MARKET WEEK -- Stocks  ---  The Trader:  First-Quarter Profit Reports Brighten M

 

  Stocks rose moderately last week, as investors reacted favorably to

first-quarter profit reports from such companies as Microsoft, Intel, Texas

Instruments, Merck, American Express and J.P. Morgan Chase.

  The Dow Jones Industrial Average added 56 points, or 0.5%, to close at 10,257

while the S&P 500 index moved up 14 points, or 1.2%, to 1125; the Nasdaq

advanced 40 points -- 2.3% -- to 1797.

  Wall Street digested hundreds of profit reports from large companies in the

heaviest reporting week of the quarter. Not all the news was received favorably.

Former stalwarts Pfizer and Colgate-Palmolive released disappointing results,

prompting declines in their stocks. Boeing and Veritas Software were weaker on

earnings news as were BellSouth, SBC Communications and Finnish cell-phone

giant, Nokia.

  Elsewhere in the troubled telecom sector, Qwest Communications fell after

reducing its 2002 financial guidance and WorldCom dropped in after-hours trading

Friday after it did the same.

  Rob Gensler, manager of the T. Rowe Price Media and Telecommunications fund,

says a common theme in many of the tech profit reports was "fabulous cost

controls and light end demand. That's the nature of the early stage of a

recovery."

  He points to Microsoft, Texas Instruments and Nokia. Gensler is cautious on

the semiconductor sector, where he believes the recent pickup in demand has more

to do with a rebuilding of inventories among the industry's customers than any

significant pick-up in final demand for many of the products that incorporate

semiconductors, like cellular phones and networking equipment.

  Valuations in that group remain high with Texas Instruments up 1.50 to 33.30

in the week, trading for over 100 times estimated 2002 profits and 40 times

projected 2003 earnings. Intel, which gained 1.71 to 30.10, also is no bargain,

trading for 40 times projected 2002 profits and 30 times estimated 2003 earnings

of $1 a share.

  Gensler says that, unlike in 2000, an "intelligent debate" now is possible

about the valuations of most major tech issues, including Microsoft. The

software giant, which rose $1.27 to 57.20, trades for around 29 times projected

calendar 2003 profits of $2 a share. That's not cheap, but Microsoft continues

to boast what's probably the finest balance sheet in Corporate America, with $54

billion in cash and investments worth almost $10 a share.

  The big issue with Microsoft is whether its profit growth, which has slowed to

about a 5% annual pace, will accelerate to a low double-digit rate or stay

around current levels. It will take a meaningful acceleration in the

profit-growth rate to support a sustained rally in Microsoft's stock. Gensler

says Nokia is looking more attractive now that it trades around 17, roughly 20

times projected 2003 profits.

  Both Pfizer and Colgate-Palmolive fell despite reporting profits that were in

line with Street estimates. Pfizer's problem was its warning of a slowdown in

second-quarter profit growth, although the world's largest drugmaker still

expressed confidence in its original 2002 profit estimate of $1.56-to-$1.60 a

share, up about 20% from last year's $1.31.

  Pfizer was off $1.50 to 37.80. Pfizer not only expressed confidence in its

2002 outlook but reiterated guidance of 15% gains in profits per share in both

2003 and 2004. That would imply 2004 earnings of more than $2 a share. If Pfizer

is correct, its stock could be appreciably higher in 12 months, but investors

remain concerned that the woes that have affected Merck, Bristol-Myers Squibb

and Schering-Plough may eventually hit Pfizer.

  Colgate dropped $4.43 to 54.40 after reporting a 9% growth in profits to 49

cents a share as investors reacted poorly to lackluster sales-volume growth of

2.5% in the quarter. Pricey consumer stocks like Colgate, now trading for 25

times estimated 2002 profits of $2.20 a share, need to report mid-single digit

gains to support their valuations.

 

  Media: Added Value

 

  Advertising-driven media companies have surged since their September lows amid

optimism that ad spending will revive in the second half of this year.

  Viacom, at 50.50, is up 80% from its September low, and Clear Channel

Communications, the leading independent radio operator, has picked up by 50%, to

53. Disney is back in favor, rising to 25 from a low of 15.50. And even the

supposedly stodgy newspaper stocks have risen sharply and now trade at record

valuations.

  The two main laggards are AOL Time Warner, which is bedeviled by troubles at

its AOL Internet business, and Rupert Murdoch's News Corp. AOL languishes around

21 and News Corp., up 0.65 to 27.65 in the five sessions, has risen a relatively

modest 20% since its September low of 23. News Corp.'s relative weakness is less

explicable -- because its Fox network TV business, cable-TV properties, TV

stations, and global newspaper operations are sensitive to ad spending.

  "News Corp. is an attractive situation," says Rob Donahue, co-manager of the

Salomon Brothers Capital fund. He and many other investors favor News Corp.'s

Class-A shares, which trade for around 23.50, a four-point discount to the

regular voting shares, which are controlled by Murdoch.

