The Bull Market Weekly Report
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The Bull Market Weekly Report
THE BIG PICTURE -- WHAT'S HAPPENING OUT THERE?
MARKET UPDATE
The major indices went up a few percentage points for the second straight week, despite a gloomy jobs report. The S&P 500 closed at 927 on Friday. We have been expecting the S&P to reach about 950, which is the top of the recent trading range. It may get there on the strength of the administration's proposed tax cuts, as well as some mildly encouraging economic news on investment spending. After initially selling off, the market quickly digested the jobs news and resumed its upward progress.
In spite of deteriorating employment, a healthy 166 of the 240 Sectors in our database were in the black last week. And 9 of the 10 leaders were from Technology. Data Storage and Processing Systems led the way with better than 16% gains each. Other leaders included Printed Circuit Boards, Networking & Communication Devices, Application Software, Semiconductor-Integrated Circuit Boards, Diversified Communication Devices, Electronic Stores, Semiconductor Equipment & Materials, and Communication Equipment. Encouragingly, these are Sectors that can drive an economic recovery.
However, the drags on corporate profit growth remain strong. We have discussed these concerns in past issues of the newsletter. Primary among them is corporate pricing power, which is necessary for profit growth, and it has not improved. Moreover, the Dow is at the same level now as it was at the start of 1999 and the S&P and the Nasdaq are at 1998 levels. Accordingly, we have a ways to go before enough of the damage to the market has been repaired and we can safely say we have beaten off the bear.
So, we see the market holding its own over the next few months and perhaps rising to the next level of resistance, which is about 965 -- and perhaps the subsequent level of 1000 -- for the S&P. In the meantime, value stocks like the ones in the Fundamental Portfolio should show improvement. Also, our scans are finding many stocks in firming patterns, which is a hopeful sign for the overall market and positive for the Trading Account. Of course, a war or further global tensions would change that picture.
Market Indices from Around the World
Friday, January 17, 2003 Index
Close Change Day% WTD% MTD% YTD%
UNITED STATES -
- - - - -
Dow Jones 8587 -111 -1.3% -2.3% 3% 3%
S&P 500 902 -13 -1.4% -2.8% 2% 2%
NASDAQ 1376 -48 -3.3% -4.9% 3% 3%
NASDAQ 100 Trust 25 -1 -4.3% -6.6% 4% 4%
S&P 400 79 -1 -1.7% -2.6% 1% 1%
TREASURY BONDS
- - - - - -
10 Year 4.02 down 5 basis points
-14bp +20bp +20bp
30 Year 4.93 down 4 basis points
-13bp +14bp +14bp
EUROPE
- - - - - -
UK FT-SE 100 3821 -61 -1.6% -3.9% -3% -3%
FRANCE CAC 40 3057 -86 -2.7% -3.3% 0% 0%
GERMANY DAX 2919 -135 -4.4% -3.9% 1% 1%
ASIA
- - - -
JAPAN NIKKEI 225 8690 81 0.9% 2.6% 1% 1%
HONG KONG HANG SENG 9615 -129 -1.3% -1.1% 3% 3%
AMERICAS
- - - - -
BRAZIL BOVESPA 11676 -276 -2.3% -4.6% 4% 4%
CANADA TSE 300 6756 -71 -1.0% -0.7% 2% 2%
MEXICO BOLSA 6204 -128 -2.0% -2.3% 1% 1%
MARKET OVERVIEW
MIXED EARNINGS MIX UP MARKET
It was a pretty rough week for the market. While the market moved at a minimum early in the week, a flurry of high-profile earnings reports made the market move big-time. Unfortunately, most of the movement was of the negative variety. For the week, all three major indices finished on the downside, with the Nasdaq leading the decline on disappointing Tech earnings.
If early-week trading was any kind of indicator, investors didn't expect much pessimism in this week's earnings reports. Monday was a very wishy-washy session, and the major indices finished near where they started on the day. But Tuesday was strongly positive, as all three indices finished with 0.5% gains or better.
That's when the first bomb dropped. INTEL (INTC, $16.34, down 1.08) was the bomber, reporting better-than-expected earnings but reducing its capital spending. The market took that as a sign that a much-awaited Tech recovery was farther off than investors thought.
What ensued was a bout of earnings announcements in the Tech sector that confirmed Intel's sentiments. APPLE COMPUTER (AAPL, $14.10, down 0.62) and YAHOO (YHOO, $18.37, down 1.63) reported earnings after the bell on Wednesday. Apple posted a second straight quarterly loss. Yahoo released an earnings report similar to Intel's: The Internet firm beat earnings, but not by as much as investors were hoping for.
The lukewarm results continued on after the bell on Thursday. IBM (IBM, $81, down 7) experienced a 56% decline in its profits and cautiously backed its 2003 profit targets. MICROSOFT (MSFT, $51, down 5) issued a bevy of news, not only issuing earnings but also declaring its first-ever dividend and enacting a 2-for-1 stock split. While the software giant bested estimates, it too remained cautious on future earnings projections. Further earnings disappointments from SUN MICROSYSTEMS (SUNW, $3.75, down 0.02) and ADVANCED MICRO DEVICES (AMD, $6.03, down 1.38) added to negativism engulfing the sector.
While Tech stocks submitted to the bad news, they weren't the only ones to suffer from discouraging profit statements. The Dow Jones felt the pain from Intel, IBM, and Microsoft. But the index had its own high-profile earnings report to deal with as well. GENERAL ELECTRIC (GE, $25, down 1) posted a decline in 4Q earnings, causing the conglomerate to miss its traditional target of double-digit earnings growth for the year.
Investors were hoping for a solid earnings season that would provide a foundation for a quicker economic recovery. But after this week's disappointments, the earnings environment remains shaky at best. Last quarter's earnings were good, but that was due to the high number of earnings warnings that came out before the actual reports. This time around, we didn't see many earnings downgrades. So, companies have to deal with higher expectations and only a few companies are passing the test. That doesn't bode well for the rest of the reporting period. Watch out for even more pessimism in the coming weeks.
For the week, the Dow Jones sank 198 points, a rough 2.3%, to close at 8587.
The S&P fell 26 points, an even-rougher 2.8%, to finish at 902.
And the Nasdaq plunged 72 points, a heartbreaking 5.0%, to end the week at 1376.
ECONOMY WATCH
1. RETAIL SALES RISE
Retail sales rose 1.2% in December, the Commerce Department said Tuesday. The increase met economist expectations and was the largest rise in five months. The figures were led by auto sales, which jumped a surprising 5%. But the auto sales masked a disappointing performance by non-auto retail sales, which remained flat for the month at just over $230 billion. Economists were expecting a 0.2% increase in the number. So, these numbers echo the gloomy performance that we've seen in the Retail sector lately.
2. PPI IS TAME
The latest producer price index (PPI) reading came out Wednesday. The PPI remained unchanged while the core index fell 0.3% in December, according to the Labor Department. For the year, the PPI jumped 1.2%. The monthly reading surprised economists, which expected a 0.3% rise in the overall index and a flat reading in the core index. The core PPI factors out food and energy costs which typically are volatile. The falling core PPI reignited fears of deflation for some economists, but overall the market ignored the news. It's earnings season, so corporate developments are in the forefront right now.
3. BUSINESS INVENTORIES RISE
The Commerce Department reported Wednesday that business inventories rose 0.2% in the month of November. Sales increased 0.3% for the month. Inventories are now at their highest level in a year. Year-over-year, inventories are up 0.6%, while sales are up 3.5%. The inventory uptick could suggest that businesses are boosting up supply in anticipation of a pickup in demand this year.
