One Page Annotated WSJ Summary, Tuesday July 11th

by: David Jackson
David Jackson
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Alcoa Posts Strong Profit But Sales Disappoint

  • Summary: Alcoa (NYSE:AA) reported second quarter profit up 62% y/y and guided for demand to remain strong, but the stock dropped 4.5% after hours as revenue ($7.96 billion) came in below analyst estimates. The first blue chip company to report this quarter, Alcoa noted that 3Q would be seasonably weaker, another impetus for the immediate selloff. CEO Alain Belda doesn't see weakness in China, as some speculated, but rather an ongoing shortage of alumina and aluminum for the nation in the midst of a massive building boom. Belda further cited strength in aluminum on the metals exchanges, strong demand in the aerospace market as well as construction, commercial-vehicle and canned-sheet markets. The Journal notes that some metals analysts expect a drop in aluminum pricing in the next 6-12 months, and that Alcoa stock has recently appreciated due to speculation that Australian concerns BHP Billiton (NYSE:BHP) and Rio Tinto (RTP) may be looking for a takeover.
  • Comment on related stocks/ETFs: Birinyi's TickerSense notes that historically, when AA trades lower after hours following its earnings report, it tends to stay down over the course of the following trading day, despite a jump in the first half-hour of trading.

Lucent Again Warns of Sagging Sales

  • Summary: Lucent Technologies Inc. said that it revenue would decline 13% year over year and 5% sequentially in its fiscal Q3 (ending June 30th) due to lower sales to US wireless carriers and Chinese telcos. But CEO Pat Russo claimed that indications for future sales of high-speed wireless data gear for later this year looked healthy. This is Lucent's second pre-announcement so far this year: in January it predicted that sales for the year would be flat. Then, in April, it stopped issuing guidance, citing its merger with Alcatel which is still expected to close at year end.
  • Comment on related stocks/ETFs: Lucent's stock (LU) fell 2.6% in after-hours trading in response to the announcement. But serial-disappointers tend to get penalized in the longer term, and there won't be many eager buyers today as the stock is "dead money" at least until the FQ3 results are finally announced July 26th. Given Lucent's history of missing numbers, the positive spin about future sales lacks credibility. Impact on other stocks: Lucent's press release stated clearly that the shortfall was concentrated in wireless. That's negative for other wireless infrastructure companies including Ericsson (ERICY), Motorola (MOT), Nokia (NYSE:NOK), Powerwave (NASDAQ:PWAV) and Andrew (ANDW), though Motorola and Nokia have less exposure to infrastructure due to their handset businesses. Weak wireless demand could also impact Qualcomm (NASDAQ:QCOM), and Cisco (NASDAQ:CSCO) which provides core routers for wireless networks. More broadly, Lucent's shortfall could negatively impact all the networking stocks -- including the wireline and optical stocks such as Nortel (NT), Tellabs (NASDAQ:TLAB) and JDSU (JDSU) -- due to its position as the bellweather of the US telecom equipment space. Weakness in wireless is particularly concerning because it's the strongest part of the telecom equipment market, and now joins the list of weak technology end-markets, including PCs (weakness from Dell, AMD and Intel), storage (EMC) and flat panels (3M and AU Optronics).

LG.Philips LCD Swings to Net Loss Amid Decline in Panel Prices

  • Summary: Korean LCD manufacturer LG Philips LCD missed analyst expectations for Q2 profitability and forecast lower panel prices in Q3. The company announced a Q2 net loss of 322 billion won ($340.6 million) versus consensus expectations of 319.5 billion won, and revenue of 2.315 trillion won versus consensus of 2.31 trillion won. Panel prices fell 18% in Q2 and shipments rose 17%. LG Philips forecast LCD panel price declines of a mid-single digit percentage in Q3, and expects its EBITDA margin to be in the "low teens", little changed from the Q2 level of 10%.
  • Comment on related stocks/ETFs: LG Philips's results were broadly consistent with prior data points from 3M and earlier comments from AU Optronics, and only marginally worse than LG Philips' own pre-announcement. Weakness is now widely expected in the flat panel market, so the Q2 numbers shouldn't further impact the stocks. However, LG Philips' Q3 forecast of further single digit price declines and its projected failure to raise its EBITDA margin is negative for the group, particularly competitor AU Optronics (NYSE:AUO). Note also that Matsushita is doubling its plasma capacity.

