Economic data lifts US stocks

US Equities

On Tuesday, Wells Fargo & Co. (WFC, $55, CSFB: Outperform) is expected to report a $0.93 EPS vs. $0.84 a year earlier. We believe WFC's will report good results, although loan businesses could decrease from last quarter due to increasing loan rates. We maintain our Buy rating on Wells Fargo.

On Wednesday, analysts would wait for Aflac Inc.'s (AFL, $35.52, CSFB: Neutral) to report a profit of $0.46 a share, compared with $0.45 y-o-y. AFL is struggling to report growth in the U.S., which weighs on its stock prices. However, the company reported the last quarter's better-than-expected growth in Japan.

This market accounts for about ¾ of AFL's total sales (source: Bloomberg). On the one hand, after a 12%-gain in stock price since our recommendation on April 29th, we would advise to take some partial profits on Aflac. We will increase our stop-loss to $34.20 from $28, securing an 8%-profit.

American International Group Inc. (AIG, $61.08, CSFB: Outperform) will report its quarterly earnings on Thursday. Consensus forecast $0.977 EPS, up from $0.70 a year earlier. We maintain our Buy rating, and our stop-loss at $57.

Last week, press reports indicated the NYSE could impose disgorgement of around $150 million, plus fines, on the five specialists under investigation for improper trading activity. The NYSE will seek compensation for investors after finding the specialists drove up costs by stepping into trades in which orders could have matched without intervention.

Spear Leeds & Kellogg (SLK), a subsidiary of GS, is the second-largest NYSE specialist firm by volume and is involved in the investigation. This would impact Goldman Sachs Group Inc. (GS, $87.17, CSFB: Not rated). Merrill Lynch estimates SLK's specialist business has produced revenues of approximately $250 million - $300 million this year, and accounts for about 2% to 3% of GS's YTD net revenues of $12 billion. This would increase GS's stock price volatility.

We maintain our target price at $95 and our stop-loss at $80. The other firms under investigation are Van der Moolen Holding NV, LaBranche & Co., FleetBoston Financial Corp.'s Fleet Specialists, and Bear Wagner Specialists LLC, majority owned by Bear Stearns Cos.

The drug maker Merck & Co (MRK, $48.63, CSFB: Neutral) is scheduled to report earnings on October 22, before market opening. We are expecting a USD 0.85 per share before items, up from USD 0.78 in the same quarter last year. This will be the first quarterly resut since the spin off of Medco Health Solutions.

Merck's report will represent the pharmaceutical business on a standalone basis and we will therefore be looking to get greater visibility on the company's profit margins in the pharma business. Merck historically trades at a discount as a result of the lower profitability related to the low margin Medco unit.

Thus it will be important for the management to build up investor confidence by reporting improving profitability and a clear roadmap to growth in order to eliminate the persisting valuation discount to its peers.We reiterate our positive stance towards Merck based on the attractive valuations and the indicated dividend yield of 3.04%. A good set of earnings numbers could bring some momentum into Merck's share price.

Share prices in the technology sector are likely to be volatile, as the earnings season progresses. Earnings expectations for the companies in the sector are high and accordingly there is a risk of disappointment. Valuations in various segments, especially the semiconductor sector,very rich, leaving no margin for error in terms of meeting earnings expectations.

Like last week International Business Machines Corp (IBM, $89.23, CSFB: Outperform) reported solid numbers, meeting earnings forecasts with an EPS of USD 1.02, but the stock sold off, as revenue growth of 8.6% y-o-y slightly missed analysts' expectations. Nevertheless the outlook for IBM remains intact and some new contract wins and new research collaboration agreements will contribute to further growth. We expect IBM to gain track, as corporate IT spending gradually picks up.

We would however recommend investors considering locking in some short-term profits in technology stocks, in the light of the expected high volatility in the sector and the risk of results missing the high expectations. We are also setting sell levels for our recommended stocks in the sector, in order to protect some of our gains and to avoid incurring losses. We would sell Dell Inc should it drop below USD 35.50, Oracle Corp at USD 11.50, UTStarcom Inc at USD 33.50 and IBM Corp at USD 89.

Altria Group (MO US, $44.95) published its 3Q03 results last week. GAAP EPS was $1.22 vs. $2.06 in 3Q02. It fractionally beat consensus, although largely through non-operating items ie currency gains. Philip Morris USA reported an operating income decline of 24.4% to $1.15bn.

Its total shipments fell 1% to 48.9 billion cigarettes on flat premium volumes and a 10.6% decrease in its discount volumes. Marlboro's retail share in the quarter was 38.1% vs. 37.8 in 2Q03 and 37.7% in 3Q02. From a volume and share perspective, PMUSA performed well. Philip Morris International remains stable but challenged in its main European markets such as France, Italy and Germany where tax hikes have hurt volumes.

Our investment conclusion is that the operational environment remains tough for PM USA and PM International. However, fundamentals have been stabilizing gradually over the last 4qtrs or so. In our view, investors have taken an unduly conservative view of MO's US tobacco litigation challenge.

There have been a string of huge tobacco hurdles that have been crossed just in the last two months and it is in line with our view of diminishing legal risks. We maintain our BUY rating with a target of $48 and stop loss of $39.