4. PRICES STAY IN CHECK
The consumer price index (CPI) rose 0.1% in December, the Labor Department said Thursday morning. The core CPI experienced a similar 0.1% increase. Economists were looking for a 0.2% rise, so the number was a surprise. For all of 2002, the CPI ticked up 2.4%, compared to a smaller 1.6% increase in 2001. The CPI numbers tell the same story as the PPI figures released Wednesday -- inflation is still not a problem.
5. INDUSTRIAL PRODUCTION FALLS
The Federal Reserve said Friday that industrial production fell 0.2% in December, the fourth decline in the last five months. Economists were expecting a 0.2% rise for the month. Production dropped a sharp 2.4% in the fourth quarter and 0.6% for the year. In 2001, industrial production sank 3.5%, making this the first two-year decline since 1974-75. Falling auto production was a major reason for the drop. Over the past year, auto sales have helped support an economic recovery, but the automakers are expecting a decline in demand in 2003.
IN THE NEWS
I. CASE CLOSED: AOL CHAIRMAN RESIGNS
AOL TIME WARNER (AOL, $14.81, down 0.07) chairman Steve Case resigned Monday, effective in May, ending a wild era for the media company. The former CEO of America Online before the firm's merger with Time Warner, Case was a strong backer of the online unit. Without him in management, AOL may spin off its troubled online division and change the parent company's name to Time Warner. Since the merger of the two companies in 2001, AOL's stock has dropped 70%, due in large part to the struggles of America Online. The division faced slowing advertising and subscriber growth, as well as stiff competition from broadband Internet service providers. Since Time Warner's media properties are not nearly as troubled as the online division, a spin-off likely would be accepted favorably by Wall Street and its shareholders.
II. DUKE IS A LAME DUCK WITH LOWER EARNINGS FORECASTS
DUKE ENERGY (DUK, $17.90, down 3.10) warned Monday that its earnings in 2003 won't reach previous projections, and the stock was hammered on the news. The firm, which had projected full-year earnings of $2.00 a share, now expects profits to come in at 10 cents less than that forecast. The lowered estimate includes a restructuring charge of 65 cents a share. In addition, the company will take a 4Q charge of 40 cents partly due to 2,000 job cuts. The company continues to suffer from the Enron scandal fallout, with declining energy trade volume and increasing credit concerns and government regulation. As a result, Duke will cut back on capital spending this year by more than half, to just $3.2 billion. The Energy sector is still reeling from the Enron debacle, and we'd stay away from everyone in the sector until the companies can fix their problems.
III. ALCATEL TELLS INVESTORS OF HIGHER EARNINGS
ALCATEL SA (ALA, $6.54, up 0.78) surprised investors and provided the Tech sector with a shot in the arm Tuesday. The Telecom equipment maker upwardly revised its 4Q revenue and earnings projections, as the company experienced better-than-expected benefits from its restructuring efforts. Alcatel said that revenue growth should be in the high 20% range sequentially over the third quarter, while operating earnings should be "around breakeven" after accounting for one-time charges. The firm's previous estimates were for 20% revenue growth and a breakeven quarter BEFORE the one-time charges. The news sparked a Tech rally Tuesday, especially in the Telecom and Networking sectors.
IV. SIMON SAYS DEAL MUST HAPPEN BY FEBRUARY
SIMON PROPERTY GROUP'S (SPG, $32, down 2) quest to acquire TAUBMAN CENTERS (TCO, $17.24, up 1.08) continued Wednesday, as the #1 U.S. mall owner increased its bid for the properties and added a partner. Australian firm Westfield America Trust joined Simon in offering $20 a share for Taubman. Simon also placed a deadline on the offer, saying that it would remove its hostile bid if less than two-thirds of Taubman's shares were tendered by February 14th. Previously, Simon was offering a lone bid of $18 a share, too low by Taubman's estimation. Even if two-thirds of public shareholders agree to the offer by the deadline, the deal won't be set in stone. But at least it would pressure Taubman's board of directors to reconsider the sale. Like we've said before, we like this deal and it would be a boon to Simon's business if it goes through.
V. BANK OF AMERICA BANKS ON CONSUMERS FOR HIGHER EARNINGS
BANK OF AMERICA (BAC, $71, down 1) released its 4Q financial results before the bell Wednesday. The bank's earnings jumped 27% year-over-year to $1.69 a share, on a slight revenue increase from $8.90 billion to $8.97 billion. The higher profit topped analysts' estimates of $1.63 in earnings. Full-year earnings totaled $5.91 a share in 2002, up from the 2001 profit of $4.18. Growth came from a number of different consumer business areas, including mortgages and debit cards. But revenues were suppressed by the bad loan problem that many Wall Street banks face. Bank of America plans to continue riding consumer businesses in 2003.
VI. GM POSTS STRONG EARNINGS
GENERAL MOTORS (GM, $40, up 1) released its 4Q earnings Thursday morning. The company reported a profit of $1.71 a share, nearly tripling the firm's earnings of 60 cents a share in the year-ago period. Net income quadrupled to just over $1 billion. The results surpassed analysts' estimates for $1.53 in earnings for the quarter. Despite the high number of incentives that the automaker offered to its customers, GM was able to boost earnings on the strength of truck sales. On average, trucks are more profitable for the company than cars.
But all is not stellar with GM. 2003 earnings are expected to fall, as the firm faces rising pension costs, slower U.S. sales, and downward pricing pressure coming from -- that's right -- the high number of incentives. So basically, the firm's lower prices this year boosted 2002 earnings by taking potential profits away from 2003 earnings. Personally, we like to invest in companies that focus on the long-term instead of the short-term. And it is our strong contention that General Motors is heading for some serious trouble ahead.
VII. SEARS BEATS ESTIMATES
SEARS, ROEBUCK (S, $29, up 1) posted a stronger-than-expected fourth quarter. The retailer announced earnings of $2.11 a share, up from $2.02 in the year-ago quarter. Analysts were expecting just $1.91 a share from the company. Sears experienced weakness in its credit card division. The company struggled to deal with a 26% jump in personal bankruptcies and the ensuing rise in credit card delinquencies. But strong holiday sales in the firm's Lands End division made up for the decline. However, that's not particularly good news, since the weaker business (credit cards) makes up two-thirds of the firm's profits.
VIII. EBAY TRIPLES ITS PROFIT
Online auction website EBAY (EBAY, $75, up 2) announced that its 4Q02 earnings tripled 4Q01 results. The company earned net income of $87 million, or 28 cents a share, vs. a 9-cent profit in the year-ago quarter. Analysts were looking for earnings of 24 cents a share. Revenues almost doubled from $220 million to $415 million in the quarter. For the year, net income rose from $90 million to $250 million, almost triple. eBay expects the strong performance to continue in 2003, as the company raised its projections for the current year. For instance, the firm expects to earn 30 cents a share in the first quarter, 5 cents higher than the consensus estimate.
IX. SUN SETS ON SUN'S EARNINGS
SUN MICROSYSTEMS (SUNW, $3.75, down 0.02) reported its biggest quarterly loss ever after Thursday's close. The computer maker reported a loss of $2.3 billion, or 72 cents a share, in its fiscal second quarter (ended December 29), wider than the 13-cent loss in the year-ago period. Excluding a $360 million restructuring charge, the company experienced a break-even quarter, better than the 2-cent loss that analysts were expecting. Revenues, however, fell 6% to $2.9 billion but rose 6% from 3Q numbers. Facing stiff competition from IBM (IBM, $81, down 7), HEWLETT-PACKARD (HPQ, $19.23, down 1.62), and DELL COMPUTER (DELL, $25, down 2), the company has focused on cutting costs in order to drive profits, or in this case narrow the loss. It looks like Sun has more work to do.
