Still cautious on the US stock market

US equities

Reporting season is coming to an end this week. Among our recommendations, the following companies are expected to report their figures these coming days.

• Gillette Co. (G, $30.25, CSFB: Not rated); $0.292 EPS expected on August 5,
• Masco Corp. (MAS, $23.90, CSFB: Not rated); $0.455 EPS expected on August 6,
• The Macerich Co. (MAC, $36.85, CSFB: Neutral); $0.290 EPS expected on August 7, and
• Carolina Group. (CG, $25.09, CSFB: Not rated); $0.970 EPS expected on August 7.

On the macroeconomic side, Factory Orders for June, ISM Non-Manufacturing for July, and Consumer Credit for June will this week's key data. (Source: Bloomberg).

Masco Corp.'s 2Q'03 result is expected to meet or to exceed street estimates of $0.455 EPS next Wednesday. This would represent a 5.8% increase y-o-y.

However, the company is aggressively repurchasing its shares, hence we remain more cautious than analysts. Several new product programs are working in coating and cabinets, but contrary to analysts, we do not believe that strong home sales would be a driver for a rise Masco's share price.

According to Bloomberg, stock price is not significantly correlated with new home sales. In the current environment, we believe the company's strengths come from currency gains (the company had 16% of its revenue coming from Europe at the end of FY 2002) and from its diversified business segments (5 in total), each having a significant part in MAS' sales, protecting earnings from a shortfall. Hence we reiterate our long-term Buy rating on MAS, believing a 2.34% gross dividend yield makes the stock attractive.

Within our cautious view on the broad market we have filtered out two trading opportunities. The first recommendation, which is also within our theme of energy stocks, is the second largest oil service company Halliburton Co.

Halliburton (HAL, $22.24, CSFB: Outperform) reported strong Q2 results with revenues growing to $3.6 billion. Net EPS was of $0.06, versus an estimated $0.02. Contracts in Iraq contributed 9% of the revenues.

Company management said it expects a gradual improvement in the second half of the year in most regions and all business segments. The results were mainly supported by firm results in its core oilfield business. We believe that Halliburton should continue to see strong earnings momentum thanks to the favourable oil price, and the exploration and production segment being in an up trend.

One caveat is that the company is in settlement talks for asbestos claims concerning its engineering and construction group Kellogg Brown & Root (KBR).

CSFB models that in a worst-case scenario the company would incur total liabilities of approximately $1.7 billion, reducing 2004 EPS by $0.09 to $1.38.

Halliburton trades at an approximate discount to its peers of 35%, taking in account the above model, which results in a fair value of around $30 when closing the valuation gap to its peers. Which means that possible asbestos claims at current levels appear to be priced in. Hence the stock looks attractive for an investor seeking exposure to the oil service sector.

We see the stock as a trading position with price target at $25. Since the asbestos cases remain a risk factor, we would also recommend setting a tight stop loss level.

The second trading opportunity is the wholesale drug distributor Cardinal Health Inc (CAH, $56.10, CSFB: Neutral). Cardinal reported an 'in-line' quarter on the top and bottom line, though bottom line was positively impacted by much lower interest expenses and lower tax rate. The stock fell 15% after the company reported its quarterly earnings, due to a revised EPS growth guidance for fiscal 2004, reduced to "mid-teens or above", from 20-21%.

The reason for the downward revision was deterioration in operating margins in the pharmaceutical distribution segment. Cardinal Health's operating margin was down 42 basis points year on year in this segment.

The company also cited a competitive pricing environment and vendor margin pressure. According to the pharmaceutical industry research firm IMS Health Inc, pharmaceutical sales will rise 10-11% this year, down from 12% last year and almost 17% in 2001, due to fewer approvals of new drugs.

Based on the fiscal 2003 profit of $3.19 reported, we assume a 15% EPS growth for 2004, which gives us a $3.67 FY04 EPS. In this perspective the stock trades at a 14.9x 2004 P/E ratio, which despite a possible slowdown in earnings could lead to a partial recovery rally in the share price.

As possible margin pressure in the industry could persist this is a risk factor for the earnings growth in the long term. Therefore we see the stock as a trading position and would recommend setting a tight stop loss level.


European equities

• The DJ EUR Stoxx 50 closed the week slightly higher at 2479.70
• Vodafone reported solid key performance figures. We would use current weakness to buy ahead of interims in November.
• Update on 2Q results of BNP Paribas, ENI and Aventis.
• Consider ELN on BNP Paribas

With intense corporate newsflow and loads of economic data from both side of the Atlantic to digest, European markets edged only slightly higher reflecting that doubts about the state of the economy and corporate expectations remain.