  Donahue believes the near-record valuation gap between Viacom and News Corp.

is too wide, given the similar fundamentals affecting both companies. Donahue

says the News Corp. A-shares could top 30 in the next year. Rich Bilotti, Morgan

Stanley's entertainment analyst, has a price target of 35 and pegs the company's

year-end asset value at $32 a share. News Corp.'s A-shares are back where they

stood in 1998.

  News Corp.'s chief asset is an 85% interest in Fox Entertainment, which

controls the Fox network, TV stations, Fox cable properties -- including the

successful Fox News -- as well as the Fox movie studio. That stake is worth $18

billion, or $12.50 per News Corp. share, with Fox at 24.50. News Corp. also has

a sizable presence in the British and Australian newspaper business, owns 40% of

the BskyB, the European satellite operator, controls other global satellite TV

assets and owns nearly half of Gemstar-TV Guide.

  One reason that News Corp. trades at a steep discount to Viacom is management.

The Street loves Viacom president Mel Karmazin and views the 71-year-old Murdoch

with some distrust in light of concern that he's a dynastic empire-builder who

plans to pass control of the company to his 30-year-old son, Lachlan. The risk

is that the untested Lachlan turns out to be a value destroyer -- like the

third-generation Seagram chief, Edgar Bronfman Jr., who engineered the

disastrous sale of Seagram to France's Vivendi, whose stock has since collapsed.

  Yet Donahue argues that News Corp. is a well-run enterprise with a solid

balance sheet, a strong franchise, and considerable operating leverage because

of Murdoch's cost-cutting initiatives. News Corp.'s projected year-end 2002 net

debt of $5 billion is the lowest among its peers -- AOL is projected to have $28

billion in net debt. News Corp.'s market value is around $33 billion. There's a

perception that Murdoch is only interested in accumulating assets, but Donahue

points out that Murdoch unloaded the Fox Family Channel to Disney last year for

$5.5 billion, a huge 35 times trailing pre-tax cash flow.

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MARKET WEEK -- Stocks  ---  The Trader:... -2-

  News Corp., however, grossly overpaid for its 43% stake in Gemstar TV Guide,

which it bought from Liberty Media last year. That stake was initially worth

$6.6 billion (175 million Gemstar shares at 38). It's now down to $2 billion

with Gemstar at 11. News Corp. is expected to have taken a $2 billion Gemstar

writedown in the latest quarter and could be forced to take additional $2.5

billion hit if Gemstar doesn't recover.

  Adjusting for its complex structure, Bilotti values News Corp. at just 11

times estimated 2002 pre-tax cash flow, defined as earnings before interest,

taxes, depreciation and amortization, a steep discount to Viacom, which has a

cash-flow multiple of over 17.

 

  Lusterless Liftoff

 

  Apparently hoping to capitalize on the success of JetBlue Airways' recent

initial public offering, Wall Street underwriters -- led by Salomon Smith Barney

-- priced the 30 million share IPO of ExpressJet Holdings, the regional jet

operator for Continental Airlines, at $16 a share on Wednesday, the high end of

a pricing range of $14 to $16.

  But ExpressJet is no JetBlue, and the aggressive pricing of the deal drew a

lukewarm reception. ExpressJet finished the week at 16.15. JetBlue, the

low-fare, high-growth, Southwest Airlines-wannabe, went public at $27 a share on

April 14, immediately surged to 45 in frenzied trading and ended last week at

44, nearly 50 times projected 2002 profits of 90 cents a share.

  ExpressJet, which flies as Continental Express, is the country's largest

operator of regional jets. It has experienced strong revenue growth in recent

years and aims to significantly expand its capacity in the near future. But it's

independent in name only, because of its complete dependency on Continental for

its revenues, traffic, aircraft, and a wide array of systems and services that

supports its operations.

  ExpressJet's profitability, moreover, is based on an unusual contract

relationship with Continental that now guarantees ExpressJet a 10% operating

margin before calculation of certain costs, regardless of Continental's overall

profitability. Without that guarantee, it's unlikely that Continental could have

carved out ExpressJet as a separate company.

  ExpressJet earned $48 million, or 89 cents a share, in 2001, on nearly $1

billion in revenues, despite the industry's record $9 billion in losses. And

ExpressJet is expected to earn about $1.05 a share in 2002 and $1.25 in 2003. At

16.15, the stock doesn't appear expensive trading for 16 times 2002 profits, but

those profits are an artificial construct.

  Sam Buttrick, the airline analyst at UBS Warburg, says Continental's

guarantee of profits for its high-growth regional business is a "bad business

decision" from its standpoint -- one that also poses risks to ExpressJet

holders. The current contract is subject to change at the end of 2004.

"Continental is outsourcing the growth portion of its network and insourcing all

of the risks. Companies are supposed to do the opposite," Buttrick says.

