Earnings expectation for semiconductor companies in the US

US Stocks

The advisory committee voted 8 to 3 to recommend that the FDA approve the drug in Type 2 diabetes. Earlier Bristol-Myers-Squibb and Sanofi-Synthelabo filed their Avapro, a hyper tension drug as well, for the same application, but failed in the US while getting an approval in Europe.

This is good news for Merck & Co., as it is depending on fast growing drugs such as Cozaar, to offset generic competition for its blockbuster painkiller Vioxx. This development is positive for Merck's share price which has been under pressure in the past few months, due to some concerns about the company's product pipeline, as the follow-up version of Vioxx was withdrawn for more data. However, at current levels the stock has priced in quite a lot of disappointment and trades with a 20% discount to its peers regarding the earnings.

Another pharmaceutical company that has been struggling for quite a long time is Bristol-Myers Squibb. The company's CEO lately got a notice from the board that he would loose his job, if he was unable to turn around the company soon. We would not bet on the CEO's success, as there is not much to come out of Bristol-Myers pipelines in the near term, which could act as a growth catalyst.

Pfizer has been very successful in the past, and still is growing faster than its US competitors. However, this has not been reflected in the share price over the last few months. Rather, it has been weighed down due to competition for its top selling cholesterol-lowering drug Lipitor, coming from Astra-Zeneca's Crestor. Assuming that Crestor becomes a $3-4 bln drug in the next few years, there is still room for growth as the total US market for cholesterol-lowering drugs totals $14 bln. Lipitor could possibly grow by 50% to $10 bln in sales in the next five years. Apart from that, Pfizer expects to file 15 new drugs to the FDA by 2006, which should sustain the company's long term growth.

The State of California's jobless rate climbed to 6.4% in March, which is a 5-year high, as employers continued to wait for clearler signs of recovery. Being the sixth largest economy in the world, California certainly has an impact on the nation's economic growth.

The good news is that the layoffs are levelling off, with Southern California doing better than Northern California for obvious reasons. The Bay Area continues to bear the blunt of the State's slowdown. The jobless rate in Santa Clara County, the heart of Silicon Valley, was 7.4% last month.

So far, the State is not creating any net new jobs. Only the services and trade sectors are showing net job gains in March, while transportation, public utilities, manufacturing continued to shed jobs.

The stock market remains extremely nervous, the mere mention of a SEC investigation will send stock prices plunging, coupled with the 1Q result announcements, the investment plan for the interim is to accumulate fundamentally sound companies on weakness.

US Technology

During the last earnings season in February, semiconductor companies have been cautious in forecasting for the March-1Q02 results. As a consequence, we do not expect those companies to miss their forecasts on a broad base. However we do not expect any upbeat results either. Focussing on the current quarter (June-2Q02), we expect results to be quite flat relative to the March quarter (which is currently being announced), due to the lack of immediate demand drivers. PC sales are seasonally flat in the June quarter, as are handsets and consumer electronics. According to such seasonal patterns, companies in those areas have not issued strong forecasts. We do not expect much growth over the near term concerning the PC or the handset businesses. One segment that should see further demand is the DVD player and the digital camera market, which have remained relatively strong.

In general, we see the semiconductor cycle as having bottomed, but we are still cautious about forecasting any sustainable growth trend. Communication semiconductors, notably for the wire-line segment, will probably see some further weaknesses ahead due to the persistently tight IT spending environment globally. But, we believe it is not all doom and gloom in the communications semiconductor space.

Numerous data points are suggesting continued strength in the WLAN (Wireless Local Area Network) chip demand. While we are growing more hopeful towards this segment, we would still like to see a credible 'killer-application' come into the market to seriously entice end-users to broadly adopt WLAN usage. For the time being, we believe the technology platform is in the early demand stage and still in a 'nice-to-have' mode, and has yet to migrate towards a 'must-have' capability. Nevertheless, we believe WLAN technology is a segment that is worth keeping a close watch on relative to other segments within the wire-line communications space.

