Relief brought by the war (page 1 of 3)

US Equities

• Recommendations update
S&P 500 increased 7.5% last week on optimism that a war in Iraq will be short. Hence, for investors who want to play this short rebound, we added the Bank of New York Co. Inc. (BK, $22.20, CSFB: Restricted) on our recommendation list with a Buy rating. Correlation with the S&P 500 is at 0.94 and beta is at 1.35 (source: Bloomberg). In January 2003, BK agreed to purchase CSFB's Pershing unit for $2bn in cash. Pershing is the largest global provider of correspondent clearing services and outsourcing solutions for asset managers, brokers, and other financial intermediaries (source: Bank of New York). The theme is on an increase in trading volumes. However investing in BK remains risky due to further writedowns of loans, and a weak equity market, which could have a negative impact on BK's Asset Management unit.

With the beginning of the war in Iraq, volatility in aerospace & defence stock prices increased significantly. For last week, S&P 500 Defence & Aerospace index volatility rose to 29.00, while average volatility since the beginning of the year reached 22.00 for this index (source: Bloomberg). Besides volatility, pension expenses for 2000-02 could still add pressure on defence contractors' stock prices. The majority of defence companies use multiyear smoothing function of asset returns. Hence variation in pension income affects earnings for several years. So far, among large defence companies, only Boeing Co. (BA, $28.10, CSFB: Outperform), and Raytheon Co. (RTN, $27.78, CSFB: Outperform) have provided explicit 2004 pension expenses. Boeing estimates that pension expense will decrease to $75 million (about $0.094 per share) in 2003 from $404 million ($0.36 per share after-tax) in 2002, then to a $175-300 million ($0.22-0.38) expense in 2004. Raytheon estimates that pension expense will move to $295 million in 2003 ($0.49 per share) from $89 million in 2002 ($0.15), and then increase to a $618 million ($0.97) in 2004. Our recommended defence contractor, Northrop Grumman Corp. (NOC, $82.35, CSFB: Outperform), is the one of the few companies that does not smooth its pension returns. Therefore, all of the underperformance in the plans for 2000-02 is already reflected in its figures. As a result, we maintain our Buy rating on NOC. For investors looking for yield, we believe the 7% Northrop Grumman preferred shares could be interesting. The shares are convertible until April 4th, 2021 at a ratio of 0.9111. The current price is $122.

The drug maker Pfizer Inc. (PFE, $31.96, CSFB: Outperform) is getting closer to finalising its planned acquisition of its competitor Pharmacia Corp. (PHA, $44.45, CSFB: Outperform). Pfizer is selling several of its products in order to comply with agreements reached with the European Commission and the US Federal Trade Commission, as these drugs would compete with drugs in Pharmacia's portfolio or would give Pfizer a dominant position in one therapeutic area. The divestitures involve mostly minor products, which will not have a material effect on Pfizer's earnings, as the main focus remains on the synergies that the integration of Pharmacia into Pfizer's operations will generate and as a consequence strengthen the company's profitability further. Both companies will have consolidated sales of around $45 billion and a research and development budget of $7 billion. Pfizer expects to achieve $2.5 billion in annual cost savings by streamlining its businesses.

The finalisation of the acquisition will certainly strengthen Pfizer's position and should over time be reflected in the share price.