European equities

The DJ Stoxx 50 closed the week 1.3% higher at 2550.82 driven by corporate results from both sides of the Atlantic


• After a sharp increase of MAN AG within the last 5 days we decided to lock in a profit of 15% since 13 August

• CSFB increased its target price for SAP AG and Adidas-Salomon AG

The market was guided by corporate results from both sides of the Atlantic. Among the heavyweights in Europe were Philips, ASML and Nokia: Philips (PHIA NA; EUR 22.59) reported better than expected 3Q earnings and posted its second straight quarterly profit.

The solid performance was achieved by cost cutting, strong contributions of the 21% stake in TSMC and LG Philips. On an operating level, the company took a loss of EUR 126m. Philips did not give a detailed outlook, however the general tone was reasonably confident and the management expects its Consumer Electronics division in the US to be 'close to breakeven' and confirms a positive result in its Semiconductor unit in the 4Q.

On the other hand, they were more cautious on the Medical division due to tougher market conditions in Europe. From a valuation point of view, CSFB attaches a sum-of-the-parts valuation of EUR25 for Philips. ASML (ASML NA; EUR 13.66) reported a smaller than expected 3Q net loss despite its order backlog surprising on the upside. As almost half of the new orders came in the last two weeks of the quarter, it is not long enough to base new trend predictions on it.

Trading on a PE04 of 47x, markets imply an accelerated recovery in sales and margins, which is not necessarily in line with the statement of the CEO as 'he sees signs of recovery (but) riddled with inconsistencies'.

Nokia (NOK1V FH; EUR 14.60) reported EPS in line with expectations and above the range provided as a guidance (EUR 0.18 on a reported basis). The 1ct EPS surprise was, however, already discounted in the price. Reasons for the disappointing reaction could be found in 1) subdued company comments on 4Q margins guidance.

3Q handset margins were at 22.4% and 4Q is historically a strong quarter for margins (4Q 02 24.7%). 2) flat to slightly higher guidance for 4Q phone sales when markets expected more 3) EPS guidance for the 4Q of between EUR 0.21-0.23 is also well off the figure of EUR 0.26 a year ago and 4) lower than estimated average selling price.

On the positive side, Nokia confirms the trend in strong growth in demand for handsets and states that its market share in the overall mobile phone market rose to 39% which is just short of the 40% target for this year. Our rather neutral stance on the company stems from the fact that we are yet to see a catalyst.

The insurance sector as a whole posted a strong performance this week lead by the German insurers. The German government may allow companies to deduct stock market losses from their tax bill, which would save the insurance industry up to EUR 10bn this year.

Munich Re (MUV2 GY; EUR 97) would be among the companies benefiting the most. In addition, Munich Re announced its long awaited capital increase on Friday. Munich Re will raise EUR 3.8bn in a 2 new for 7 existing shares-offer for at least EUR 75 per share, which is a discount of 23.5% to Thursday's closing.

The share offer will begin on the 28 October and end on the 10 November. Allianz (ALV GY; EUR 83), which holds 13.6% of Munich Re said that they will buy at least half of the new shares and Hypovereinsbank (HVM GY; EUR 16.04), which holds 13.2% supports the rights issue fully. The rights issue is the first step along the road to restore the group's AA rating.

Further steps would involve a reduction of stakes in Allianz, Commerzbank and Hypovereinsbank. The rights issue earlier on from Allianz, Swiss Life and Zurich Financial Services all helped stabilise the share price. Over the long term we believe the capital increase will act act as a support for Munich Re and in the short term will at least remove some uncertainty.

After SAP (SAP GY; EUR 123.56) pre-announced its key figures the week before, the company released detailed 3Q earnings ahead of expectations this week (net income increased 25% to EUR 252m, EPS came in at EUR 0.81 versus consensus forecast of EUR 0.62-0.65) and increased their guidance for the full year operating margin to around 26%.

The earnings outlook was also revised upwards towards the higher end of the range of EUR 3.45 - 3.60. The stock is currently trading at 30x 04 earnings, however, according to CSFB it is worth noting that SAP in the past has seen multiple expansion when it is perceived to be in an upgrade cycle.

If the stock were to return to its pre-bubble multiple of an average of 36x the stock could move to around EUR 145 per share. Accordingly, CSFB raised its target price for SAP on Friday from EUR 130 to EUR 140.

The stock currently sees some profit taking after a 13% increase following the companies pre-announcement. We believe reported market share gain should support the downside and reiterate our positive stance towards SAP with a target price of EUR138.

CSFB increased its target price for Adidas-Salomon (ADS GY; EUR 79.42) by 7% to EUR 108.06. We currently have a medium-term target of EUR 85. However, if the company manages to report decent 3Q figures (the 3Q is the most important quarter representing 57% of 2003 annual net income), we believe the company should gain momentum approaching 2004. Adidas-Salomon is not only positively geared towards a weakening US Dollar, but has a strong product pipeline, powerful strategic initiatives and trades on attractive valuations.

MAN AG (MAN GY; EUR 22.80) increased 12.7% in the last 5 days. After we reiterated our buy at EUR 18.25 and EUR 19.43 at the end of September and given the sharp increase, we decided to lock in a 15% profit since 13 August and remove the stock from our recommendation list. We continue to like the stock from a fundamental point of view and will look at adding it back at lower levels.