. SECTOR-RELATED NEWS
BLUE CHIPS
GENERAL ELECTRIC'S EARNINGS ARE DIM
Before Friday's opening bell, GENERAL ELECTRIC (GE, $25, down 1) released its 4Q financial results. The conglomerate earned net income of $3.1 billion, or 31 cents a share, after taking a previously-announced $1.5 billion charge. Profits fell 21% from the company's 4Q01 earnings of 39 cents a share but met Wall Street expectations. Revenue, however, topped expectations, increasing 4% to $35.4 billion. For the year, GE earned total net income of $15.1 billion, 7% more than in 2001.
TODD'S TAKE: This marks the end of a disappointing year for GE. In its first full year after the retirement of fabled CEO Jack Welch, the conglomerate failed to reach double-digit earnings growth. Instead, the company increased earnings only 7%. The 4Q earnings decline marked the second such decline of the year, as earnings fell in the first quarter of 2002 as well. As a result of the lackluster performance, the stock fell almost 40% last year.
This quarter, earnings were hurt by the slow economy, reduced capital spending, and higher raw material costs. In addition, business was down in the firm's power systems and consumer products divisions. Sales of gas turbines, a big growth driver over the past few years, dropped 16% in the latest quarter. The consumer products business posted a heavier decline, as profits fell 32% year-over-year. But the commercial finance division grew earnings by 30% and profits at GE's NBC television network rose 14% on the strength of "Friends" and other fan favorite programs. The popular sitcom is coming back for another season, so expect the strong performance at NBC to continue next year.
Speaking of next year, the current quarter will be another tough one for GE. The company said that earnings likely will fall 5-10% from 1Q02's numbers, more than the 3% drop that analysts expect. Either way, the results would mark a second straight quarterly decline. However, the company reaffirmed its 2003 earnings forecast of $1.55-1.70 a share, a range of 3-13% earnings growth. So, there remains the possibility that GE will return to double-digit growth in 2003. We think that growth will be closer to 5% than 13%.
No doubt about it: GE is going through a rough period right now. The conglomerate is so big and diverse that it cannot escape the grasp of a slow economy. But GE's diversification will keep the company from stumbling too much. You can see that effect in this quarter's earnings report: A couple of businesses posted significant losses, but a couple of others picked up some of the slack. This is a tough earnings environment for all companies, so this earnings announcement is expected. General Electric IS effectively, the world market. And the world economies are struggling now.
TECHNOLOGY
EARNINGS WITH A CAPITAL E FROM INTEL
INTEL (INTC, $16.34, down 1.08) became the first big-name firm to report earnings, and the company reported the first high-profile earnings surprise of the season. After Tuesday's close the chipmaker announced 4Q earnings of 16 cents a share, more than doubling the year-ago profit of 7 cents. The numbers also topped the consensus analyst estimate of 14 cents. Revenues jumped from $7 billion in 4Q01 to $7.2 billion in 4Q02. However, Intel lowered its capital expenditure estimates for the year, expecting to spend $3.5-3.9 billion in 2003. Last year, the firm spent $4.7 billion on capital equipment.
TODD'S TAKE: The Tech sector rallied in anticipation of a good earnings report from Intel, and investors got what looked like a glowing report at first glance. But after a closer look, the company's report was negative for the sector, and the stock sold off. 4Q revenue was surprisingly strong, and according to the company, "Orders continued to come in through the holiday season."
Average prices for the chipmaker's microprocessors increased because of higher sales of laptops and servers, which use more expensive chips than normal desktops. The firm also sent out record microprocessor and motherboard chipset shipments and increased market share in most of its core business areas, according to Intel executives. For instance, sales jumped to an all-time high in Asia, especially in China and Taiwan. But sales remained strong in Europe and Japan as well. Everything's going great for Intel then, right?
Not so fast, Jack! A closer look at this quarter's earnings report shows us that much of Intel's profits came from cost-cutting. Investment bank Morgan Stanley says that the firm's fourth quarter "clearly reflects the seasonal uptick in PC demand, but it also shows significant restraint on behalf of Intel, which is now starting to drive the bottom line." The company confirmed this, saying, "What we've seen for essentially eight quarters is flat revenues.no underlying economic growth."
It's not so much that the Chip sector is improving at a quicker pace, but instead that Intel is exercising fiscal thrift. One example of the company's frugal stance is its expected level of capital expenditure this year. The firm will tighten its capital spending budget for 2003. That's not good news for the Semiconductor Equipment sector, as Intel is the industry's biggest customer. Losses in stocks such as APPLIED MATERIALS (AMAT, $13.53, down 2.17) and KLA-TENCOR (KLAC, $36, down 5) reflect this reality.
Still, many investors and analysts predict a recovery in the Chip sector this year, and Intel mentioned that the replacement of obsolete PC's will boost computer and chip sales. MICROSOFT (MSFT, $51, down 5) will help jumpstart the replacement drive, as it will soon end technical support on its Windows 98 and Windows NT 4 operating systems, forcing many customers to replace their systems.
Overall, Intel's earnings report is optimistic. But it is cautiously optimistic. The company definitely doesn't predict a quick recovery in the Chip or PC sectors. The firm is doing business at a strong clip, but this isn't the kind of earnings report that will make us go out and buy Tech.
TECHNOLOGY
MICROSOFT EARNINGS A MIXED BAG
Holding $40 billion in cash, MICROSOFT (MSFT, $51, down 4) Thursday announced its first-ever dividend, as well as a 2-1 stock split. The good news was tempered, however, by lowered earnings guidance for 2003 and a weak macroeconomic outlook for the Tech industry.
Microsoft had been the only Dow company not to declare a dividend. Until now. The company called the dividend of 16 cents a share (8 cents post-split) a "starter" dividend that is in the same ballpark as that of other large Tech companies. The stock split represents the ninth such split since the company's IPO in 1986.
Microsoft's revenue for the quarter ending Dec. 31, 2002, was $8.54 billion, up 10% over the same period in the prior year. Earnings came in at 47 cents a share, which compared to a 41-cent profit in the prior year. EPS and revenue figures were in line with the previous quarter's guidance. This quarter's EPS included a 3-cent charge for lawsuits and 5 cents for impairments.
The company's cautious optimism and this quarter's positive earnings were tempered by disappointing macroeconomic results overall, and the company does not expect to see a significant upturn in IT spending in the short term.
TODD'S TAKE: Microsoft management announced guidance for 3Q03, ending March 31, expecting EPS of 47 cents on revenues of $7.7 billion, down from this quarter's revenue figures. EPS for the full fiscal year ending June, is expected to be $1.91, on revenues of $32 billion. This is down from previous guidance of a $1.94 profit on $32.4 billion in revenue.
Management reported several macroeconomic factors that contributed to the downgrade in guidance, including PC unit volume being flat to only slightly up and soft IT spending overall. PC demand was down in the US, Japan, and Latin America, with low single-digit growth seen in Europe, Middle East and Africa.
Offsetting those negative factors were the success of the Windows XP operating system. Additionally, revenue from server platforms experienced better-than-expected 12% growth, due to a shifting trend towards lower-cost standard hardware that runs Microsoft platforms as opposed to the alternative Unix system. SQL Server revenues also grew in the double digits, due to recent adoption of this Microsoft software by federal government agencies and renewals of several major enterprise agreements. Microsoft also saw revenues in the Home and Entertainment segment grow 40%, due to strong performance of the Xbox gaming platform.
