Tuesday, January 16, 1996
MARKET CLOSE

INDEX:

I. Market News: Late Rally Pushes Markets Forward
II. Heroes: Chase-Manhattan, Chemical Bank, Citicorp, Healthsource, Healthsouth, Concord Health, Pediatrix Medical, OrthoTech, Cantab Pharmaceuticals, Sequana Therapeutics, Lam Research
III. Goats: Apogee, Allied Healthcare, Watts Industries, Rocky Mountain Chocolate, Merisel, Bio-Vascular, C-COR Electronics
IV. Investment Perspective: Intel Disappoints After the Bell
V. Calendar: Wednesday's Economic Events

MARKET CLOSE

DJIA: 5088.22 +44.44 (+0.88%)
S&P 500: 608.44 +8.62 (+1.44%)
NASDAQ: 995.87 +7.30 (+0.74%)

MARKET NEWS

Yesterday, the SOX Index (semiconductors) had its largest one-day drop in history. It won't be helped by Intel tomorrow, however. After the bell today, Intel posted disappointing earnings (see Investment Perspective). Sun Microsystems, however, posted earnings after the bell of $0.65 per share, 7 cents better than estimates.

In other market news, the Mitsubishi-Schroder chain store sales numbers dropped 1% and the Johnson Redbook survey was down 0.9%.

HEROES

They were calling today Super Tuesday on CNBC---and not because of anything to do with the presidential elections. New York's giant "money-center" banks all reported earnings today. "Money-center" banks are massive institutions that serve borrowing centers, somewhat like the Federal Reserve Banks for regional banks. Chase-Manhattan Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CMB)") else Response.Write("(NYSE:CMB)") end if %> reported $1.69 a share ($1.40 was estimated) and was up $3 7/8 to $60 7/8 while Chemical Bank <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CHL)") else Response.Write("(NYSE:CHL)") end if %>, which it will soon acquire, rose $3 3/8 to $58 1/2 when they reported earnings of $1.81 a share ($1.65 was the estimate). Citicorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CCI)") else Response.Write("(NYSE:CCI)") end if %> was up $4 3/4 to $68 1/4 when it reported $1.72, seven cents above consensus. A number of regional powerhouses, including First Interstate <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:I)") else Response.Write("(NYSE:I)") end if %>, Nationsbank <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NB)") else Response.Write("(NYSE:NB)") end if %>, Wells Fargo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:WFC)") else Response.Write("(NYSE:WFC)") end if %> and First Chicago NBD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:FCN)") else Response.Write("(NYSE:FCN)") end if %> all chimed in as well. The recipe for all of this success? Loan growth, cost cuts, stock buybacks and the lack of a much ballyhooed consumer credit problem. Bank stocks are off about 6.3% since the beginning of the year on fears of deteriorating consumer credit quality; some analysts were even predicting large charge-offs. Only select cases like Nationsbank and First Chicago came close to meeting these predictions.

Healthsource Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HS)") else Response.Write("(NYSE:HS)") end if %> CEO Norman Payson sparked a rally in the shares when he announced that the company expects to see revenues in the fiscal first quarter double from year-ago levels. Healthsource was up $2 1/2 to $32 1/2 on this news and Payson's claim that the company had set a goal of growing earnings by 25% annually---actually lower than most analysts' five-year estimates. Last year, Healthsource pulled in $208.4 million in revenues. Payson stated that he was generally comfortable with analyst estimates, but would not comment on any specific period. Analysts are currently predicting $1.09 for fiscal 1996, implying a fair value of $31 given the long-term growth estimates of 28%. In unrelated news, HEALTHSOUTH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HRC)") else Response.Write("(NYSE:HRC)") end if %> was up $1 3/4 to $32 after it set a definitive exchange ratio for its Surgical Care Affiliated takeover. HEALTHSOUTH will give 1.1726 shares for each share of SCA.