The German IFO Survey, which is the most watched sentiment index in Europe came in at 89.2 for July up from 88.8 in June, but slightly shy of expectations of 89.5. While the current component of he index decreased from last month, expectations surpassed consensus forecast and lead the index higher on the whole.

Rising stock markets, low interest rates and the plan to bring forward a proposed income tax cut in Germany contributed an improved outlook. This is the third consecutive gain in the index and there is the chance that the expectations component continues to point to stronger GDP growth in 2H of 2003.

However, economic fundamentals need to improve in line with expectations over the coming weeks. This week, the German manufacturing production and orders for June will be released together with the unemployment figures, which could affect the outlook for consumption.

The ECB met on Thursday and left interest rates unchanged at 2% as expected. Due to the summer break there was no press conference to give further insight into latest economic data.

The earnings season continued with a focus on the Telecoms, bank and energy sector:

Vodafone (VOD LN; GBP 1.15) reported a solid set of 1Q KPI (key performance figures), which are supportive for the company's 10% subscriber and revenue growth target for fiscal 2004. 1Q subscribers increased to 3m and ARPU could be raised in two key European countries (Italy and UK, Germany remained flat). Vodafone has now a customer base of 122.7m, which is 18% more than last year.

Since 1 August, Vodafone welcomed a new CEO: former president and COO of Airtouch communications Arun Sarin will take the place of Sir Christopher Gent. As pointed out in the recent AGM, Vodafone needs to focus on economies of scale and drive top-line growth further, possibly through acquisitions. Arun Sarin has the reputation of being an innovative operating man with a track record of generating shareholder value.

The biggest challenge will be integrating its 45% stake in Verizon Wireless, which is held through AirTouch. But there could also be renewed interest in Cegetel, which is 70% owned by Vivendi Universal through SFR, which remains among the most profitable operations in Europe. Vodafone has given Vivendi Universal six-month notice to end the stand off, which prevents Vodafone from buying any Vivendi Universal shares.

This will likely cap the share price over the medium-term. However, we would advise to buy on weakness ahead of interims in November, which should show robust margins. For the long-term investor, Vodafone remains the no 1 or 2 player in all core markets and we are confident that its new CEO can deliver on the expectations.

One of this week's outperformers was BNP Paribas (BNP FP; EUR 47.55) after it reported figures slightly better ahead of expectations. The positive surprise came mainly from a record 2Q net banking income (increase of 13% yoy) and from the lower loss provisions. Improved earnings from corporate and investment banking helped revenue and gross operating profit to record highs, but the stronger USD impacted profits from consumer banking.

Return on equity came in at 14%. We reiterate our buy for investors with a long-term horizon. Going forward a recovery in the French retail market, which remains one of the most attractive in Europe, could be expected.

Wholesale banking should remain robust with improving earnings driven by better operating performance in investment banking and lower cost of risk in commercial banking. Looking at valuations the stock trades at a discount to its peer average and we view the decision to buy back EUR 2bn in the coming 18 months as an improvement in acquisition discipline, which should support the stock further.

ENI (ENI IM; EUR 12.977) reported an 8% increase in EBIT yoy despite a strong Euro. 2Q oil production rose 5%, which is on track to reach the company's target for annual growth of 6% through 06 making it one of the fastest growing oil companies. We reiterate our buy on ENI, which comes with an attractive dividend yield of 5.7%.
Our other favorite oil stock Total (FP FP; EUR 128.70) will be reporting this Wednesday.

According to a recent study by Citigroup, BNP Paribas, ENI and Total rank at the top out of the top 15 European large caps, screening them by (1) trading at a discount to the market and (2) enjoying relative earnings upgrades.

Historically, portfolios based on positive earnings revisions have outperformed stocks with poorer earnings revisions. A possible alternative to gain exposure to these counters could be through an ELN. Given the current technical support, indicative levels for BNP Paribas look attractive with a floor of around 94%, 36 days and an indicative yield of around 10%.

Aventis (AVE FP; EUR 43.89) reported better than expected 2Q figures, which reflected a recovery of US sales of its two main blockbusters Lovenox and Allegra. The company retained its guidance of high single digit underlying revenue growth and reported EPS growth in the mid to high teens.

But this is on a changed currency assumption at USD 1.10 per EUR whereas the previous guidance was at USD 1.02 per EUR. So, in effect this is a 2-3% upgrade. We believe the shares remain undervalued trading at around a 22% discount to European sector average and remains attractive for long-term investors.