Tech stocks to remain volatile, take profit where possible

US Technology

While investor sentiment has definitely improved over the last few weeks, investor risk appetite has also expanded on the hope for an earnings recovery in 2002. We expect earnings to improve more in the 2H02 than anytime earlier. Also, we expect technology stock prices to remain volatile ahead, and as such we continue to suggest taking-profits where possbile.

Ciena Corporation (CIEN US $14.26 CSFB rating: BUY) announced a 4Q01 net loss of $1.8 billion with EPS of $5.51. Though CIEN's 4Q01 sales totalled $367.8 million with EPS of $0.05 (up 27% from last year), the firm's increased research and development spending combined with a $1.7 billion charge (goodwill-impairment charge, restructuring costs, deferred stock charges, payroll taxes on stock-option exercises and amortisation of goodwill) wiped out its gains, and caused the firm to fall into negative territory.

Although the firm's news seemed to have dropped a bomb for the entire technology sector, CIEN still believes that its overall 2001 performance was good considering the general state of the economy and the dismal telecom sector.

CIEN is anticipating gloomy future forecasts for 2002, with revenue to decline 30-40% q/q in January with further declines in April. We suggest to avoid CIEN for the time being until it's stock price stabilises further at around $12.00.

Qwest Communications Intl Inc (Q US $12.33 CSFB rating: BUY) said it plans to cut its workforce by an additional 7,000 jobs along with its fourth quarter and full year growth outlook for 2002, as it has yet to see the demand for its voice and data services to bottom out.

The company warned that its 2001 revenues for the full year would come in at $19.8 billion, below analyst expectations of $20.3 billion. Net loss for 2001 is now expected by the company to fall in the range of $2.30 to $2.38 a share. Looking into 2002, Q now expects revenue to be in the range of $19.4 billion and 19.8 billion, again below analysts' estimates of $21.11 billion. We recommend to avoid Q as we believe the stock is trying to establish a firm floor above $11.00.

Europe

The recent profit or sales warning from companies such as Merck, Bristol Myers, Cap Gemini, Logica, Lucent, Ciena etc. have brought valuations back into investors' minds. While some more optimism for next year is definitely warranted these cautious comments underline that an economic recovery will not occur as a V-shape recovery. We consider last week's setback as a healthy sign of the market that it is aware of valuations. The market is currently in a typical consolidation mood and as long as indices do not drop too much on bad news we view it as a positive sign that the market wants to go higher.

We continue to follow our cautiously optimistic investment strategy for 2002. Investors should use weakness that could occur early next year to build up equity positions. We believe that the low level of interest rates and the fiscal measures taken this year will finally cause the economy and earnings to recover. In terms of valuations European equities are traded at a discount to the US market. Even though the European economies will lag the US recovery it will be perception of better times ahead that will lead equities to recover.

As the economic recovery remains our base case scenario we continue to stick to our preference for cyclical stocks into next year. We would also reiterate our positive call on pharmaceuticals. While the sector had a good run this year and might therefore be neglected if the risk appetite increases we believe that valuations have reached attractive levels after the recent declines in the sector. The technology sector is likely to remain volatile, especially in the early part of the year. At this point in time a great deal of a recovery appears to be priced, which is why we would use the sector to trade actively.

Nokia (EUR 28.05; NOK1V FH) surprised the market by not only reiterating but increasing its EPS forecast for Q4. Nokia expects 4Q01 EPS to be in the range of 0.18-0.20 from 0.16-0.18. The company reiterated its guidance for sequential sales growth of 20% in Q4, with mobile phones seeing 25% sequential growth. Nokia experienced record unit sales in the handset division and expects substantial market share gain this quarter. CSFB expects Q4 volumes to reach 40 million handsets, which implies a market share of 37 - 38.5%. Nokia reiterated its guidance for Q4 global handset sales of 105-110 million.

The company indicated that pricing environment was healthy with ASP's only slightly down from 4Q00, which provides support to the operating margin. The strong sales in October and November were driven by its new GPRS phone 8310 and TDMA and CDMA sales in America. We feel that the stock is fairly valued at this level and expect it to trade in a range of EUR 25-29. As with many other technology stocks we expect Nokia to offer good trading opportunities over the coming months.

Roche (CHF 114.50; ROG VX) announced that it would seek to merge Nippon Roche with Chugai to form a new company called Chugai Pharmaceuticals. This is a strategically important step as it increases Roche's sales arising from Japan from 6% in 2000 to a pro forma 19% of the total. Japan is the second biggest market for pharmaceuticals globally. The structure of the deal has the hallmarks of Genentech, in that Roche will be the majority shareholder, with a 50.1% interest in the new business. Chugai will retain its name and identity and remain listed on the Tokyo Stock Exchange. Although Roche's short-term outlook remains focused on its weak product pipeline and management problems we believe that the stock is attractively valued with little downside risk. We expect news flow to improve next year, which should have a positive impact on the share price.

Yesterday, Vivendi Universal (EUR 57.35; EX FP) finally announced the purchase of USA Networks for USD 10.3bln in cash and stock. This gives Vivendi the content and distribution, especially in the TV industry, which it did not really have before. Coupled with its recent alliance with satellite broadcaster Echostar this deal fully addresses Vivendi's needs in terms of integration and distribution on the US market (CEO Messier). The company expects the deal to boost EBIT in 2002 by EUR 600 million. Vivendi has made a big step in becoming a truly global media company. However, uncertainty about the success of the new strategy remains, which is why we remain cautious on the stock.

The FDA rejected GlaxoSmithkline's (GBP 16.85; GSK LN) application for the approval of an extended version of Augmentin, which is one of GlaxoSmithkline's fastest growing drugs. This comes as another blow to GlaxoSmithkline's already weak product pipeline. In addition to this and more importantly, an American court ruled in favour of two generic companies and rejected one (expiring 2018) of the four patents on Augmentin. However, the same court also ruled in favour of GSK by upholding another patent on Augmentin that is due at the end of 2002.

The court is expected to decide on the other patents within the next few weeks. The financial impact is not very significant. US sales of Augmentin (2000 GBP 725m) are only 4.1% of group sales. Assuming the other two patents were rejected as well generic competition to Augmentin from 2003 onwards would result in a 3.5% EPS downgrade. This would still result in double-digit EPS growth 2003-05. What is more important than the financial impact is the psychological impact of a further adverse ruling on the remaining Augmentin patents.

There could be danger that the financial markets start to take a more draconian view of patent expiries in general. For the time-being we recommend to be cautious on GlaxoSmithkline even though we expect the stock price to settle at around current levels. We prefer Aventis (EUR 74.35; AVE FP) even though Aventis also has a USA patent dispute with one of its major drugs Allegra. We believe that the current weakness in Aventis' share price reflects this point.