EMC Warns of Quarterly Shortfall

  • Summary: EMC Corp. announced that it will miss prior projections for Q2 earnings and revenue. It now expects revenue of $2.59 billion versus $2.66 billion, and EPS of $0.12 versus $0.13. It blamed the shortfall on customers delaying orders and customers transitioning faster than expected to its new Symmetrix DMX-3 platform, leading to orders that it was unable to fulfil. EMC announced plans to acquire RSA Security (RSAS) two weeks ago for $2.3 billion.
  • Comment on related stocks/ETFs: At the time of writing (~ 10.30 am), EMC's stock (EMC) is down about 3% versus a Nasdaq up almost half a percent. The question is whether EMC's decline is enough. Its pre-announcement (see key excerpts from the press release) should raise suspicions in multiple areas. First, companies frequently blame revenue shortfalls on delayed orders, but given that the public revenue projections they provide are usually conservative, a revenue miss almost always implies a serious demand shortfall. Second, trying to put positive spin on a revenue miss -- in this case, "our customers love our new product so much that we couldn't manufacture enough of it -- reeks of denial. And finally, this miss comes soon after EMC announced the acquisition of RSA Security (RSAS) that would have the impact of diversifying its revenue sources out of its core storage market. "Diversifying acquisitions" should always raise red flags. Investors should be thinking hard about other tech companies that have announced "diversifying acquisitions" recently. Finally, EMC is a barometer of the tech market. We've now seen weakness in storage, PCs, chips and flat panels. Investors should be in no doubt about the health of the tech market. Meanwhile, Daniel Lord says EMC's problems run deep.

Sun Pursues Bigger Role In Blade-Server Market

  • Summary: Sun Microsystems is today announcing a new blade server system designed by a team led by Sun co-founder Andy Bechtolsheim and based on AMD chips. The Sun Blade 8000 has four processor sockets per blade. IBM and H-P offer four-socket blades to customers on request, and believe the sweet spot in the market is for two socket blades. Blade servers account for only 7% of the server market now, according to IDC, but that number is expected to rise to 26% by 2010. Sun previously introduced a blade server in 2003 but withdrew it from the market in 2005 due to inadequate performance.
  • Comment on related stocks/ETFs: Incrementally positive for Sun (NASDAQ:SUNW) -- any new product with credibility helps. Stronger positive impact on AMD (NYSE:AMD) and another negative data point for Intel (NASDAQ:INTC), as Sun's choice of AMD is further validation of AMD's lead in server chips over Intel, and the design win will lead to multi-year sales. Negative for Rackable Systems (OTCPK:RACK) which sells AMD-based blade servers, and also (though less so) for IBM (NYSE:IBM) and HP (NYSE:HPQ) which compete in this market but focus on 2-socket blade systems. No impact on Dell (NASDAQ:DELL) because Dell doesn't sell into this market segment.

