Positive earning momentum continues in telecom sector (page 1 of 3)

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.