European tech companies started the confession period (page 3 of 3)

Banking stocks continued to be the most underowned sector (-2.79% on a free-float basis), which we believe is not justified, given attractive valuation and a lower interest rate environment. UBS, ABN Amro and Deutsche Bank remain our preferred picks in the banking sector. Even though some price action took place since the beginning of the year we would be surprised if investors who built up defensive sectors aggressively during December had reversed their strategy so quickly.

STMicroelectronics (STM FP; EUR 48.45) reported 4Q00 earnings in line with expectations. Relative to the sector this was a good set of numbers but it became apparent that nobody can remain immune to the current industry correction. STM reported 4Q00 EPS of USD 0.50, revenues grew 48% yoy and 8% sequentially. Gross margins grew to 47.4%, which was slightly below our expectations.

Looking into the details of the numbers shows that the other income and financial profits offset the somewhat weaker than expected operating result. STM gave guidance only for 1Q01. The management expects revenues to decline by 8-9% in this period reflecting order rescheduling in Telecom and PC peripherals and on-going inventory correction in digital set top boxes. STM's outlook confirms that the industry situation has not stabilised yet but assuming a soft landing and capital expenditure not falling further we believe that the stock will trade in a range for the next few months.

With 42% of overall revenues coming from STM's twelve key customers (less volatile pricing) and being the fastest growing of the top10 global semiconductor manufacturers we believe that STM remains the best way to play the re-acceleration of the industry dynamics expected for 2H01. Despite the near-term risks, we believe that STM's ability to outperform the industry, its lower pricing volatility and its valuation make the stock very attractive. STM is currently traded at a 45% and 37% P/E 01-02 discount to its closest competitor Texas Instrument. We believe this is not justified and recommend buying the stock in weakness with an investment horizon of 12 months.

Ericsson (LMEB SS; SEK 105) reported a 4Q00 operating loss (after ex. Items) of SEK 1.5 bln. The handset unit generated 4Q losses (incl. Restructuring charges) of SEK 10.2 bln, which was in line with expectations. The stocks 11% decline came much more on disappointing news from the network unit. The network unit generated a 4Q00 profit of SEK 9.384 bln and margins of 15.3%, which was short of our's and the market's estimate. The profit shortfall came on the back of additional R&D spending and was not a result of the declining margin. Ericsson has decided to increase its R&D spending on 2.5 and 3G networks at the expense of margins.

While this will trigger earnings reduction in the short-term we believe that it will enable Ericsson to further strengthen its position in this industry. The positive element in Ericsson's earnings report was the announcement to outsource its handset production to Flextronics. Ericsson keeps the responsibility for development, technology and design but removes the operational risk. Even though there seems to be no near-term catalyst for a re-rating we believe that Ericsson is addressing the key problems. We expect the stock to trade in a range for the first half of the year but believe that the company's growing position in mobile infrastructure will be rewarded in share price appreciation once visibility improves and upgrades to the forecasts become more prevalent.


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