Multicare Cos. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MUL)") else Response.Write("(NYSE:MUL)") end if %> signed a definitive agreement to acquire Concord Health Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CHGR)") else Response.Write("(NASDAQ:CHGR)") end if %> for $7.25 per share, causing Concord's stock to rise $1 1/4 to $7 1/8. With the completion of the deal, Multicare will own or lease 100 long-term care facilities with 12,000 beds. The trend in the industry has been consolidation, with industry giant Integrated Health Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IHS)") else Response.Write("(NYSE:IHS)") end if %> announcing just yesterday the acquisition of Standish Care Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:STAN)") else Response.Write("(NASDAQ:STAN)") end if %>. Acquisition will fuel the growth of these companies for a while as they gobble up the smaller public and privately-owned players. Other health care acquisitions today include Pediatrix Medical Group's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PEDX)") else Response.Write("(NASDAQ:PEDX)") end if %> buy-out of Neonatal Specialists for $6 million in cash, sending Pediatrix shares up $3 3/4 to $27 3/4, and DePuy's cash tender offer of $10.35 for OrthoTech <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ORTH)") else Response.Write("(NASDAQ:ORTH)") end if %>, driving those shares up $1 1/8 to $9 3/8.

Cantab Pharmaceuticals PLC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CNTBY)") else Response.Write("(NASDAQ:CNTBY)") end if %> was up $1 1/4 to $5 3/4 today after it signed an option covering the use of Ribi ImmunoChem Research's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:RIBI)") else Response.Write("(NASDAQ:RIBI)") end if %> MPL immunostimulant as an adjuvant in Cantab's therapeutic vaccine against genital warts. The market apparently liked the terms of the agreement, which gives Ribi an annual license fee and places it as sole supplier of the product until commercialization. Sequana Therapeutics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SQNA)") else Response.Write("(NASDAQ:SQNA)") end if %> rose $3 1/2 to $26, apparently in sympathy. Sequana also specializes in skin diseases.

Lam Research <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LRCX)") else Response.Write("(NASDAQ:LRCX)") end if %> tore up the track today, rising $2 7/8 to $36 1/2 after being up more than $3 intra-day. The semiconductor equipment manufacturer reported earnings of $1.12 a share on a diluted basis, 7% ahead of the $1.05 (on a diluted basis) that analysts were looking for and 12% ahead of the prior quarter. Lam's profit margins rose to 11.5% from 10.9% in the year-ago period, with revenues up 68% and earnings per share chugging ahead 75%. Lam Research makes chemical vapor deposition (CVD) and etch products for the semiconductor manufacturing industry. Its performance stands in stark contrast to the dire warnings of ebbing semiconductor equipment orders that have been boggling the market.

GOATS

Apogee <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:APGG)") else Response.Write("(NASDAQ:APGG)") end if %> slid $3 1/4 to $4 3/4 today after the company flat-out said that it would not make its estimates or beat last year's numbers for the fourth quarter. The company has had a lot of problems with its long-term care operations and anticipates a profit shortfall in certain practices. Smith Barney took this opportunity to cut the shares from "buy" to "under-perform." In unrelated news, Allied Healthcare <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AHPI)") else Response.Write("(NASDAQ:AHPI)") end if %> will also miss its numbers next quarter and was down $3 to $11 1/4 today as a result.

Watts Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:WTS)") else Response.Write("(NYSE:WTS)") end if %> dropped $1 1/2 to $18 1/4, losing for the second day in a row after it reported that earnings would be lower than expected. What caused today's down-draft? Smith Barney's Tobias Levkovich slashed his rating on the shares from "buy" to "neutral" while cutting his 1996 estimate to $1.57 a share and his 1997 forecast to $1.80. Watts wasn't the only sufferer; Piper Jaffrey fried Rocky Mountain Chocolate <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:RMCF)") else Response.Write("(NASDAQ:RMCF)") end if %> today, sending the shares down $2 1/2 to $8 1/8 after it cut the stock's rating from "buy" to "market performer." Rocky Mountain reported earnings of $0.18 a share last Friday, compared to $0.18 in the same quarter a year ago, despite a revenue increase of 32%. Why these cuts would hit the stocks so hard after the companies demonstrated to the world that their core businesses were not doing well is one of those things for the "efficient market" people to hypothesize about.

