Positive earning momentum continues in telecom sector

United States
U.S. auto sales are expected to decline this year due a weak U.S. economy. Furthermore, the threat of a war would likely put pressure on demand in this industry. Analysts expect that the Big Three's, namely General Motors Corp., Ford Motor Co., and DaimlerChrysler AG, production to be down about 7%-8% (source: Merrill Lynch). Hence, we prefer suppliers to automakers. In general, suppliers have a higher operating margin, and indebtedness is lower. Finally, we believe the effects of a downturn in the auto industry are smaller for suppliers due to customers' diversification, the use of high-tech features in order to distinguish them and to comply with safety and emission regulations. Our top pick in this sector is Johnson Controls Inc. (JCI, $80.95, CSFB: Not covered). With its two segments, Automotive Systems Group, and, Controls Group, the company generated revenue of $20.1 billion (+9.09% y-o-y) in 2002. Automotive sales made up 74% of total sales last year, while the controls group made up the remaining 26%.

Technology stocks declined last week, after Intel (INTC, $16.34, CSFB: Neutral) and Microsoft (MSFT, $51.46, CSFB: Not rated) gave conservative guidance for the coming quarter.

Intel, during its earnings release said it expects its revenue for the first quarter of this year to be up to 9% lower than the $7.16 billion it achieved in the last quarter of 2002. It also expects deterioration in its profitability, with its gross margins declining by one percentage point to 50%. In order to maintain profitability the company will reduce its capital expenditure for the year and will focus on achieving more cost-effective production.

Microsoft also expects a slowdown in its revenues for the first six months of this year. The company cites a decline in deferred revenues from multiyear contracts as the reason. Microsoft had loaded customers with incentives to close some multiyear contracts during its July quarter in order to boost revenue, and expected that the market would recover soon enough to avoid a dip in revenues.

We had recommended reducing Microsoft in early December, as our concerns about valuations arose due to the low visibility that we foresaw for the IT spending environment. We continue to believe that the first quarter of the 2003 will be slow. We will have to look out for some early positive data, which would indicate a return to more solid growth, before buying into computer related stocks. In the mean time, we expect to see further weakness in this sector.

Gillette (G US, $32.03, CFSB: Not Rated) is now included in our US Recommendation list. After several years of disappointing earnings, we believe Gillette's outlook for 2003 appears to be brighter. The first clear sign is that Jim Kilts has managed to give the Company a new lifeline since taking over the helm as Chairman and CEO two years ago. There has been a marked improvement in Gillette's culture and we believe Kilts has managed to instil much needed internal control and financial discipline. There are three key drivers for G going forward:

1) We believe that Gillette's razors and blades business has shirked off the funk of the past two years whereby growth had been hampered by excessive investment spending and inventory loading.

2) The worst should be behind for the Battery business. After two years of restructuring, G has finally managed to mitigate the drag that the battery business has had on the Company's share price. We do not expect a bright outlook fro the battery business in 2003, but neither do we foresee further deterioration. Batteries now account for just 11% of the company's total profits, which should diminish its impact on the bottom line.

3) Quarterly growth at the company may prove to be unpredictable given the heavy promo spending behind the new launches, but we believe for the full year, this should smooth out. We do not foresee much capital appreciation over the next twelve months. We would recommend Gillette to investors with an outlook spanning 12-18 months. We are attaching a $35 target price to the stock with a stop loss of $27. Gillette will be posting FY02 results on the 28th January 2003. Consensus estimates for the full year is EPS of $1.137. We will have a write up on the results the day after the announcement.

Carolina Group (CG, $22.77, CSFB: Not rated). Last week we recommended investors take partial profit on Carolina as the company's share price has rallied 23% since we recommended the stock on the 3rd of December 2003. However, we also did mention that investors should maintain part of their initial investment in Carolina, as we still believe an investment in the stock to be primarily a dividend play. Carolina at present yields 7.82%. We are changing our stop-loss level to $17.70 from $15.50 and maintain our target price of $23.00.

