Tis the Season to be Warning

By: Chad Hudson | Wed, Jul 25, 2001
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It’s the middle of earnings season and companies one after another are guiding down estimates for the third quarter. Most companies are fessing up regarding the third quarter and a few for the fourth quarter. However, most companies are still holding out that the third quarter will be the bottom with the fourth quarter showing modest growth, at least sequential growth. Here are some quote and comments from various companies in different industries:

Dow Jones CEO, Peter Kann, "We have no reason to expect an advertising turnaround in the third quarter and we have certainly have not seen one so far in July." Earnings at Dow Jones fell by more than half on 18% lower revenues in the second quarter.

Knight Ridder is encouraged because the rate of decline has held steady in each of the three months in the second quarter, but this decline has been 8%-9% each month. Knight Ridder said that July looks to be "a decline in the mid single digits instead of the high single digits." It might be a little premature calling a bottom when conditions are still deteriorating. Knight Ridder singled out Detroit, Philadelphia and San Jose as its worse markets with 11.3%, 14.2% and 24.6% declines respectively. Help wanted ads in San Jose "during the quarter was down in the high 50s." While Knight Ridder experienced a 7.3% decrease in overall advertising revenue, it was very uneven throughout the country and segments. The West Coast was the hardest hit, with Kansas City experiencing a 14.3% gain. Not surprisingly employment advertising pulled down classified advertising, "It was down 38.2% overall, and once you know that, you have the big picture." Also not surprising, real estate was up 22.8%.

Kodak: "we have yet to see signs of economic recovery."

Dana Corp: "we're less optimistic today about the rate of recovery in the North American OE markets than we were at the outset of the year."

Cummins, maker of diesel engines, saw revenue decline by 18%. Most of the decline was in the heavy-truck and the light-duty automotive and recreational vehicle units, sales fell 41% and 34% respectively.

Delphi Automotive gets the lemons-to-lemonade award. In reporting its second quarter results it trumpeted that revenue from non-GM customers accounted for 32% of revenue, up from 28% in the year ago period. Glancing over the financials reveals that while non-GM business grew 1.5%, the real reason is the 15.5% drop in GM sales.

Sales at AMD declined 16% from the year-ago period and 17% sequentially. AMD, along with so many other tech companies, has resorted to hoping for a recovery. "If current conditions prevail, the company expects that overall revenues could decline in the range of 10 to 15 percent in the current quarter. With a decline in sales of this magnitude, the company would report an operating loss. Normal seasonality coupled with a recovery in some of the markets for flash memory products should enable the company to increase revenues and return to solid profitability in the fourth quarter." Last quarter AMD expected sales to decline as much as 10%. Also noteworthy, AMD neglected to include its EPS estimate for the year. Analyst went ahead and put it in writing for them. Robbie Stephens lowered full year earnings to $0.39 from $1.50, and 2002 earnings were lowered to $0.70 from $1.90. Considering AMD earned $0.43 during the first half, Robbie Stephens is not banking on much of a second half recovery.

Last quarter EMC stated: "We believe that most IT budgets in the U.S. and many in international markets are now in their final firming stages for the year, reflecting both the current economic outlook and the realization that information is at the center of business." EMC also thought that "In times like these companies are investing in EMC products and services in order to save money and deliver business impact." My how business can change in three short months. Last week EMC noted that "The global economic environment has become much tougher. I cannot recall a more difficult environment in terms of technology spending than the one that has unfolded over the past few months. It is now expected that IT spending may shrink on a year-to-year basis for the first time in decades. …Weakness in capital spending is taking a big bite out of IT budges in a number of industries around the world."

Gateway's sales were down year-over-year and sequentially, 21% and 16% respectively. The only bright spot was its sales to small and medium business (units shipped up 27%) and its education channel (up 11%). Sales in the U.S. Consumer unit declined 36%. International sales didn’t fare any better. Europe was off 46% from the year ago period and Asia Pacific sales fell 36%. Gateway is another company that is still expecting a better second half. However, its outlook has diminished from April when it expected "unit sales to be up as compared with last year, and expects to return to profitability on an income from continuing operations basis." Now Gateway only "expects unit volume to increase sequentially over the next two quarters, although it may not meet last year's levels."

Infineon, Europe's second largest semiconductor maker, confirms the weakness in PC and handset markets in its latest earnings release. Infineon reported memory chip sales 62% lower than last year. A weak market and a 30% drop in average selling prices were blamed. Sales of wireless communication chips were also dramatically lower, with sales falling 41%, "due to the further deterioration of the mobile handset market with order cancellations and delays from major customers." Its outlook for the second half "remains low and there are no clear signs of a market recovery in the coming months. "

Nokia declined to issue any guidance for the rest of the year citing a lack of market visibility. However, they are able to forecast that sales will soar in 2002 by 25%-to-35%. When will companies figure out that the last couple years were the anomaly and consumers are not upgrading phones and computers every-other day, and are not likely to ever again.

The technology cancer continues to infect other sectors in the economy. Commercial real estate is quickly becoming the next preverbal "next shoe." While Silicon Valley continues to receive most of the press, the technology boom spread to other areas of the country. Denver was one of these areas. Denver's real estate woes have been addressed in the past, but a recent survey indicates it is getting worse and is likely to get much worse. The vacancy rate along the northwest corridor jumped to 32% from 3.8% at the beginning of the year according to a report from Fuller and Co. Chris Ball, a broker with Fuller and Co, thinks it could get vacancy rates as high as 50% before it begins to stabilize. In fact, the market has turned so fast Ball said, "If you had asked me last week, I probably would say it would max out at 40 percent. Now I think it will be at 40 percent within 30 days." Ball also said that this area is not officially offering incentives, but in a different area of Denver, "landlords are upfront that you can get six, nine, or 12 months of free rent."

Boston is another area that boomed with the technology. The earnings release from Boston Properties provides a glimpse on how other areas are doing. It reported that the occupancy rate in the Greater Boston area declined almost 5% to 94.6% in the first six months of the year. Given the severity of the manufacturing sector it is not surprising that industrial properties experienced the largest drop in occupancy rates, down 8.6% since the beginning of the year.

Nationally, the vacancy rate jumped to 10.8% from 9.5% at the end of the first quarter. This is the highest vacancy rate in the last four years according to Torto Wheaton Research. The speed of the slowdown combined with long construction time has created a market that is going to get much more out of equilibrium before it gets any better. There is about 75 million square feet that will be added to the market in the second half of the year. This is on top of the 50 million square feet that was added in the first half.

Residential housing continues to defy the economic downturn. Almost every homebuilder has posted strong earnings and backlogs. Centex reported its' best ever first quarter (period ending June 30), with sales up 19% and backlogs growing 17%. Its mortgage division has really boomed. Total orginations increased 50% and loan volume soared 62%. Centex's average loan size grew 8% to $151,000, confirming the trend of higher home prices and/or increased leverage. The surprising statistic is the profit per loan ballooned 224% to $1,189. Beazer Homes also announced its best ever third quarter with revenue and closings up 15%. New orders and backlog also posted records, up 34% and 31% respectively.

The realization that the second-half recovery is not materializing as previously forecasted just three months ago is likely to push companies to further reduce costs and layoff workers, ala Lucent. This could prove to be the final blow to a consumer that has kept the economy out of recession. However, it is extremely worrisome that the strength of the consumer is akin to the strength of U.S. companies displayed just a few quarters ago. Companies spent the last several years concentrating on maximizing earnings above all else, including sound finance. This is now ending with the largest write-offs in history. At this point it appears to be only a matter of time until the over-leveraged consumer fares the same fate.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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