Buy US insurance and banking

US Equities

In 2003, the insurance, and the banking sectors underperformed the S&P 500. While the benchmark had a return of about 29% for the year, the insurance sector delivered a 21% return, and the banks had a return of about 27%.

As valuations are still high, we prefer invest in the laggards, and therefore, focus on these two sectors in the short-term.

In the insurance sector, we recommend Allstate Corp. (ALL, $44.70, CSFB: Outperform), and IPC Holdings Ltd. (IPCR, $42.91, CSFB: Not rated).

Allstate stock price rose about 24% since our recommendation in mid-August 2003. We increased our target price to $49, because we believe there is still a room to increase. ALL has a P/E of 12x, compared with a P/E of 22x for the S&P 500 Insurance index.

IPC Holding is our recommended mid-cap re-insurer. We see a fair value at about $44, which is conservative in our view, given a P/B ratio of 1.38x, compared with a P/B ratio of 1.85x for the larger capitalized insurers.

In the banking sector, we recommend Wells Fargo & Co. (WFC, $57.19, CSFB: Outperform), Bank of America Corp. (BAC, $79.02, CSFB: Outperform), and Hibernia Corp. (HIB, $23.53, CSFB: Neutral).

We believe Wells Fargo is suitable as a long-term growth play. Its position covering the entire US reduce the geographical risk. Furthermore, the balance sheet is among the healthiest in the sector. Finally, it gives an attractive gross dividend yield of 3.15% (source: Bloomberg).

Higher stock price volatility characterizes Bank of America. Therefore, we have a trading buy on this security, with a trading range from $68 to $95. Good fundamentals and gross dividend yield of 4.05% (source: Bloomberg).

Hibernia is a regional bank in Southern U.S. On January 15, the company reported a 4Q EPS of $0.46, in line with the consensus expectations. This result represented a 5% increase from 3Q and a 10% rise y-o-y. For the full year, HIB reported earnings of $1.64, up 5% from year ago results. The company expects earnings to grow 8% to 10% in 2004. We have a Buy rating on this mid-cap.

Express Scripts Inc (ESRX, $68.30, CSFB: Outperform), the pharmacy benefit manager on the US Recommendation List on Friday hit our 12-months price target of USD 67, closing at USD 68.30, returning 18.80% since recommendation on October 22.

Express Scripts was added as one of our mid-cap ideas and in the meantime has surpassed the USD 5 billion in market cap, moving into the large cap segment. Nevertheless, the growth perspectives for the company remain intact.

Playing a key role helping benefit sponsors to restrain the rapid growth in pharmaceutical cost, pharmacy benefit managers face a friendly environment and should profit from a growing customer base, as well as from the increasing Medicare spending.

Hence we see further upside in Express Scripts share price and increase our 12-months target price to USD 74, an incremental 8.35% from current levels. We would like to advise investors taking partial profit in Express Scripts.

In the past few weeks risk appetite in US equity markets has increased, which has resulted in sharp price increases in stocks that have been lagging the market due to weak fundamentals.

Like stocks in the communication equipment sector, the networking companies have in the last two weeks experienced a revival. The rally, which was initiated by improving sentiment towards IT spending and upbeat earnings in the sector has however also led to a multiple expansion in these stocks.

Juniper Networks Inc (JNPR, $29.93, CSFB: Neutral) as the latest example, which surprised with a net EPS of USD 0.04, up from USD 0.02 a year earlier as sales rose to USD 186.6 million from USD 157.2 million a y-o-y saw its share price surge 30.53% in Friday's session, after the company also predicted that sales for the current first quarter 2004 would grow to USD 210-215 million.

Juniper said it would be facing increasing demand for Internet Protocol networking products, as voice calls are increasingly routed as data packets over cable networks.

Analysing the numbers we are not as euphoric and believe that first signs of overheating are appearing. Taking Juniper, the stock is trading at 187.06x reported earnings, respectively 123.17x expected earnings, as well as 16.61x price to sales, the stock anticipates a very strong recovery. And even though the company mentioned that it saw revenue growth trends intact, we see growth as overly priced in.

We can extend this observation to the Nasdaq Composite, which is currently valued at a 124.65x reported earnings and a 44.35x expected earnings, which assumes an expected 2.81 fold y-o-y earnings growth in 2004. We believe these expectations are exaggerated.

We would therefore advise investors with large exposure to technology stocks to start taking profit in the sector, as we could see the pendulum swing back and stock valuation returning to more reasonable levels.

As a defensive dividend yield play, which would offer a diversification to the aggressive technology stocks the iShares on the Dow Jones Select Dividend Index fund (DVY, $54.41), an exchange traded fund aiming to track the performance of a selected diversified basket of dividend yielding stocks, would offer a very good match.

We are getting cautious towards the expensive valuations and we believe that the segment of high dividend yield stocks in this perspective offers value.


Europe

European indices reached new highs after the Euro retreated over 3.3% during the week.