Software distributor Merisel Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MSEL)") else Response.Write("(NASDAQ:MSEL)") end if %> tumbled $1 3/8 to $4 1/4 after it said that earnings for its fourth quarter would be "extremely disappointing." The company expects a net loss of $0.15 to $0.20 a share on $1.6 billion in revenues. Slower-than-anticipated growth in Germany and Canada caused by problems with newly installed systems is reminiscent of competitor Tech Data's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:TECD)") else Response.Write("(NASDAQ:TECD)") end if %> problems last year. Analysts had been looking for a profit of $0.14 a share.

Bio-Vascular <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BVAS)") else Response.Write("(NASDAQ:BVAS)") end if %> got pounded today, down $2 1/8 to $7 1/8, when it reported that its first two quarters would get crunched as a result of a government decision to decrease Medicare reimbursement for lung reduction surgery. Bio-Vascular's Peri-Strips are used in lung volume reduction surgery to prevent air leaks. Roughly 50% of lung volume reduction patients had Medicare pay for it, meaning that Bio-Vascular's core business there could get trashed.

C-COR Electronics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CCBL)") else Response.Write("(NASDAQ:CCBL)") end if %> reported earnings sharply below estimates today, soaking the shares for $5 to close at $16. C-COR blamed the lack of telecommunications reform for domestic softness as well as poking at the fact that the budget is still not balanced. We assume that the company also believes that the fact that there is no federal holiday for Elvis's birthday also hurt their bottom line. The international market, in C-COR's estimation, has just slowed; they evidently could not find a foreign government to pick on. C-COR makes communications equipment for a variety of networks.

INVESTMENT PERSPECTIVE: Bummer News for Intel or Disaster for the Industry?

I. The Numbers

Intel Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INTC)") else Response.Write("(NASDAQ:INTC)") end if %> reported lower-than-expected earnings after the bell today---just what the market has been afraid of the last few days. Here is the preliminary breakdown:

4th Quar Dec. 30: 

                     1995                    1994 
Revenues        $4,580,000,000           $3,228,000,000  (+41.8%)
Net income          $0.98                   $0.78        (+25.6%)

Zacks Analyst Watch listed consensus estimates of $1.11 a share for the fiscal fourth quarter, meaning Intel missed its numbers by 12%.

Investors need to remember that last year's fourth quarter had a $475 million charge for bad Pentium chips, which worked out to about $0.35 a share. It was this charge, which Intel loaded with everything but the kitchen sink, that allowed Intel to have such great numbers for the rest of the year.

II. Why Did Intel Miss Its Numbers?

Intel completely blew its numbers for two reasons: gross margins were lower than expected and they had a much higher-than-expected write-down due to components it purchased in its motherboard business. Gross margins, or the percentage left over after a company pays for raw materials and costs of production, were down to 48% from 52%. I speculated when Intel released earnings last quarter that gross margins would have to trend down as the company began to slash prices on its Pentium processors and ramp up production on the Pentium Pro. Product transitions in CPUs for Intel have historically resulted in lower gross margins in the middle since the company does not have the new chips in mass production but is already cutting prices on the old chips to stay a generation ahead.

The Packard Bell/Cirrus Logic debacle came back to bite Intel as well. Profitability was impaired by high personal computer motherboard reserves because of inventory write-downs for purchased components. Simply put, Intel overestimated demand for its low-end CPUs, just like the rest of the free world. Intel had to write-down the value of components purchased for use in PC motherboards because it did not sell them and the value of the components themselves decreased. As SRAM and DRAM prices plummeted in the spot markets, so did the value of Intel's inventory---the write-down a recognition of the loss they took there.

Intel's accounts receivable decreased to $245 million in the fourth quarter, mainly because a portion was converted into an outright loan to staggering Packard Bell, which desperately miscalculated the demand for low-end X486 computers. Buttressing this was Intel's acknowledgment that X486 chips decreased in sales compared to just last quarter, while Pentium shipments continued to be strong. The 75-megahertz Pentium processor was the unit volume leader, but the market is shifting to 100-megahertz and faster Pentiums, suggesting that the shift to higher-powered processors is even catching Intel by surprise.

III. Not All Bad News In This Quarter

Intel reported that its book-to-bill ratio exceeded 1.0 in the fourth quarter, implying that its core CPU business remains strong and that it can sell almost everything it can produce. Intel is almost completely out of the X486 business, leaving AMD, Cyrix, OPTi, NexGen and Team Asia to fight it out here. Nearly a full generation ahead of its competition, Intel enjoys a lead that it will be able to capitalize on in the coming two years.