Time Warner Expects Offering AOL Free Will Be Costly

  • Summary: Time Warner expects that its plan to offer AOL for free will reduce its subscription revenue from $1.6 billion in 2006 to $800 million in 2009, with the impact on profits offset by a reduction in marketing of $1 billion over 3 years and a rise in advertising operating margins from 17% to 42%, leading to single digit growth in operating profit from 2006-9. The plan assumes growth in advertising revenue of 25-30% annually, lower than the actual growth rate of 35% since 2004 including acquisitions. The plan is supported by Time Warner CEO Jonathan Miller but resisted by some employees who may be hit by management restructuring and thousands of layoffs. AOL currently accounts for 20% of Time Warner's operating profits. "If AOL fails to meet growth targets for ad sales, Time Warner could take a substantial hit to its bottom line. "
  • Comment on related stocks/ETFs: This is the second article on AOL's new strategy; the key points it adds to the first article are (1) support from CEO Jonathan Miller, and (2) more detailed numbers to back up the assertion that AOL can grow its operating income by single digits from 2006-9. But investors will want to examine the risks carefully. One scenario: The number of AOL subscribers will decline faster than expected due to cuts to AOL's marketing budget, its workforce reductions and mass defections, as subscribers move to high-speed ISPs without facing loss of their email accounts. That could lead to fewer page views for AOL properties and therefore less advertising revenue. Moreover, freed from automatic log in to an AOL home page, subscribers might find that they prefer the free content offered by Yahoo (NASDAQ:YHOO) and Google (NASDAQ:GOOG), and might even be lured into moving their email accounts to those providers. Bottom line: this is high-risk for Time Warner's stock (NYSE:TWX), and the value investors who currently own it may not want to stick around to see what happens.

Vonage Buys Three Internet Phone Service Patents

  • Summary: Internet phone company Vonage announced that it has acquired three patents relating to data compression in an attempt to shore up its legal position in suits brought against it by Verizon and Sprint Nextel and a $180 million suit announced yesterday by Klausner Technologies. Vonage acquired the patents, for an undisclosed sum, from Digital Packet, which has itself filed suit against Verizon and Sprint Nextel; Vonage will now take over those suits. Vonage said it hadn't yet seen the Klausner Technologies complaint which relates to the delivery of voice mails in email form.
  • Comment on related stocks/ETFs: Incrementally positive for Vonage (NYSE:VG) -- at last! In retrospect, Vonage's IPO was smart from a purely financial stand point, in that it raised a lot of cash at an excessive valuation. If it can spend that cash on valuable patents, that might provide the company with some genuine underlying value and barriers to entry. Otherwise it will die a slow death in the telco-cable competitive grinder. If the Digital Packet patents are genuinely valuable, that could be incrementally negative for Verizon (NYSE:VZ) and Sprint Nextel (NYSE:S).

Airbus Plane Orders Tumble 58%; Boeing Makes Up Lost Ground

  • Summary: Airbus won just 117 plane orders in 1H06, less than a quarter of the orders booked by rival Boeing (NYSE:BA), and a decline of 58% from Airbus' comparable year-ago period. Boeing's first half orders were 480, up from 439 in the first half of 2005. Airbus' 1H06 deliveries were higher than Boeing's, but the dropoff in orders raises serious concerns about the French jet maker's ability to maintain its competitive edge against Boeing. For the past years, Airbus has won more orders than Boeing, but that tide may be turning, as Boeing's twin engine planes are more fuel efficient -- a key factor in this high fuel cost environment. Production delays for Airbus' A380 superjumbo and poor sales for its planned A350 have forced Airbus to reconsider the design of that aircraft.
  • Comment on related stocks/ETFs: Boeing stock has been rallying since the beginning of the year, up from the mid-$60s to the current $80. This latest news may extend that trend. Note also that Alcoa reported last night extremely strong demand for aluminum for the aerospace market.

Online Stock Trades Get Even Cheaper

  • Summary: New York institutional brokerage Genesis Securities is today launching a service for retail investors called SogoInvest that will charge $3 per stock trade with no minimum balance, with a 90 day introductory offer of $1 per trade. Florida-based TradeKing launched last year with $5 trades. Schwab cut prices this month for customers with under $50,000 in assets to $13 per trade, USAA cut its price per trade in May from $8 to $7 for those with $50,000 of USAA-managed investments and in December Bank of America cut its price to $5-10, depending on the level of client assets with the firm. Price cuts have accelerated partly due to industry consolidation due to Ameritrade and E*Trade's acquisitions. Online brokerages now hold an estimated 15-20% of their clients' money and have increased their share of discretionary financial assets from about 3.8% in 1995 to 10.1% in 2006. During that time, full-service brokerages increased their share of assets from 11.3% to 15.4%, and regional brokerages from 1.2%% to 2.1%.
  • Comment on related stocks/ETFs: A cursory reading of the article is incrementally negative for Ameritrade (NASDAQ:AMTD) and E*Trade (NYSE:ET), as consolidation should have reduced price competition rather than intensify it. Schwab (NYSE:SCHW) comes out of the article looking particularly uncompetitive. But a more careful reading is positive for the online brokerage stocks, particularly the data showing the increase in their share of total assets and of their client's money. Their profits are now more dependent on spreads than trade commissions. New start-up brokerages will find it hard to compete with the wide range of financial services (including mortgages and banking) offered by the online brokerages. Incrementally negative for traditional bank stocks, particularly the regional banks. Another reason to short the Regional Bank HOLDRs ETF (NYSEARCA:RKH)? See also the recent article on online banking.