Management was less specific about long-term guidance for FY04, stating, "To have good results against others in 04, we are going to have to book new business, work on our costs, and finally we'll need some help from the economy." Management noted during the earnings conference call, "We'll have a tough issue" if server and PC unit shipments don't increase in 2004.
Basically, the earnings report showed solid results but raised concerns over the company's future. We applaud the concept of the dividend, but think it is puny in reality. Microsoft generates so much cash that the payout won't cause the company to taper off its growth. However, like we mentioned earlier this week, Microsoft is trading at a high valuation. The company will have to keep showing solid earnings improvement in order to justify its high PE.
The company is growing at 10% a year, and should have a PE of 10. Give it a 15 PE and you have a $29 stock. Give it a PE of 20, TWICE the historical average, and you have a $38 stock. We're concerned.
FINANCIAL
BANK ONE, WACHOVIA BANK ON CONSUMERS
A number of companies reported their 4Q financial results, including a couple of firms in the Banking sector. BANK ONE (ONE, $39, up 1) announced net income of $840 million, or 72 cents a share, for the quarter -- a 56% jump over last year's 46-cent profit, which included a $220-million restructuring charge. Excluding the 2001 charge, net income rose 10% year-over-year. Analysts expected the bank to earn 72 cents, so the results were right on the money. For all of 2002, Bank One earned $2.80 a share.
WACHOVIA (WB, $38, unch.) increased its profits by 22% in the latest quarter. The bank reported net income of $890 million, or 66 cents a share, compared to earnings of 54 cents in 4Q01. The results included a charge of 6 cents a share related to the firm's merger with First Union. Excluding the charge, the bank met analysts' estimates of 72 cents in earnings. For all of 2002, Wachovia earned $2.60 a share, an 80% jump over 2001's results.
TODD'S TAKE: Solid reports from a couple of bank stocks in our Financial Portfolio. Both banks met expectations for a 72-cent profit, despite the continued market downturn.
As was the case with BANK OF AMERICA (BAC, $71, down 1) Tuesday, consumer businesses propped up earnings in the fourth quarter for the firms. Bank One, the nation's #6 bank, earned $335 million from its retail businesses, 16% more than 4Q01 excluding one-time charges in the year-ago period. As a testament to the booming residential real estate market, home equity loan production jumped 48% over 4Q01 to $4.9 billion and increased 20% to $790 million over 3Q02. The firm now holds a portfolio with $28.5 billion in loans, a 13% expansion from last year.
In addition, average core consumer deposits grew 9% to $66 billion in the quarter. And the company prepared for even more growth in the retail business, opening new banking centers, extending center hours, and refurbishing existing centers and ATMs. Bank One's CEO had only positive things to say, mentioning that the bank "enters 2003 in an extremely strong position." Also, "We are confident that we are making all of the investments necessary to achieve quality growth as we continue to focus on the customer."
Wachovia's performance confirmed that business in the fourth quarter was consumer-driven. General Bank revenue, which includes revenue from both retail and small business customers, increased 4% from the third quarter of 2002 and 5% from the fourth quarter a year ago. Key factors for the expansion included solid growth in core deposits and residential mortgage-related revenues, investment sales through the branch system, and continued strong debit card sales volume.
Loans grew 5% subsequently and 9% year-over-year, mainly due to strength in consumer real estate-related products. Average core deposits jumped 8% from 4Q01 levels, and average low-cost deposits surged 21% year-over-year.
In 2002, Wachovia increased its dividend by 8%. Combined with price appreciation, the stock generated a total annual return of nearly 20% -- the best performance among the 50 largest U.S. banks. 2003 looks solid, if not spectacular, as well, according to the nation's fifth-largest bank, as the firm feels "very confident" about its prospects in 2003.
These latest bank reports show how big a part the consumer is of the overall economy. Consumers are driving this recovery, not only by buying products but also by borrowing money from banks to buy them. And if the stock market shrugs off its bearish ways and the job scene improves, consumers will be able to sustain their spending. That will pay off big time for the banks.
PHARMACEUTICALS
PFIZER: KING OF THE DRUG SECTOR
Special to The Bull Market Report
By Chuck Benemerito
OUR TAKE: Pharmaceutical giant PFIZER (PFE, $30, down 1) is already the world's largest drug company in terms of market capitalization ($190 billion). When it completes the acquisition of PHARMACIA (PHA, $41, down 1), however, the drug giant will become the largest drugmaker in terms of sales as well.
The combined company expects to generate $53 billion in revenues this year, more than current sales leader MERCK (MRK, $58, down 2) expects to make. After the deal, Pfizer will own a stable of drugs that includes 12 different treatments with annual sales of at least $1 billion. Currently, Pfizer owns such blockbuster drugs as cholesterol treatment Lipitor, depression drug Zoloft, and Viagra.
The acquisition of Pharmacia, which should be completed in March, gives Pfizer treatments such as Rogaine (hair loss), Nicorette (tobacco addiction), and Celebrex, the arthritis drug that the companies have sold together for four years. And Pharmacia also sells treatments for diseases that Pfizer doesn't yet cover. For instance, Pharmacia owns the cancer drug Camptosar and the heart disease treatment Eplerenone, both of which Pfizer is lacking.
As you can see, the new company will have a strong drug pipeline. And the firm won't face patent expirations on its blockbuster treatments anytime soon. Lipitor holds its patent until 2010, Viagra until 2011, and Celebrex until 2013. In contrast, patents for SCHERING-PLOUGH'S (SGP, $22, down 1) treatment Claritin and ELI LILLY'S (LLY, $66, down 1) drug Prozac both expired last year, so those two companies will have to find new blockbuster treatments to replace their big revenue producers.
Another benefit of the merger is the cost savings that Pfizer sees from the deal. This year, the company projects $1.4 billion in costs savings. In 2004, the firm expects to save $2.2 billion. That's a significant amount of dough that the company can put towards developing new drugs.
The stock's current fundamentals are encouraging as well. There are 26 analysts that cover Pfizer, and 24 of them hold at least a "buy" rating on the stock (13 rate it a "strong buy"). And even with its high market cap, Pfizer is a good value at this price. The company expects to earn $1.84 a share this year, giving it a PE of under 17. Right now, the whole Drug sector is trading at over 19x 2003 earnings. Additionally, Pfizer is one of just seven U.S. firms that have a "AAA" credit rating, and that keeps the company's borrowing costs at a minimum.
With such strong indicators, we expect Pfizer to perform well for the next few years. The Pharmacia deal is a good strategic move for the company. However, since Pfizer is so big now, some investors are worried that the firm will have to keep acquiring companies in order to support future growth. But if Pfizer's past acquisition history is any indication of what the future holds, we're not worried about the firm's ability to pick out the winners in the field.
2. THE BULL MARKET REPORT PORTFOLIO CORNER
Baby boomers are headed into their golden years in droves, needing everything from increased health insurance to assisted living. Few other industries are supported by such incredible demographics trends, not only in the United States, but also globally. Relative to the broad market's performance and even on an absolute basis the stocks of HMOs continue to do well. One index that measures their performance is up about 26% year-to-date. Hospital stocks are up about 18%.
If you're a long-term investor, a dose of healthcare stocks could give your portfolio a nice shot in the arm. Many of the stocks in our portfolio have the size and market dominance it takes to squeeze out extra profits from every dollar of revenue they generate. And best of all, our portfolio holdings have attractive valuations relative to the earnings growth that we expect they will achieve for the foreseeable future. HMOs are one of the few industries that have pricing power in the current low inflation environment. Part of the reason behind the move higher this year is that HMOs have been able to increase premiums without losing customers.