Demand in Japan and the Asia-Pacific region remained strong despite flat growth in North America compared against the year-ago period. Intel remains a worldwide growth powerhouse whose products are required everywhere from Kiribati to Angola. If Intel can make good on its generation lead and hold the line on gross margins, it should be able to book a respectable year in 1996 and a great year in 1997.

Another positive point is the fact that Intel continues to put its massive cash hoard to work. The company bought back one million shares in the fourth quarter at a cost of $63 million. For all of 1995, Intel bought back 18.9 million shares at a cost of $1 billion. Intel also expects its 1996 capital spending budget to increase to $4.1 billion from $3.6 billion in 1995---not necessarily great news for Intel but wonderful news for semiconductor equipment manufacturers. With Intel increasing its outlay by 14%, it almost guarantees a trickle-down effect that will give the stronger equipment manufacturers solid growth into next year.

IV. Next Quarter Does Not Look Great

The worst news today is that Intel sees revenues in the first quarter essentially flat compared to this quarter and sees gross margins in the "high 40s"---meaning they could continue to slip. With Intel predicting that interest and other income will be in the $60 to $65 million range, you can almost start making your own estimates as to how much the company will make next quarter.

Given that higher depreciation is supposed to offset reserves for purchased components in the fourth quarter, you have revenues of $4.6 billion, gross margins of around 47% and other income of $60 to $65 million. Intel expects expenses to be flat next year with the tax rate dropping 0.3% to 36.5%. Thrown all together, you can expect earnings of around $1.00 to $1.05 a share for Intel---not that different from today's results.

The conclusion here? Expect Intel's numbers to be notched down for FY 1996 to somewhere in the $4.25 to $4.75 range by the reasonable analysts. Expect Rick Whittington to cut his estimates on Intel to $2.00 and predict that McDonald's will join the PowerPC coalition to market the McPowerPC chip with its new @McDonald's subsidiary, taking significant market share from Intel.

V. So What Happens Tomorrow?

Intel is the 800-pound gorilla of the semiconductor market. Although Intel's problems are limited to motherboard unit and write-downs resulting from aggressive ordering, the slip in margins will worry investors severely. Investors might remember that 1994 was a disaster for Intel stock because gross margins slipped through the entire year. There is some speculation that Intel might start thinking about dumping the motherboard business, but this seems a bit extreme given that Intel only recently entered this product line and has internal plans to dominate here.

Motherboards, however, are lower-margin than CPUs---something I wrote about the last time Intel reported its numbers. The product transition I already mentioned and the motherboards increasing as a portion of Intel's product mix will almost certainly drag down gross margins. Unless the company does a heck of a lot of sweet-talking tonight, 16 times trailing earnings might seem rich for a company that is acting more and more like a cyclical. The slowdown in earnings growth is evident; we have seen 46%, 36%, 38% and now 26% in the last four quarters, with more lower-margin products making up a larger portion of revenues in the future.

The stock is Nasdaq halted so there is no trading currently going on via the Instinet. The halt will definitely stay in place until the conference call is over tonight. You can't get in on the conference call, but at 8:00 PM EST you can call (402) 222-9904 and listen to the recording, meaning you will get just as much information as the analysts are getting on this one.

Will the technology stocks get killed tomorrow? They might not. Ascend Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ASND)") else Response.Write("(NASDAQ:ASND)") end if %> looks like it beat numbers by 150% but who can tell, and Sun Microsystems was 14% ahead of estimates, meaning that the "Internet Infrastructure" stocks are doing well---auspicious for Cisco Systems, 3Com, Bay Networks and Cascade Communications. With this kind of demand, the Internet still has the potential to drive growth in technology in the future---growth we are only beginning to see.

CALENDAR: Wednesday's Economic Events

---October Trade in Goods and Services (8:30)
---Federal Reserve Board releases "Beige Book" on US Economic Activity (12:00)
---Treasury announces size of 2- & 5-Year Notes (2:30)---tentative
---ABC/Money Magazine Consumer Confidence Polls (6:30)
---President and Congressional Leaders scheduled to resume budget negotiations

Byline: Randy Befumo (MF Templar)