Defense Titans Seek New Israeli Sales

  • Summary: Two of the largest U.S. defense contractors are in talks with the Israeli government to supply systems to help that nation defend its citizens from rocket attacks launched by Palestinians from the Gaza Strip. Northrop Grumman (NYSE:NOC) has recently discussed the sale of its laser-based system that the U.S. Defense Department decided against deploying. Raytheon (NYSE:RTN), meanwhile, has held talks with Israel regarding its rapid-fire gun system that the U.S. Army currently uses in Iraq to defend against artillery and mortar attacks. Northrop's test-proven system, named 'Skyguard', is based on technology funded by $400 million of U.S. and Israeli financing. Skyguard's radar identifies an incoming projectile, then a high-energy laser fires at the missile, heating its warhead until it explodes while in flight. Raytheon's 'Phalanx' is an advanced gun that takes a different approach, firing up to 4,500 rounds of ammo a minute after its radar locks on an incoming threat.
  • Comment on related stocks/ETFs: Northrop and Raytheon have another high-profile long range missle defense test coming up next month. A recent Barron's article found Northrop's business model of producing next-generation systems that allow for smaller and smarter forces also lines up nicely with defense budgets aimed precisely in that direction.

Kimco to Acquire Pan Pacific Retail For $2.9 Billion

  • Summary: Kimco Realty (NYSE:KIM), the nation's largest strip-mall REIT, will buy Pan Pacific Retail (PNP) for $2.9 billion, expanding its reach in the West Coast. Kimco will pay $70 a share for Pan Pacific, a price that represents no premium over PNP's closing price Friday, though PNP had risen about 7% in the past two weeks on speculation regarding an acquisition. A Morgan Stanley REIT analyst estimates the capitalization rate -- ROI for the first year of ownership -- on this transaction to be 6.3%. It's been a record year for M&A activity in the REIT sector.
  • Comment on related stocks/ETFs: This comes just one day after Centro Watt bought up another strip-mall owner, Heritage Property of Boston. What smaller mall REITs are left in this consolidation process?

Corporate Debt Begins to Worry Bond Investors

  • Summary: Companies are using debt to buy back stock and issue special dividends rather than invest in cash-generating growth, and that's starting to worry some bondholders. In Q1 the volume of investment grade debt raised by companies rose 72% year over year, junk bond issuance was up 25% and bank lending "soared". Yet in the first half of this year companies repurchased $200 billion of stock and paid out $108 billion of dividends. As a result, S&P reports, there were 2.7 debt rating downgrades this year for every upgrade, compared to 1.5 to 1 last year. Cisco's acquisition of Scientific Atlanta this year, for example, was funded by issuance of $6.5 billion of bonds, despite the fact that Cisco had $15 billion of cash. It then announced that it would increase its stock buy-back by $5 billion in addition to the previously announced $35 million. Cisco's stock is up 11% year to date, while the bonds are down 4% since issuance. Tribune Co announced in May that it would use bank debt and bonds to repurchase up to 25% of its stock. Moody's then cut the credit rating on its bonds to junk and their price dropped. Heinz said it would raise its dividend by 17% and repurchase $1 billion of stock, prompting S&P to cut its debt rating and outlook.
  • Comment on related stocks/ETFs: Although increased leverage raises risk, this phenomenon is positive for equity investors. Cisco's (CSCO) decision to repurchase stock is a strong positive as the company generates enough cash flow from operations to repay the debt. Tribune (TRB) and Heinz (HNZ) are less clear since their core growth is in question.