MARKET UPDATE
The major indices went up a few percentage points for the second straight week, despite a gloomy jobs report. The S&P 500 closed at 927 on Friday. We have been expecting the S&P to reach about 950, which is the top of the recent trading range. It may get there on the strength of the administration's proposed tax cuts, as well as some mildly encouraging economic news on investment spending. After initially selling off, the market quickly digested the jobs news and resumed its upward progress.
In spite of deteriorating employment, a healthy 166 of the 240 Sectors in our database were in the black last week. And 9 of the 10 leaders were from Technology. Data Storage and Processing Systems led the way with better than 16% gains each. Other leaders included Printed Circuit Boards, Networking & Communication Devices, Application Software, Semiconductor-Integrated Circuit Boards, Diversified Communication Devices, Electronic Stores, Semiconductor Equipment & Materials, and Communication Equipment. Encouragingly, these are Sectors that can drive an economic recovery.
However, the drags on corporate profit growth remain strong. We have discussed these concerns in past issues of the newsletter. Primary among them is corporate pricing power, which is necessary for profit growth, and it has not improved. Moreover, the Dow is at the same level now as it was at the start of 1999 and the S&P and the Nasdaq are at 1998 levels. Accordingly, we have a ways to go before enough of the damage to the market has been repaired and we can safely say we have beaten off the bear.
So, we see the market holding its own over the next few months and perhaps rising to the next level of resistance, which is about 965 -- and perhaps the subsequent level of 1000 -- for the S&P. In the meantime, value stocks like the ones in the Fundamental Portfolio should show improvement. Also, our scans are finding many stocks in firming patterns, which is a hopeful sign for the overall market and positive for the Trading Account. Of course, a war or further global tensions would change that picture.
Market Indices from Around the World
Friday, January 17, 2003 Index
Close Change Day% WTD% MTD% YTD%
UNITED STATES -
- - - - -
Dow Jones 8587 -111 -1.3% -2.3% 3% 3%
S&P 500 902 -13 -1.4% -2.8% 2% 2%
NASDAQ 1376 -48 -3.3% -4.9% 3% 3%
NASDAQ 100 Trust 25 -1 -4.3% -6.6% 4% 4%
S&P 400 79 -1 -1.7% -2.6% 1% 1%
TREASURY BONDS
- - - - - -
10 Year 4.02 down 5 basis points
-14bp +20bp +20bp
30 Year 4.93 down 4 basis points
-13bp +14bp +14bp
EUROPE
- - - - - -
UK FT-SE 100 3821 -61 -1.6% -3.9% -3% -3%
FRANCE CAC 40 3057 -86 -2.7% -3.3% 0% 0%
GERMANY DAX 2919 -135 -4.4% -3.9% 1% 1%
ASIA
- - - -
JAPAN NIKKEI 225 8690 81 0.9% 2.6% 1% 1%
HONG KONG HANG SENG 9615 -129 -1.3% -1.1% 3% 3%
AMERICAS
- - - - -
BRAZIL BOVESPA 11676 -276 -2.3% -4.6% 4% 4%
CANADA TSE 300 6756 -71 -1.0% -0.7% 2% 2%
MEXICO BOLSA 6204 -128 -2.0% -2.3% 1% 1%
MARKET OVERVIEW
MIXED EARNINGS MIX UP MARKET
It was a pretty rough week for the market. While the market moved at a minimum early in the week, a flurry of high-profile earnings reports made the market move big-time. Unfortunately, most of the movement was of the negative variety. For the week, all three major indices finished on the downside, with the Nasdaq leading the decline on disappointing Tech earnings.
If early-week trading was any kind of indicator, investors didn't expect much pessimism in this week's earnings reports. Monday was a very wishy-washy session, and the major indices finished near where they started on the day. But Tuesday was strongly positive, as all three indices finished with 0.5% gains or better.
That's when the first bomb dropped. INTEL (INTC, $16.34, down 1.08) was the bomber, reporting better-than-expected earnings but reducing its capital spending. The market took that as a sign that a much-awaited Tech recovery was farther off than investors thought.
What ensued was a bout of earnings announcements in the Tech sector that confirmed Intel's sentiments. APPLE COMPUTER (AAPL, $14.10, down 0.62) and YAHOO (YHOO, $18.37, down 1.63) reported earnings after the bell on Wednesday. Apple posted a second straight quarterly loss. Yahoo released an earnings report similar to Intel's: The Internet firm beat earnings, but not by as much as investors were hoping for.
The lukewarm results continued on after the bell on Thursday. IBM (IBM, $81, down 7) experienced a 56% decline in its profits and cautiously backed its 2003 profit targets. MICROSOFT (MSFT, $51, down 5) issued a bevy of news, not only issuing earnings but also declaring its first-ever dividend and enacting a 2-for-1 stock split. While the software giant bested estimates, it too remained cautious on future earnings projections. Further earnings disappointments from SUN MICROSYSTEMS (SUNW, $3.75, down 0.02) and ADVANCED MICRO DEVICES (AMD, $6.03, down 1.38) added to negativism engulfing the sector.
While Tech stocks submitted to the bad news, they weren't the only ones to suffer from discouraging profit statements. The Dow Jones felt the pain from Intel, IBM, and Microsoft. But the index had its own high-profile earnings report to deal with as well. GENERAL ELECTRIC (GE, $25, down 1) posted a decline in 4Q earnings, causing the conglomerate to miss its traditional target of double-digit earnings growth for the year.
Investors were hoping for a solid earnings season that would provide a foundation for a quicker economic recovery. But after this week's disappointments, the earnings environment remains shaky at best. Last quarter's earnings were good, but that was due to the high number of earnings warnings that came out before the actual reports. This time around, we didn't see many earnings downgrades. So, companies have to deal with higher expectations and only a few companies are passing the test. That doesn't bode well for the rest of the reporting period. Watch out for even more pessimism in the coming weeks.
For the week, the Dow Jones sank 198 points, a rough 2.3%, to close at 8587.
The S&P fell 26 points, an even-rougher 2.8%, to finish at 902.
And the Nasdaq plunged 72 points, a heartbreaking 5.0%, to end the week at 1376.
ECONOMY WATCH
1. RETAIL SALES RISE
Retail sales rose 1.2% in December, the Commerce Department said Tuesday. The increase met economist expectations and was the largest rise in five months. The figures were led by auto sales, which jumped a surprising 5%. But the auto sales masked a disappointing performance by non-auto retail sales, which remained flat for the month at just over $230 billion. Economists were expecting a 0.2% increase in the number. So, these numbers echo the gloomy performance that we've seen in the Retail sector lately.
2. PPI IS TAME
The latest producer price index (PPI) reading came out Wednesday. The PPI remained unchanged while the core index fell 0.3% in December, according to the Labor Department. For the year, the PPI jumped 1.2%. The monthly reading surprised economists, which expected a 0.3% rise in the overall index and a flat reading in the core index. The core PPI factors out food and energy costs which typically are volatile. The falling core PPI reignited fears of deflation for some economists, but overall the market ignored the news. It's earnings season, so corporate developments are in the forefront right now.
3. BUSINESS INVENTORIES RISE
The Commerce Department reported Wednesday that business inventories rose 0.2% in the month of November. Sales increased 0.3% for the month. Inventories are now at their highest level in a year. Year-over-year, inventories are up 0.6%, while sales are up 3.5%. The inventory uptick could suggest that businesses are boosting up supply in anticipation of a pickup in demand this year.
