Cut in chip manufacturers capital spending

United States

Boeing Co. (BA, $37.13, CSFB recommendation: Buy): as labour contract deadline approaches (September 1st contract expiration) we wish to look back at what prior strikes have meant relative to stock price performance. History suggests it's generally worthwhile to buy BA after the strike.

A look at the three previous strikes in the past 13 years suggests BA stock acts relatively unpredictably to work stoppages. The 2000 engineer strike had a substantive negative impact on the stock, which subsequently recovered.

It is difficult to see what would happen. On the one hand current low demand from airlines, with airlines inclined to put off deliveries if possible, the company is not as pressured to settle quickly, and soft job market and poor economic climate may be a mitigating factor for machinists. On the other hand, the strike fund balance, which guarantees $115 per week to every machinist, suggests adequacy to fund a sustained strike, and public sentiment weighs in favour of labour pushing back.

We would recommend to wait until the situation becomes clear. Currently, 2/3 of the machinists would have to reject Boeing's offer, expected Aug. 27-29. On business side, the company is suffering from weak orders from civil aviation. Airliners reduce their orders in order to cut costs. Furthermore, after US Airways Group Inc. filed for chapter 11, concerns rose that it could be the beginning of a "bankruptcy wave" in the airlines industry. For BA's commercial aerospace business, it is expected that cycle may through in 2003-early 2004. Finally BA's military division continues to generate profit. The company earned some contracts, which should insure division efficiency for years. Hold

General Electric Co. (GE, $32.25, CSFB rating: Buy) reported that order volume for its short-cycle businesses grew by 5%-10% y-o-y in July. Order volume in the Americas, which accounts for slightly over 60% of GE's short-cycle orders, grew at 5%-10%, while order volume growth in Europe and Asia, which account for roughly 20% of GE's short-cycle orders each, grew at 20% and 10%-15% respectively. Compared with June, these figures are slightly lower. GE reported in June an increase of 10%-15% for its short-cycle business. However this decrease should not be a surprise given the lower level of activity in the summer months. August should be also lower than in June. We reiterate our hold recommendation. We believe GE stock price would remain volatile as long as the U.S. economy does not clearly recover. Furthermore, the distrust related to companies with complicated accounting system is still in the air. This does not mean that it would happen again, but investors remain cautious and fickle.

US Technology Sector

During the last week we got the confirmation of what had to be expected concerning the semiconductor capital equipment sector: The July book-to-bill ratio fell to 1.16, from 1.26 in June, as new orders fell by 18%. This slowdown in bookings is consistent with the cut in capital expenditure by the chip-maker and foundries, which were announced during the quarter reports, due to weak end- demand and cautious expectations for the next year. A ratio of 1.16 means, that the industry is expanding, but the pace is slowing down. Looking forward, industry trends should support growth in the sector. One important driver will be the 300mm wafer technology, as it will reduce the cost of manufacturing chips. It enables more chips on one wafer, compared to the current 200mm. Other new technologies like copper interconnects, to make chips faster than with aluminium interconnects, or 13 micron technology - to reduce the size of the transistors on a chip, which allows to put more transistors on it and thus make it more powerful. The size of chips is crucial, as devices are becoming more compact, especially the mobile devices like lap-top or palm top computers.

But currently the demand for this kind of devices is not supporting the investment case for chip-makers and foundries to build new production plants and add capacity to produce latest technology semiconductors. In fact, currently the trend in the PC area is towards the lower end, using slower and older technology chips. Latest example for this is Hewlett-Packard (HPQ: $14.70; CSFB: Hold), which announced it would offer a PC for $549, using a low-end AMD (AMD: $9.67; CSFB: Hold) processor, to be able to compete with Dell Computers (DELL: $27.85; CSFB: Buy) in the race for market share. The need for the latest models coming from AMD or Intel (INTC: $17.96; CSFB: Buy), with frequencies above 2 Giga hertz is limited. Given the lack of demand, these latest products could become obsolete, before demand for those chips picks up. This means that selling prices will erode and the chip maker will not get adequate returns, which would have expected to make up for the development cost.

For the year 2003 however the semiconductor capital equipment sector is expected to see a recovery, especially in the front end of the business. This means, that with enddemand improving, the shift towards the new technologies of 13 micron, copper wire and deep ultraviolet lithography will become stronger and urge the foundries to build up new production plants using new semiconductor capital equipment.

Meanwhile the semiconductor capital equipment sector is likely to be very volatile, given the overall economical environment, and thus it is too early to invest into a recovery of this sector, as there is still some risk of disappointment and downwards revisions for 2003 estimates.


Europe Equities

• European markets posted their fourth weekly gain in five, reaching a six-week high on Thursday. The Euro STOXX50 closed the week 3.95% higher.

• Increased confidence that corporate earnings have reached a trough caused selective buying in economically sensitive sectors such as media (+12.10%), basic resources (+11.68%) and technology (+8.10%).

• Short-term traders should start taking profits.

Earnings reports over the past few weeks have broadly been in line with (lowered) expectations, which caused investors to nibble at stocks that will benefit from an economic recovery. However, even if earnings have probably bottomed in 1H02 there is little doubt that such a recovery will, at best, be muted. Hence, markets will remain volatile within a wide range. We believe that the latest rally has led markets to a level where valuations offer limited upside potential. From a trading point of view we would start taking profits.

This week's highlight will be the release of the IFO German Business Confidence Index for August. The consensus is looking for a figure of 89.5 versus 89.9 in July and a recent high of 91.6 in May. A shortfall in these figures could be the trigger for profit taking.

After strong declines in early August cyclicals managed to rebound over the last week. We feel that current valuation levels already reflect a recession. Our favourite cyclicals remain Stora Enso (STERV FH; EUR 12), Arcelor (LOR FP; EUR 12.65) and Adecco (ADEN VX; CHF 73.20).

Adecco posted a 20% rally over the past three weeks. While we believe that this might cause some short-term profit taking we remain convinced that the current stock price does not fully reflect the long-term potential of this best-positioned company. After the recent downward revision earnings estimates are well below trend, which offers scope for potential surprises. Recent data shows that US staffing volumes are starting to pick up from their lows and Adecco has confirmed its key markets, USA and France, have bottomed out and are now in positive territory. We believe that Adecco has gained market share in the recent downtrend. This and its lean structure make the company well positioned to benefit from an eventual recovery. We would use the upcoming consolidation period to buy the stock.

A growing perception that the flood catastrophe in Germany would not seriously affect most insurance companies led to a nice rally in the sector (+7.58%). However, estimates about the total damages are climbing higher by the day. At this initial stage, it seems that just 10%-15% of the total loss (estimates range between EUR 15-25bln) may be insured. Allianz (ALV GY; EUR 142.16) remains the most exposed among the bigger insurance companies. Estimates for Allianz about potential damage claims have now reached a level of EUR 250 million. Rather than these claims we remain concerned about the high sensitivity of Allianz' share price to the equity market. A continuing fall in equity markets could lead Allianz to reduce its equity market exposure to protect its balance sheet. Insurance stocks remain the sector most heavily geared to the equity market. Given our cautious stance of equity market we remain cautious on insurance stocks. CSFB has reduced earnings estimates for Allianz for 2002 and 2003 by 20% and 40% respectively to EUR 3.07 and EUR 6.63 but reiterated its estimate for 2004 of EUR 16, which makes the stock attractive over the longer period.