• We took profit on Alcatel to lock in a performance of over 15% since recommendation one week ago.
• We took profit on JC Decaux to lock in a profit of 28.9% since recommendation.
• We removed Adecco from our list after delay of the 03 audit.
• We reiterate our positive stance on SAP AG, Vodafone and France Telecom.
• We added Allianz AG and ING Groep NV to our recommendation list.

On the back of positive US economic datas, sound corporate results and a strengthening US Dollar, European indices managed to climb to new highs. Export oriented companies and sectors as well as the insurance sector lead the table during the week.

Several of our stocks reached their target prices:
Alcatel (CGE FP; EUR 13.73) had a strong run within the last week and came close to our target price of EUR 14. Given the 15.29% advance since recommendation one week ago, we will lock in the profit and wait for some consolidation / pullback for possible new positions.

Our mid cap media stock JC Decaux (DEC FP; EUR 15.35), which we reiterated to buy several times around the EUR 13 level reached our target of EUR 15. The stock yields a performance of 28.9% since recommendation and of 14.35% since the beginning of this year. We will take profit and remove the stock from our recommendation list.

The Swatch Group (UHR VX; CHF 162.25) surpassed our target price of CHF 158 on Friday. Since recommendation on 29 August 2003 the stock yields over 18%. We would advise investors, which got in at the recommended price to start take some partial profit. However given the good momentum we will keep the stock on our recommendation list for the time being.

We also removed Adecco (ADEN VX; CHF 54) after we have advised to take partial profit when the stock reached our target price of CHF 75 and CHF 80.

Adecco has issued a statement on Monday saying it has delayed the completion of its 2003 audit for three reasons: 1) Identified material weakness in internal controls in the North American operations of Adecco Staffing, 2) Resolution of possible accounting, control and compliance issues in the companies operations in certain countries and 3) Completion of the companies efforts to address these matters and determine their effect on its financial statements.

As a consequence and as could have been expected with these kind of issues the stock got hit heavily. According to CSFB, if no profit to the US operations is ever attached, Adecco's value would equate around CHF 50. CSFB also states that Adecco's cash flow (Adecco has EUR1bn of cash on balance sheet) has been robust and the company was able to halve its net debt during the last three years.

Although the share price reaction has been sharp, a lot of uncertainty still surrounds the financial outlook and we would expect the stock to remain under pressure until the issues are clarified. Therefore, we would remain cautious and prefer to get full insight into what is going on before entering into new positions.

Ahead of the official date 22 January 04, SAP AG (SAP GY; EUR 133.74) released preliminary figures for Q4 2004. Although the figures matched the official estimates given by Bloomberg, the stock got sold down as expectations got ahead of the fundamentals.

Overall the figures are good with license and total revenues in line with consensus forecast but with significantly better than expected margins which demonstrates the leverage inherent in the model.

Details are due on January 22 including some indications for the future. CSFB increased its target price from EUR 140 to EUR 150. CSFB maintains its 11% ex currency license growth forecast for 04 but with operating margins of 28.4% (vs 27.6% previous) its 04 EPS forecast rises from EUR 4.25 to 4.36. The stock currently trades at 31.7x 04 estimates and according to CSFB is as such below its upgrade multiple peak of around 35x.

We would expect some consolidation around the EUR 130 level and we maintain our positive view given SAP's status as a market leader and the fact that corporate spending is slowly picking up. We have increased our target price to EUR 153 on 6 January with a 12 months view. We reiterate our buy.

CSFB upgraded last week Europe telecoms to overweight from market weight as they see the mobile industry to continue to grow at above GDP levels with an increasing proportion of growth from next generation services.

Our two recommendations in this sector are Vodafone (VOD LN; GBP 1.4425) and France Telecom (FTE FP; EUR 23.24). Vodafone retreated slightly after touching resistance of GBP 1.50. As mentioned earlier, we would use the pullbacks towards the GBP 1.40 level for adding to new positions.

Morgan Stanley raised last week its target price from GBP 1.57 to GBP 1.80. We have raised our target price to GBP 1.66 in the first week of January and reiterate our buy at this point in time with a potential upside of 15%.

We added Allianz (ALV GY; EUR 108.62) and ING Groep NV (INGA NA; EUR 20.43) to our recommendation list. Please note this does not reflect a fundamental call on the insurance sector in general. We see it more as a play on the current positive momentum in the insurance/banking sector.

Allianz surprised the market in the last couple of days with the announcement of the sale of non-core units, which shows the determination by the management to focus on its core business. In addition we would expect a rerating of its Dresdner bank after the sharp cost cutting and expectations for a fall in loan provisions. We attach a target price of EUR 125 and a stop-loss of EUR 95.

ING offers one of the best risk/reward ratios in the sector with attractive valuation and support to earnings from the recent and ongoing restructuring and an improving equity market backdrop. We attach a target price of EUR 23 and a stop-loss of EUR 18.45.