4. PRICES STAY IN CHECK
The consumer price index (CPI) rose 0.1% in December, the Labor Department said Thursday morning. The core CPI experienced a similar 0.1% increase. Economists were looking for a 0.2% rise, so the number was a surprise. For all of 2002, the CPI ticked up 2.4%, compared to a smaller 1.6% increase in 2001. The CPI numbers tell the same story as the PPI figures released Wednesday -- inflation is still not a problem.
5. INDUSTRIAL PRODUCTION FALLS
The Federal Reserve said Friday that industrial production fell 0.2% in December, the fourth decline in the last five months. Economists were expecting a 0.2% rise for the month. Production dropped a sharp 2.4% in the fourth quarter and 0.6% for the year. In 2001, industrial production sank 3.5%, making this the first two-year decline since 1974-75. Falling auto production was a major reason for the drop. Over the past year, auto sales have helped support an economic recovery, but the automakers are expecting a decline in demand in 2003.
IN THE NEWS
I. CASE CLOSED: AOL CHAIRMAN RESIGNS
AOL TIME WARNER (AOL, $14.81, down 0.07) chairman Steve Case resigned Monday, effective in May, ending a wild era for the media company. The former CEO of America Online before the firm's merger with Time Warner, Case was a strong backer of the online unit. Without him in management, AOL may spin off its troubled online division and change the parent company's name to Time Warner. Since the merger of the two companies in 2001, AOL's stock has dropped 70%, due in large part to the struggles of America Online. The division faced slowing advertising and subscriber growth, as well as stiff competition from broadband Internet service providers. Since Time Warner's media properties are not nearly as troubled as the online division, a spin-off likely would be accepted favorably by Wall Street and its shareholders.
II. DUKE IS A LAME DUCK WITH LOWER EARNINGS FORECASTS
DUKE ENERGY (DUK, $17.90, down 3.10) warned Monday that its earnings in 2003 won't reach previous projections, and the stock was hammered on the news. The firm, which had projected full-year earnings of $2.00 a share, now expects profits to come in at 10 cents less than that forecast. The lowered estimate includes a restructuring charge of 65 cents a share. In addition, the company will take a 4Q charge of 40 cents partly due to 2,000 job cuts. The company continues to suffer from the Enron scandal fallout, with declining energy trade volume and increasing credit concerns and government regulation. As a result, Duke will cut back on capital spending this year by more than half, to just $3.2 billion. The Energy sector is still reeling from the Enron debacle, and we'd stay away from everyone in the sector until the companies can fix their problems.
III. ALCATEL TELLS INVESTORS OF HIGHER EARNINGS
ALCATEL SA (ALA, $6.54, up 0.78) surprised investors and provided the Tech sector with a shot in the arm Tuesday. The Telecom equipment maker upwardly revised its 4Q revenue and earnings projections, as the company experienced better-than-expected benefits from its restructuring efforts. Alcatel said that revenue growth should be in the high 20% range sequentially over the third quarter, while operating earnings should be "around breakeven" after accounting for one-time charges. The firm's previous estimates were for 20% revenue growth and a breakeven quarter BEFORE the one-time charges. The news sparked a Tech rally Tuesday, especially in the Telecom and Networking sectors.
IV. SIMON SAYS DEAL MUST HAPPEN BY FEBRUARY
SIMON PROPERTY GROUP'S (SPG, $32, down 2) quest to acquire TAUBMAN CENTERS (TCO, $17.24, up 1.08) continued Wednesday, as the #1 U.S. mall owner increased its bid for the properties and added a partner. Australian firm Westfield America Trust joined Simon in offering $20 a share for Taubman. Simon also placed a deadline on the offer, saying that it would remove its hostile bid if less than two-thirds of Taubman's shares were tendered by February 14th. Previously, Simon was offering a lone bid of $18 a share, too low by Taubman's estimation. Even if two-thirds of public shareholders agree to the offer by the deadline, the deal won't be set in stone. But at least it would pressure Taubman's board of directors to reconsider the sale. Like we've said before, we like this deal and it would be a boon to Simon's business if it goes through.
V. BANK OF AMERICA BANKS ON CONSUMERS FOR HIGHER EARNINGS
BANK OF AMERICA (BAC, $71, down 1) released its 4Q financial results before the bell Wednesday. The bank's earnings jumped 27% year-over-year to $1.69 a share, on a slight revenue increase from $8.90 billion to $8.97 billion. The higher profit topped analysts' estimates of $1.63 in earnings. Full-year earnings totaled $5.91 a share in 2002, up from the 2001 profit of $4.18. Growth came from a number of different consumer business areas, including mortgages and debit cards. But revenues were suppressed by the bad loan problem that many Wall Street banks face. Bank of America plans to continue riding consumer businesses in 2003.
VI. GM POSTS STRONG EARNINGS
GENERAL MOTORS (GM, $40, up 1) released its 4Q earnings Thursday morning. The company reported a profit of $1.71 a share, nearly tripling the firm's earnings of 60 cents a share in the year-ago period. Net income quadrupled to just over $1 billion. The results surpassed analysts' estimates for $1.53 in earnings for the quarter. Despite the high number of incentives that the automaker offered to its customers, GM was able to boost earnings on the strength of truck sales. On average, trucks are more profitable for the company than cars.
But all is not stellar with GM. 2003 earnings are expected to fall, as the firm faces rising pension costs, slower U.S. sales, and downward pricing pressure coming from -- that's right -- the high number of incentives. So basically, the firm's lower prices this year boosted 2002 earnings by taking potential profits away from 2003 earnings. Personally, we like to invest in companies that focus on the long-term instead of the short-term. And it is our strong contention that General Motors is heading for some serious trouble ahead.
VII. SEARS BEATS ESTIMATES
SEARS, ROEBUCK (S, $29, up 1) posted a stronger-than-expected fourth quarter. The retailer announced earnings of $2.11 a share, up from $2.02 in the year-ago quarter. Analysts were expecting just $1.91 a share from the company. Sears experienced weakness in its credit card division. The company struggled to deal with a 26% jump in personal bankruptcies and the ensuing rise in credit card delinquencies. But strong holiday sales in the firm's Lands End division made up for the decline. However, that's not particularly good news, since the weaker business (credit cards) makes up two-thirds of the firm's profits.
VIII. EBAY TRIPLES ITS PROFIT
Online auction website EBAY (EBAY, $75, up 2) announced that its 4Q02 earnings tripled 4Q01 results. The company earned net income of $87 million, or 28 cents a share, vs. a 9-cent profit in the year-ago quarter. Analysts were looking for earnings of 24 cents a share. Revenues almost doubled from $220 million to $415 million in the quarter. For the year, net income rose from $90 million to $250 million, almost triple. eBay expects the strong performance to continue in 2003, as the company raised its projections for the current year. For instance, the firm expects to earn 30 cents a share in the first quarter, 5 cents higher than the consensus estimate.
IX. SUN SETS ON SUN'S EARNINGS
SUN MICROSYSTEMS (SUNW, $3.75, down 0.02) reported its biggest quarterly loss ever after Thursday's close. The computer maker reported a loss of $2.3 billion, or 72 cents a share, in its fiscal second quarter (ended December 29), wider than the 13-cent loss in the year-ago period. Excluding a $360 million restructuring charge, the company experienced a break-even quarter, better than the 2-cent loss that analysts were expecting. Revenues, however, fell 6% to $2.9 billion but rose 6% from 3Q numbers. Facing stiff competition from IBM (IBM, $81, down 7), HEWLETT-PACKARD (HPQ, $19.23, down 1.62), and DELL COMPUTER (DELL, $25, down 2), the company has focused on cutting costs in order to drive profits, or in this case narrow the loss. It looks like Sun has more work to do.