Nielsen Plans to Track Viewership Of TV Commercials for First Time

  • Summary: Nielsen Media Research, the firm that calculates national television ratings, will start to offer formal ratings for commercial breaks in November. Nielsen will measure viewership of entire commercial breaks, not individual ads. Advertisers expect the numbers to show a sharp decline in viewership during commercial breaks, potentially lowering the price advertisers are willing to spend on TV ads and accelerating the flow of advertising dollars to new media. Network TV executives dispute that prediction. Better measurement of ad viewership may lead advertisers to demand changes to the structure of commercial breaks, for example by reducing the number of ads or allowing advertisers to specify which spot they purchase. Ad commitments for the upcoming fall season "fell slightly" year over year.
  • Comment on related stocks/ETFs: This certainly raises the risks and potential volatility of the stocks with exposure to network TV: Walt Disney (NYSE:DIS), CBS Corp. (NYSE:CBS), and (to a lesser degree) GE (NYSE:GE).

HEARD ON THE STREET: Coke Tries to Pop Back In Vital Japan Market

  • Summary: Coca-Cola (NYSE:KO) receives about 20% of its annual profits from Japanese sales, so recent weakness in its Georgia canned coffee and bottled tea lines in that nation are cause for concern. A recent Georgia ad campaign has failed, and a recall of over 2 million bottles of Coke and other drinks amidst a iron powder contamination scare has further damaged the brand in Japan. Coca-Cola CEO Nevill Isdell has a goal of increasing operating profit by 6-8% a year, and this is test year #1 for that target. Yet some analysts covering Coke expect strong Latin American sales, World Cup-driven business in Germany, and a favorable currency environment to offset the weakness in Japan. Coke shares are up 8% to date in 2006, outpacing rival PepsiCo (NYSE:PEP), but Pepsi has handily outperformed Coke over the past five years, with Pepsi up 35% and Coke down 2% during that period.
  • Comment on related stocks/ETFs: Coke has been ambitious on the US advertising front recently, teaming up with Apple (NASDAQ:AAPL) for promotion of its calorie-free Coke Zero brand, and exploring non-traditional advertising venues.

SMALL STOCKS: Alaska Air, Talbots Increase While Quantum, Connetics Decline

  • Summary: Small-caps in the computer hardware sector followed large-cap EMC downward Monday: Quantum (NYSEMKT:DSS) dropped 2% and McData (MCDT) fell 1%; Alaska Air (NYSE:ALK) rose 3% on falling crude oil prices; in the retail sector, Foot Locker's potential sale brought Talbots (NYSE:TLB) up 3.4% and Hot Topic (NASDAQ:HOTT) up 3%; ethanol maker Andersons (NASDAQ:ANDE) rose 13% following its announcement of a joint project with large-cap Marathon Oil to construct and operate ethanol plants; ADRs of Shanghai-based Linktone (NASDAQ:LTON) fell 13% following its warning of a "material negative impact" on its 2006 results due to new policies by China's large cellphone operators; software firm Kronos (KRON) fell 15% on warning for F3Q earnings; game company Take-Two Interactive (NASDAQ:TTWO) sunk 8% upon announcing an SEC investigation into its stock-option granting practice.
  • Comment on related stocks/ETFs: The announcement from Andersons is an important development for the ethanol market -- follow Seeking Alpha coverage of ethanol stocks.

Notable articles on Seeking Alpha today: Today's earnings schedule. Fund manager John Hussman predicts the market's reaction to Q2 earnings season. A preview of retail stocks' Q2 earnings. Yehuda Fruchter says Stratos International is a small cap optical value play. Shaun Rein discusses China’s new obsession with blogs and how companies can benefit. And finally, welcome to new contributor James Fraser writing about alternative energy stocks.

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