small business market.
We had noted that we believed Compaq's commentary may have been the result of negative repercussions from the company's direct efforts in this segment, rather than a reflection of weakness in industry demand. We believe Compaq's recent announcements of improved terms to select channel partners on its Prosignia line are evidence of this thesis. Since our February report, however, Compaq has subsequently indicated that weakness was not in its "small business market" as
previously stated but rather was limited to its mid-market customer segment.
We maintain that the pause in corporate demand during the month of February was caused by several factors. First, we believe that some government and corporate I/T budgets took longer than normal to be finalized. Specifically, we believe controversy surrounding Y2K and the necessary level of spending required may have stalled the finalization of I/T budgets, causing a slower-than-expected
February roll-out. Secondly, even when I/T budgets had been finalized, it appears that Y2K also created confusion and a resulting pause, as buyers struggled to allocate the dollars to spend. Lastly, while the PIII was not cited as a reason for corporate customers to postpone purchases, the price cuts coincident on older P2 technology was believed to be a factor.
We believe corporate buying has now re-accelerated with both vendor and channel checks noting improved momentum during the month. And while February demand was generally noted to be weaker than seasonally expected, March demand was generally noted as being somewhat stronger-than-seasonally expected. Still, it remains unclear whether or not March demand levels were strong enough to offset
the weakness experienced earlier during the quarter. We believe companies such as Compaq - with a March quarter end - may still be at risk. We continue to believe Dell is tracking to expectations - given the company's April quarter end and assuming continued momentum in corporate demand - and is positioned more effectively to deliver strong Q1 results. We anticipate additional updates with
Dell later this week at the company's annual NY analyst meeting
Data on pricing trends remains mixed. Continued channel checks noted that vendor ASPs remained relatively stable during the month. We continue to believe direct PC vendors remain best positioned given the slight build in inventory levels noted last month, coupled with the Intel price cuts and product launch during the month.
We believe PC stocks remain attractive and continue to recommend purchase of Compaq, Dell, and Gateway shares. We believe that while it remains to be seen whether the March momentum holds - or was strong enough to pull out February's weak results - the current trends are encouraging. We maintain that PC unit demand estimates for the year remain intact and that the weakness experienced does not affect our 1999 growth outlook for the industry. We believe Gateway is
one of the more attractive near-term plays given the company's minimal exposure to the business segment and strong growth trends in its consumer and SOHO business.
PC Channel Themes
March marked a mixed month for channel companies. On the positive side, demand trends in the month of March improved over February's weak results with channel companies generally noting accelerated revenue growth - particularly in the U.S. market. In fact, Inacom noted that demand levels during March have accelerated beyond normal seasonal trends. Other checks also noted improvement in European sales momentum.
We believe that with the first wave of Intel price cuts completed and the launch of PIII during February, coupled with the completion of the budgeting processes for many corporate and government customers, end demand has accelerated during the month of March. We remain uncertain as to whether March's strength will be sufficient to offset weakness experienced earlier during the quarter for PC and channel vendors which have a March quarter end. However, we believe that the
general trends are encouraging and suggest a reversal of the prior month's weakness. Also importantly, if the strength holds, we expect companies with an April quarter end will be better positioned to absorb the weakness experienced earlier during the year.
In addition to demand strength, pricing pressures in the channel have begun to ease. Recent updates with MicroAge, in fact, suggest the company has recently raised pricing. Others have also noted that pricing in the U.S. distribution market has improved. With CHS Electronics now aware of its actual profit levels (upon adjustment of vendor rebates which resulted in a restatement of the company's margins and earnings for FY98) we expect pricing in the European
market may similarly begin to ease. In addition to increased stability of channel pricing conditions, corporate channel sources continue to note that vendor ASPs remain relatively stable.
Also positively impacting the channel, Compaq has recently changed the terms surrounding its Prosignia line (the company's direct line targeting the small and medium business market). Initially, distributors had not been able to carry the product nor could they receive credit for sales generated by their reseller customer base. Resellers were generally reluctant to push Compaq's Prosignia
line for fear of relinquishing their customer database information - despite the agency fees offered by Compaq. The recent changes provide distributors the ability to offer Prosignia product and receive vendor incentives. We view this shift as a sign that Compaq is struggling to implement its direct initiative and as a result, has shifted the balance of power back towards its channel partners
(at least near-term) - benefiting the company's channel partners.
Inventory levels appear to be relatively stable (albeit at generally higher levels of an estimated 5 weeks - 1 week up from year-end levels). And despite much controversy, we do not believe there has been any unusual incentives or rebates offered at quarter end. We continue to expect inventory days for corporate resellers to decline sequentially while distributors will likely hold inventory days relatively flat sequentially. While inventory levels generally
remain at higher-than-targeted levels, we are not seeing evidence of further builds, and with the pick up in end demand, we would generally expect levels to be working back down.
We believe PC distributors stocks have become more attractive in light of Compaq's recent moves. We expect reseller stocks, however, will remain under pressure as a result of increased vendor focus on direct initiatives in the large corporate market space. We remain neutral on the group.
PC Retail Survey Highlights
Our survey of retail salespeople indicated that demand was in line with expectations for the month of March. Inventory levels in the retail channel remained lean and PC ASPs increased during the month, primarily due to the PIII introduction. Retail selling prices for low-end bundles (CPU, monitor, and printer) averaged $1,052 (versus $930 in February); for mid-range bundles, the average retail selling price was $1,469 (versus $1,390 in February); for high-end bundles, retail selling prices averaged $2,247 (versus $2,000 in February). The approximate mix of low-end, mid-range, and high-end systems sold
was 37%, 40%, and 23%, respectively with Compaq and Hewlett Packard remaining the most popular brands.
Disk Drive Highlights
We continue to believe that some HDD companies over-estimated Q1 demand (as a result of strong Q4 order rates) and will post weaker-than-initially-expected desktop revenues during Q1. Positively, we are not seeing any signs of inventory build (we noted last month that HDD channel inventory levels had increased over low December and January levels and had increased slightly but were well within normalized ranges) and believe that drive vendors have adjusted
build plans rather than engaged in any channel stocking. In addition, we are not expecting any earnings disappointments in light of the favorable trends in HDD vendors' efforts to lower costs and improve margins in what remains a difficult industry environment.
In addition, our disk drive checks indicate that similar to the PC and PC channel checks, drive companies have seen some acceleration in OEM order rates during the month of March. Still, unlike the PC stocks, we are not anticipating
that this recent strength will serve as a catalyst for disk drive shares. We maintain that the primary problem stems from the broader competitive landscape with too many players sufficiently well positioned to offer competitive product.
We continue to believe that the market needs to consolidate - or find another means to reduce effectively aggregate capacity - before we see a sustained recovery for the shares.
We continue to believe the group will trade in tandem until such time when the health of the broader market improves. However, we anticipate that there may be another near-term trading opportunity to the extent that some vendors encounter difficulty with the impending GMR transition - effectively removing capacity for the market and possibly presenting a near-term catalyst for the shares.
We remain neutral on the group at this time. |