Europe

As mentioned in our last few issues reality has caught up with our scepticism regarding the markets' hopes of improving leading indicators feeding through to earnings. Last week's earnings reports of GE and IBM underlined how carefully these results are scrutinised by investors. Even though we expect to see further disappointments in the weeks ahead, we believe that the pre-announcement period should have produced the worst news and spare markets from further major shocks.

European companies have been very quiet so far, which caused certain confusion, especially in the case of Vodafone (VOD LN; GBP 1.1050), which lost 15.80% for the week. Several analysts published critical notes about the nature of its business model and the soundness of its strategy. The main concerns focused on the deteriorating growth forecasts for mobile operators as subscriber growth rates stall, data services do not pick up and Average Return Per User (ARPU) does not improve. Analysts argued that mobile operators were about to see growth rates of simple utility firms. The problems in the US mobile industry (where Vodafone holds 40% of Verizon Wireless) and negative news on subscriber growth rates from NTT Docomo added to last week's confusion.

We are surprised by the strong decline of the stock, as most of these factors are not new. We believe that at current levels the market has already priced Vodafone as a low-growth utility company even if the strongly negative sentiment on the stock will continue to keep volatility high. With a P/E03E ratio of 20x Vodafone is traded at a clear discount to its peers despite being the undisputed leader in the sector.

Investors are anxiously waiting for Vodafone's release of its Key Performance Indices on April 25, 2002 as well as for the announcement of an asset write-off, which is the main reason for the current uncertainty, in our view. So far, the company did not make any statements to the recent decline in its stock price but we would like to point out that in the past, Vodafone has managed to deliver on its forecasts. Despite our stop-loss being broken (GBP 1.20) we want to wait the release of the KPI and the outlook given by the management before making a decision. The stock remains 'Hold'.

Financials have held up relatively well closing the week unchanged. We believe that a moderate recovery of the global economies would be positive for these stocks. Interest rates might not rise as fast as previously expected while the overall sentiment shows an improvement in terms of the bad debt situation. This would, in particular have a positive impact on next year's earnings, as provisions would be lower. For the time being we stick to insurance stocks with Allianz (ALV GY; EUR 278.10) as our core recommendation. We would use a further decline in the banking stocks as a buying opportunity for investors with a higher risk appetite.

Aventis (AVE FP; EUR 75.25) reportedly sounded very confident during a roadshow in Frankfurt. Management reiterated its forecasts for CAGR sales to 2004 of 11% to 12% and 25%-30% in EPS. The main drivers are strong sales growth rates in its top ten selling products as well as an improvement in its product mix. Aventis will report 1Q02 earnings on April 30, 2002. We expect the newsflow to improve in the months to come, as detailed data will confirm the strong growth of its top selling products and the R&D day in June will reveal progress on new drugs. At current levels Aventis trades at the bottom end of industry multiples due to concerns regarding a fall in the patent protection of Allegra. Even in a worst case scenario (Allegra losing patent protection), the stock would still be trading at a 10% discount to the market. We recommend using the current weakness as a buying opportunity. We expect the stock to see a re-rating in the months ahead.

Roche (ROG VX; CHF 126.25) suffered from a rating downgrade to 'underweight' by a broker but also from profit taking ahead of Tuesday's sales figures. CSFB expects sales growth in local currency terms of 9% in Pharmaceuticals, 12% in Diagnostics and 3% in Vitamins & Fine Chemicals.

MAN (MAN GY; EUR 25.83) held its annual investor day on Thursday. Overall, management projected confidence for the full year despite a difficult first quarter. The big negatives came from a sharp decline in printing and new truck orders, however group capex is down 10%-15% and the employee rationalization program continues on track. Overall management is confident in a positive cash flow for the full year. At 3.9x 2003 EBITDA and 0.3x sales, MAN looks cheap and we would use the current weakness as a buying opportunity.