. SECTOR-RELATED NEWS
BLUE CHIPS
GENERAL ELECTRIC'S EARNINGS ARE DIM
Before Friday's opening bell, GENERAL ELECTRIC (GE, $25, down 1) released its 4Q financial results. The conglomerate earned net income of $3.1 billion, or 31 cents a share, after taking a previously-announced $1.5 billion charge. Profits fell 21% from the company's 4Q01 earnings of 39 cents a share but met Wall Street expectations. Revenue, however, topped expectations, increasing 4% to $35.4 billion. For the year, GE earned total net income of $15.1 billion, 7% more than in 2001.
TODD'S TAKE: This marks the end of a disappointing year for GE. In its first full year after the retirement of fabled CEO Jack Welch, the conglomerate failed to reach double-digit earnings growth. Instead, the company increased earnings only 7%. The 4Q earnings decline marked the second such decline of the year, as earnings fell in the first quarter of 2002 as well. As a result of the lackluster performance, the stock fell almost 40% last year.
This quarter, earnings were hurt by the slow economy, reduced capital spending, and higher raw material costs. In addition, business was down in the firm's power systems and consumer products divisions. Sales of gas turbines, a big growth driver over the past few years, dropped 16% in the latest quarter. The consumer products business posted a heavier decline, as profits fell 32% year-over-year. But the commercial finance division grew earnings by 30% and profits at GE's NBC television network rose 14% on the strength of "Friends" and other fan favorite programs. The popular sitcom is coming back for another season, so expect the strong performance at NBC to continue next year.
Speaking of next year, the current quarter will be another tough one for GE. The company said that earnings likely will fall 5-10% from 1Q02's numbers, more than the 3% drop that analysts expect. Either way, the results would mark a second straight quarterly decline. However, the company reaffirmed its 2003 earnings forecast of $1.55-1.70 a share, a range of 3-13% earnings growth. So, there remains the possibility that GE will return to double-digit growth in 2003. We think that growth will be closer to 5% than 13%.
No doubt about it: GE is going through a rough period right now. The conglomerate is so big and diverse that it cannot escape the grasp of a slow economy. But GE's diversification will keep the company from stumbling too much. You can see that effect in this quarter's earnings report: A couple of businesses posted significant losses, but a couple of others picked up some of the slack. This is a tough earnings environment for all companies, so this earnings announcement is expected. General Electric IS effectively, the world market. And the world economies are struggling now.
TECHNOLOGY
EARNINGS WITH A CAPITAL E FROM INTEL
INTEL (INTC, $16.34, down 1.08) became the first big-name firm to report earnings, and the company reported the first high-profile earnings surprise of the season. After Tuesday's close the chipmaker announced 4Q earnings of 16 cents a share, more than doubling the year-ago profit of 7 cents. The numbers also topped the consensus analyst estimate of 14 cents. Revenues jumped from $7 billion in 4Q01 to $7.2 billion in 4Q02. However, Intel lowered its capital expenditure estimates for the year, expecting to spend $3.5-3.9 billion in 2003. Last year, the firm spent $4.7 billion on capital equipment.
TODD'S TAKE: The Tech sector rallied in anticipation of a good earnings report from Intel, and investors got what looked like a glowing report at first glance. But after a closer look, the company's report was negative for the sector, and the stock sold off. 4Q revenue was surprisingly strong, and according to the company, "Orders continued to come in through the holiday season."
Average prices for the chipmaker's microprocessors increased because of higher sales of laptops and servers, which use more expensive chips than normal desktops. The firm also sent out record microprocessor and motherboard chipset shipments and increased market share in most of its core business areas, according to Intel executives. For instance, sales jumped to an all-time high in Asia, especially in China and Taiwan. But sales remained strong in Europe and Japan as well. Everything's going great for Intel then, right?
Not so fast, Jack! A closer look at this quarter's earnings report shows us that much of Intel's profits came from cost-cutting. Investment bank Morgan Stanley says that the firm's fourth quarter "clearly reflects the seasonal uptick in PC demand, but it also shows significant restraint on behalf of Intel, which is now starting to drive the bottom line." The company confirmed this, saying, "What we've seen for essentially eight quarters is flat revenues.no underlying economic growth."
It's not so much that the Chip sector is improving at a quicker pace, but instead that Intel is exercising fiscal thrift. One example of the company's frugal stance is its expected level of capital expenditure this year. The firm will tighten its capital spending budget for 2003. That's not good news for the Semiconductor Equipment sector, as Intel is the industry's biggest customer. Losses in stocks such as APPLIED MATERIALS (AMAT, $13.53, down 2.17) and KLA-TENCOR (KLAC, $36, down 5) reflect this reality.
Still, many investors and analysts predict a recovery in the Chip sector this year, and Intel mentioned that the replacement of obsolete PC's will boost computer and chip sales. MICROSOFT (MSFT, $51, down 5) will help jumpstart the replacement drive, as it will soon end technical support on its Windows 98 and Windows NT 4 operating systems, forcing many customers to replace their systems.
Overall, Intel's earnings report is optimistic. But it is cautiously optimistic. The company definitely doesn't predict a quick recovery in the Chip or PC sectors. The firm is doing business at a strong clip, but this isn't the kind of earnings report that will make us go out and buy Tech.
TECHNOLOGY
MICROSOFT EARNINGS A MIXED BAG
Holding $40 billion in cash, MICROSOFT (MSFT, $51, down 4) Thursday announced its first-ever dividend, as well as a 2-1 stock split. The good news was tempered, however, by lowered earnings guidance for 2003 and a weak macroeconomic outlook for the Tech industry.
Microsoft had been the only Dow company not to declare a dividend. Until now. The company called the dividend of 16 cents a share (8 cents post-split) a "starter" dividend that is in the same ballpark as that of other large Tech companies. The stock split represents the ninth such split since the company's IPO in 1986.
Microsoft's revenue for the quarter ending Dec. 31, 2002, was $8.54 billion, up 10% over the same period in the prior year. Earnings came in at 47 cents a share, which compared to a 41-cent profit in the prior year. EPS and revenue figures were in line with the previous quarter's guidance. This quarter's EPS included a 3-cent charge for lawsuits and 5 cents for impairments.
The company's cautious optimism and this quarter's positive earnings were tempered by disappointing macroeconomic results overall, and the company does not expect to see a significant upturn in IT spending in the short term.
TODD'S TAKE: Microsoft management announced guidance for 3Q03, ending March 31, expecting EPS of 47 cents on revenues of $7.7 billion, down from this quarter's revenue figures. EPS for the full fiscal year ending June, is expected to be $1.91, on revenues of $32 billion. This is down from previous guidance of a $1.94 profit on $32.4 billion in revenue.
Management reported several macroeconomic factors that contributed to the downgrade in guidance, including PC unit volume being flat to only slightly up and soft IT spending overall. PC demand was down in the US, Japan, and Latin America, with low single-digit growth seen in Europe, Middle East and Africa.
Offsetting those negative factors were the success of the Windows XP operating system. Additionally, revenue from server platforms experienced better-than-expected 12% growth, due to a shifting trend towards lower-cost standard hardware that runs Microsoft platforms as opposed to the alternative Unix system. SQL Server revenues also grew in the double digits, due to recent adoption of this Microsoft software by federal government agencies and renewals of several major enterprise agreements. Microsoft also saw revenues in the Home and Entertainment segment grow 40%, due to strong performance of the Xbox gaming platform.
