A new outlook for commodity stocks (page 1 of 3)

US equities

Commodity stocks had a good week, as hopes for an economic recovery lifted the sector. Since an improvement in the economy would also drive demand for commodities, investors started to buy into commodity related stocks. We value the commodities industry as attractive, as we believe that it is at the trough of the cycle and is in a transition phase to new growth.

It is not only crude oil, on which we have turned positive a while ago, and which has seen stable high prices, even after the war premium dissipated. But we are also beginning to see an improvement in metal prices as well. Aluminium prices are recovering since the sharp decline in 2001, where huge overcapacity has plagued the market. A phase of consolidation and restructuring followed, which eliminated some of the excess capacity. The industry has also learned to implement tight capital discipline during the downturn.

For 2003, worldwide aluminium sales should increase by 4-7%, mainly due to a price increase, according to Standard & Poor's. Data points coming from US aluminium maker Alcoa Inc. (AA, $24.61, CSFB: Outperform) underpin this view. Alcoa has reported stronger than expected earnings, but the most encouraging point was an improvement in margins.

This came despite high energy costs and shows that Alcoa's efforts to cut cost are starting to bear fruit. Alcoa will continue slashing cost to further improve profitability and give the company the potential to outperform the industry as demand picks up. We believe that it is a good time to buy into the stock, as an investment in the commodity sector, based on our long-term positive view on commodities. Alcoa's indicated dividend yield of 2.44% makes the stock additionally attractive.

Last week we added International Business Machines Corp., or IBM (IBM, $88.04, CSFB: Neutral), to our list of recommended stocks, as we believe that the company has been neglected of late and has underperformed the information technology sector during the rally over the last two months. In our view, this is not justified if we look at IBM's consistency in revenues over the last two years. They have remained relatively stable and the outlook is equally attractive.

IBM has been growing its IT services business, also through the acquisition of the PriceWaterHouseCooper consulting business, to make its revenues less dependant on technology cycles, as this business is characterized by long term contracts providing IT service companies with a large amount in recurring revenues. During 2002 IT services have made up 48% of IBM's revenue and for 80% of its pre-tax profits. With the increasing complexity of computer infrastructure, the IT service business has a good long-term outlook, as more support will be needed.

However If the IT services business provide the stability in earnings, the company's key growth engines are the company's hardware and increasingly its software division. The software division achieves gross margins of 85%, which will boost the company's profits once IT spending recovers.

Qualcomm Inc. (QCOM, $33.55, CSFB: Neutral) is another stock in the technology sector, which has not been participating to the rally, but has the potential to see a share price appreciation. The risk of competition has put the Qualcomm share price under pressure, as Texas Instruments Inc. (TXN, $20.50,CSFB: Not rated) announced plans to enter the CDMA chipset market. Competition however should not start to play a role until late 2005, which gives Qualcomm the time to capture the first wave of growth in the CDMA market.