  Buttrick, whose firm wasn't involved in the ExpressJet underwriting, also has

been critical of the management of UAL, parent of United, for providing

attractive contract guarantees to its main regional jet providers, Atlantic

Coast Airlines and SkyWest, at a time when UAL is suffering large losses.

  In forming ExpressJet, Continental essentially carved out $1 billion of its

annual domestic revenue of $6 billion and guaranteed an operating profit on that

$1 billion. Buttrick says Continental management "can't be faulted for

exploiting" the valuation anomaly in a market that accords a higher valuation to

regional-airline profits than major-airline earnings, to the extent that they

exist. Independent regionals Atlantic Coast Airlines and Skywest both trade

around 24, roughly 20 times estimated 2002 profits.

  ExpressJet now is valued at about $1 billion, more than half of Continental's

current market value of $1.8 billion. Continental still owns 34 million

ExpressJet shares, worth $544 million. Continental's more commonly traded

Class-B shares ended Friday at 27.90 -- down more than two points on the week --

after reporting an operating loss for the first quarter of $1.79 a share. The

other major carriers, excluding Southwest Airlines, also reported sizable

losses.

  The problem with the Continental/ExpressJet relationship is the inherent

conflict over their profit split. Continental has some incentive now to reward

ExpressJet because of its current 50%-plus ownership stake, but Continental

intends to sell off its remaining interest. After a six-month lockup period,

Continental may sell "some or all of its shares," the ExpressJet prospectus

states. Continental's stake could be gone in a year.

  It's notable that AMR, parent of American Airlines, so far has resisted the

idea of spinning off its regional unit, American Eagle. "American is the only

one that seems to have recognized the shell game for what it is," Buttrick says.

American is believed to be concerned about the potential conflicts created by an

IPO of its regional unit.

  The ExpressJet deal didn't do much for Continental's stock last week, perhaps

because investors figured that the ExpressJet deal amounted to a financial shell

game that effectively increased the risks at Continental.

 

  -- There was more bad news last week from Qwest Communications as the owner of

the old U.S. West again cut its revenue and cash-flow estimates. Qwest lowered

its 2002 revenue target by $1 billion, to $18-to-$18.4 billion and cut its

pre-tax cash flow projection to $6.4-to-$6.6 billion from around $7 billion. The

news triggered a one-notch downgrade of its debt rating by S&P, to

triple-B-minus, and raised concerns about the company's ability to honor its

recently renegotiated bank-credit agreement.

  The bad news overshadowed reports that Qwest is in discussions to sell its

Yellow Pages operations for $8 billion to $10 billion. Such a sale could allow

the company to reduce its hefty debt load of $25 billion. The stock sank nearly

a point to 6.60 on Friday, but was up 30 cents on the week.

  Qwest bulls argue that the stock looks attractive trading for under six times

projected 2002 cash flow, a slight discount to SBC, BellSouth and Verizon

Communications. "The sum of the parts is significantly higher than the stock

price," says Susan Kalla, a telecom analyst at Friedman Billings & Ramsey. Other

investors favor SBC, BellSouth and Verizon because of their stronger financial

positions. The SBC and BellSouth reports showed that their profit growth is

slowing.

  After the bell Friday, WorldCom Group cut its 2002 cash-flow estimate to $7

billion-$7.5 billion, below Street projections of $8 billion. Its stock promptly

fell $1.09, to 4.89, and was off 12 cents on the week.

  ---

                       VITAL SIGNS

 

 

                      FRIDAY'S   WEEK'S    WEEK'S

                       CLOSE     CHANGE    % CHG.

 

DJ Industrials      10257.11     +66.29    +0.65

DJ Transportation    2796.87     -78.16    -2.72

DJ Utilities          308.74      +6.11    +2.02

DJ 65 Stocks         2998.53      +4.68    +0.16

DJ US Total Mkt       262.50      +3.28    +1.27

NYSE Comp.            593.78      +5.78    +0.98

Amex Comp.            924.72     +23.86    +2.65

S&P 500              1125.17     +14.16    +1.27

S&P MidCap            549.90      +7.73    +1.43

S&P SmallCap          256.48      +3.00    +1.18

Nasdaq               1796.83     +40.64    +2.31

Value Line (arith.)  1324.52     +20.87    +1.60

Russell 2000          517.40      +1.94    +0.38

Wilshire 5000       10635.05    +129.08    +1.23

 

                                 Last Week     Week Ago

 

NYSE Advances                    2,075         2,186

Declines                         1,305         1,196

Unchanged                          100            98

New Highs                          516           558

New Lows                            59           112

Av Daily Vol (mil)               1,532.1       1,580.2

Dollar

(Finex spot index)                 116.29        117.74

T-Bond

(CBT nearby futures)               100-18        100-31

Crude Oil

(NYM light sweet crude)             26.38         23.47

Inflation KR-CRB

(Futures Price Index)              200.88        195.27

Gold

(CMX nearby futures)               302.30        302.10

  ---

Apr-20-2002 03:23 GMT