Management was less specific about long-term guidance for FY04, stating, "To have good results against others in 04, we are going to have to book new business, work on our costs, and finally we'll need some help from the economy." Management noted during the earnings conference call, "We'll have a tough issue" if server and PC unit shipments don't increase in 2004.
Basically, the earnings report showed solid results but raised concerns over the company's future. We applaud the concept of the dividend, but think it is puny in reality. Microsoft generates so much cash that the payout won't cause the company to taper off its growth. However, like we mentioned earlier this week, Microsoft is trading at a high valuation. The company will have to keep showing solid earnings improvement in order to justify its high PE.
The company is growing at 10% a year, and should have a PE of 10. Give it a 15 PE and you have a $29 stock. Give it a PE of 20, TWICE the historical average, and you have a $38 stock. We're concerned.
FINANCIAL
BANK ONE, WACHOVIA BANK ON CONSUMERS
A number of companies reported their 4Q financial results, including a couple of firms in the Banking sector. BANK ONE (ONE, $39, up 1) announced net income of $840 million, or 72 cents a share, for the quarter -- a 56% jump over last year's 46-cent profit, which included a $220-million restructuring charge. Excluding the 2001 charge, net income rose 10% year-over-year. Analysts expected the bank to earn 72 cents, so the results were right on the money. For all of 2002, Bank One earned $2.80 a share.
WACHOVIA (WB, $38, unch.) increased its profits by 22% in the latest quarter. The bank reported net income of $890 million, or 66 cents a share, compared to earnings of 54 cents in 4Q01. The results included a charge of 6 cents a share related to the firm's merger with First Union. Excluding the charge, the bank met analysts' estimates of 72 cents in earnings. For all of 2002, Wachovia earned $2.60 a share, an 80% jump over 2001's results.
TODD'S TAKE: Solid reports from a couple of bank stocks in our Financial Portfolio. Both banks met expectations for a 72-cent profit, despite the continued market downturn.
As was the case with BANK OF AMERICA (BAC, $71, down 1) Tuesday, consumer businesses propped up earnings in the fourth quarter for the firms. Bank One, the nation's #6 bank, earned $335 million from its retail businesses, 16% more than 4Q01 excluding one-time charges in the year-ago period. As a testament to the booming residential real estate market, home equity loan production jumped 48% over 4Q01 to $4.9 billion and increased 20% to $790 million over 3Q02. The firm now holds a portfolio with $28.5 billion in loans, a 13% expansion from last year.
In addition, average core consumer deposits grew 9% to $66 billion in the quarter. And the company prepared for even more growth in the retail business, opening new banking centers, extending center hours, and refurbishing existing centers and ATMs. Bank One's CEO had only positive things to say, mentioning that the bank "enters 2003 in an extremely strong position." Also, "We are confident that we are making all of the investments necessary to achieve quality growth as we continue to focus on the customer."
Wachovia's performance confirmed that business in the fourth quarter was consumer-driven. General Bank revenue, which includes revenue from both retail and small business customers, increased 4% from the third quarter of 2002 and 5% from the fourth quarter a year ago. Key factors for the expansion included solid growth in core deposits and residential mortgage-related revenues, investment sales through the branch system, and continued strong debit card sales volume.
Loans grew 5% subsequently and 9% year-over-year, mainly due to strength in consumer real estate-related products. Average core deposits jumped 8% from 4Q01 levels, and average low-cost deposits surged 21% year-over-year.
In 2002, Wachovia increased its dividend by 8%. Combined with price appreciation, the stock generated a total annual return of nearly 20% -- the best performance among the 50 largest U.S. banks. 2003 looks solid, if not spectacular, as well, according to the nation's fifth-largest bank, as the firm feels "very confident" about its prospects in 2003.
These latest bank reports show how big a part the consumer is of the overall economy. Consumers are driving this recovery, not only by buying products but also by borrowing money from banks to buy them. And if the stock market shrugs off its bearish ways and the job scene improves, consumers will be able to sustain their spending. That will pay off big time for the banks.
PHARMACEUTICALS
PFIZER: KING OF THE DRUG SECTOR
Special to The Bull Market Report
By Chuck Benemerito
OUR TAKE: Pharmaceutical giant PFIZER (PFE, $30, down 1) is already the world's largest drug company in terms of market capitalization ($190 billion). When it completes the acquisition of PHARMACIA (PHA, $41, down 1), however, the drug giant will become the largest drugmaker in terms of sales as well.
The combined company expects to generate $53 billion in revenues this year, more than current sales leader MERCK (MRK, $58, down 2) expects to make. After the deal, Pfizer will own a stable of drugs that includes 12 different treatments with annual sales of at least $1 billion. Currently, Pfizer owns such blockbuster drugs as cholesterol treatment Lipitor, depression drug Zoloft, and Viagra.
The acquisition of Pharmacia, which should be completed in March, gives Pfizer treatments such as Rogaine (hair loss), Nicorette (tobacco addiction), and Celebrex, the arthritis drug that the companies have sold together for four years. And Pharmacia also sells treatments for diseases that Pfizer doesn't yet cover. For instance, Pharmacia owns the cancer drug Camptosar and the heart disease treatment Eplerenone, both of which Pfizer is lacking.
As you can see, the new company will have a strong drug pipeline. And the firm won't face patent expirations on its blockbuster treatments anytime soon. Lipitor holds its patent until 2010, Viagra until 2011, and Celebrex until 2013. In contrast, patents for SCHERING-PLOUGH'S (SGP, $22, down 1) treatment Claritin and ELI LILLY'S (LLY, $66, down 1) drug Prozac both expired last year, so those two companies will have to find new blockbuster treatments to replace their big revenue producers.
Another benefit of the merger is the cost savings that Pfizer sees from the deal. This year, the company projects $1.4 billion in costs savings. In 2004, the firm expects to save $2.2 billion. That's a significant amount of dough that the company can put towards developing new drugs.
The stock's current fundamentals are encouraging as well. There are 26 analysts that cover Pfizer, and 24 of them hold at least a "buy" rating on the stock (13 rate it a "strong buy"). And even with its high market cap, Pfizer is a good value at this price. The company expects to earn $1.84 a share this year, giving it a PE of under 17. Right now, the whole Drug sector is trading at over 19x 2003 earnings. Additionally, Pfizer is one of just seven U.S. firms that have a "AAA" credit rating, and that keeps the company's borrowing costs at a minimum.
With such strong indicators, we expect Pfizer to perform well for the next few years. The Pharmacia deal is a good strategic move for the company. However, since Pfizer is so big now, some investors are worried that the firm will have to keep acquiring companies in order to support future growth. But if Pfizer's past acquisition history is any indication of what the future holds, we're not worried about the firm's ability to pick out the winners in the field.
2. THE BULL MARKET REPORT PORTFOLIO CORNER
Baby boomers are headed into their golden years in droves, needing everything from increased health insurance to assisted living. Few other industries are supported by such incredible demographics trends, not only in the United States, but also globally. Relative to the broad market's performance and even on an absolute basis the stocks of HMOs continue to do well. One index that measures their performance is up about 26% year-to-date. Hospital stocks are up about 18%.
If you're a long-term investor, a dose of healthcare stocks could give your portfolio a nice shot in the arm. Many of the stocks in our portfolio have the size and market dominance it takes to squeeze out extra profits from every dollar of revenue they generate. And best of all, our portfolio holdings have attractive valuations relative to the earnings growth that we expect they will achieve for the foreseeable future. HMOs are one of the few industries that have pricing power in the current low inflation environment. Part of the reason behind the move higher this year is that HMOs have been able to increase premiums without losing customers.
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