Among our recommendations, the following companies will report their quarterly results:
- Citigroup Inc. (C, $36.80, CSFB: Outperform) on January 21st; expected EPS $0.459
- Schlumberger Ltd. (SLB, $40.71, CSFB: Neutral) on January 21st; expected EPS $0.313
- JP Morgan Chase & Co. (JPM, $26.19, CSFB: Outperform) on January 22nd; expected EPS $-0.093
- General Dynamics Corp. (GD, $74.15, CSFB: Outperform) on January 22nd; expected EPS $1.444
- Countrywide Financial Corp. (CFC, $53.48, CSFB: Not covered) on January 24th; expected EPS $1.918
- AmerisourceBergen Corp. (ABC, $54.26, CSFB: Outperform) on January 24th; expected EPS $0.817
- Philip Morris (MO, $41.90, CSFB: Not Rated) on 29th January; expected EPS $0.924
- Gillette (G, $32.03, CSFB: Not Rated) on 28th January; expected EPS $0.337

Europe

• The DJ EUR Stoxx 50 declined 4% to close the week at 2390.36

• Wireline sector was upgraded by CSFB from neutral to overweight

• Wireless sector is expecting OFTEL decision on UK mobile termination rates

In the second full trading week of the New Year, the DJ Euro Stoxx 50 retreated most of its advances made earlier in the year. The lack of visibility on the economy, the Iraqi crisis and residual geopolitical risks (North Korea) are likely to cap the upside potential in stocks for the time being. In addition, the IBES bottom-up consensus numbers for EPS growth in Europe still stand at 19.2%. Although the numbers are nearly always too optimistic at this time of the year, it shows the downgrade potential of earnings forecast.

Since the beginning of the year telecom stocks outperformed the broader market (performance of 10.73% vs 0.84% of DJ Stoxx 50). Telecom stocks were early into the downturn and are now stabilizing or even enjoying some upgrades. A recent review by Deutsche Bank shows that a combination of continuing strong cashflow growth in the first part of the year and relative resilience in earnings forecasts should keep the sector moving ahead of the market. The telecom sector was further lifted by a CSFB upgrade.

Vodafone (VOD LN, GBP 1.19) confirmed it was in talks with subsidiaries in Sweden (Europolitan), the Netherlands (Libertel) and Portugal (Telecel) to buy out their minority holdings. Vodafone has yet to tender a formal bid but hopes to complete the transactions by the end of the current fiscal year (31 March 2003). As the profit margins of the three entities exceed the group average, a successful execution of the plan would be mildly earnings enhancing. On the other hand, the combined cash offer of around EUR 2bn diminishes the chances of a share buy back in the near future particularly as the group also used part of its cash resources for a bond buyback offer announced at the beginning of January.

Basic resources were the second best performing sector during this week. The paper industry got a boost on the back of a broker upgrade citing improved demand in US coated-paper market which enabled the North American coated paper producers to implement a price increase of USD 40 per ton. A second increase might be realised during the 1Q03. Stora Enso (STERV FH, EUR 10.77) has the highest exposure to the US coated paper markets among the European producers with 20% of sales coming from this segment. Stora Enso is the number two paper producer in the world and we believe the attractively valued stock with a dividend yield of around 4.2% offers limited downside and substantial upside potential if the economy starts rebounding. The recent structural changes of the paper industry such as lower capacity expansion and production discipline provide the necessary background for our positive stance on the stock. Although for a sustained recovery in the sector, we need to see growth in GDP and a recovery in advertising trends, we believe that the increase in the North American prices should underpin the optimistic comments of Stora Enso's CEO on the recovery of the North American paper markets. The earnings figures for the full year will be released on 30th January and should shed some further light into the company's North American operations.

Tesco (TSCO LN, GBP 1.835) released very strong 4Q sales figures. Volume growth came in at 5% with deflation of -0.2%. Petrol inflation and strong non-food sales helped especially through the newly extended Extra hypermarkets. International sales were up 24.9% in line with expectations. We believe that with the current consolidation among the UK food retailers (bid for Safeway (SFW LN, GBP 3.05) from Morrison (MRW LN, GBP 1.8225)) and further counterbids expected from Sainsbury (SBRY LN, GBP 2.47) and Wal-Mart's Asda (WMT US, USD 49.97), Tesco could emerge in the long run as the winner as the company has the size and ability to consistently invest in price. With their goal to have as much selling space overseas as in the UK, it will become an international market player and should benefit of a re-rating. Tesco trades currently at a PE 03 of 11.9x whereas Carrefour (CA FP, EUR 39.54) is at 18x.