October 17, 2008: Morning Call

October 17, 2008: Morning Call

Fair Value: SP500 – 948.58; NDX: 1321.01; DOW – 8988.68


Technical Levels:

SPX: 848-850, 899-905 support/ 1098-1100, 1142, 1250 resistance

NASDAQ: 1640 support /1890 resistance


Events:

Pre-market EPS: CMA (.46/669.2M); HON (.96/9.6B); FHN (-.14/542.3M);SLB(1.26/7.0B)
08:30: Housing Starts (Sep): 880,000; Building Permits: 840,000
08:40: Bush speaks on the Economy
10:00: University of Michigan Confidence (Oct): 67.0
12:45: Fed’s Bullard to moderate panel on economic policy
14:00: Fed’s Evans speaks on the economy


Foreign Market Summary/Key Macro News/Commentary:

SP and NASDAQ futures are both trading 14 points below fair value at 8am ET. Futures have moved lower after the open in Europe. Europe opened 5% higher but has cut the gains to 2% at 7:30am ET. European markets briefly trading in negative territory at 6am ET and, at that point, the SP futures were trading 42 points below fair value. News flow is on the light side this morning but there is some anxiety ahead of the Housing Starts and Confidence data. Options expiration is also exacerbating the gyrations in the index futures. This expiration cycle is also unique given the huge swings this week. Typically, front-month option holders roll positions earlier in the week but premiums and October open interest is still extremely high suggesting that many market participants have deferred rolling or closing October option positions. Market participants have made substantial put purchases during this expiration cycle and there should be a better underlying bid in the futures today as those contracts are sold or rolled to further out months. Asian markets closed mixed overnight with the Nikkei gaining 2.8% while Hong Kong fell 4.4% and India dropped 5.73%. India’s Sensex closed at the lows of the session, below 10,000 for the first time this year. Recall that India doubled the margin required for equity derivatives 2 days ago. Australia declined led by oil and metals shares. Korea gave up early gains despite media reports the government could announce measures to revive confidence in the economy.


Impact Research Calls/Market Moving News:

GOOG (353.02): Google reports Q3 EPS $4.92 ex-items vs Reuters $4.75: Company reports revenues of $5.54B, including TAC, vs Reuters $5.57B. Ex-TAC revenues $4.04B vs. First Call consensus $4.05B, which does not include TAC. Key operating metrics: Google Sites gross revenue was $3.67B vs StreetAccount consensus of $3.67B, while Networks revenues were $1.68B vs SA $1.71B. Geographies: International revenues totaled $2.85B vs SA $2.78B, including the UK at $776M, and accounted for 51% of total revenues compared to 52% in Q2; company notes that international revenues would have been $59M higher at constant currency rates from Q2. US revenue came in at $2.69B vs SA $2.68B. TAC was $1.50B during the quarter compared to $1.47B in Q2; TAC as a percentage of ad revenues was 28% compared to 28% in Q2. Cash flow: operating cash flow was $2.18B and capex was $452M, resulting in free cash flow of $1.73B vs SA $1.38B. Headcount: total employees were 20.123K at quarter end versus 19.604K at the end of Q2; implies a net employee gain of 519 versus 448 in Q2. Google says will be responsible in managing the cost but did not provide specific details on the conference call. Management has consistently referenced the uncertain economic environment and provided a pledge of sorts that they will keep a close watch on spending in response to the turmoil. Management said, “"We are going to keep a close eye on costs. And that is even more true this quarter. We are very realistic about the macroeconomic environment but very optimistic about the business."

GOOG: Deutsche Bank maintains buy rating and 480 price target. Here are their comments on the earnings: “Tough times call for tough measures (costs) -Moderating growth + cost controls = 15% profit growth in 2009. We maintain our BUY investment rating on shares of Google as well as our 12-month price target of $480. While the company's positioning in the Internet media sector remains quite sound, clearly the downward pressures of a consumer spending cycle appear to be weighing on growth prospects at the company. We like the stock and the company's execution amidst an uncertain economic environment, but it is also difficult to lose sight of conference call commentary and buzzwords such as "operational efficiency" and "cost containment" and "disciplined hiring, which (in our years of watching business models develop, transition and mature) truly represent the hallmarks of slowing growth (especially in tech investing). Said another way, we believe that the Google business model is beginning to slow down, further exacerbated by massive forex headwinds that impact growth (although most of profits may remain in tact from very large-scale and sophisticated hedging programs). However, with a substantial focus on cost controls in place, we remain quite optimistic on Google's ability to deploy levers to stoke growth (if necessary) and achieve bottom-line targets in such a difficult industry environment. As for the quarter, Google posted 3Q results in-line/slightly better than our and consensus estimates on revenues and profits. Specifically, sequential net revenue growth of 4% was better than the reduced (consensus), expectations of 3% and our street-low 1.5% Q/Q growth forecast. Meanwhile, another quarter of sound operating expense controls led to higher-than-expected operating profits. Pro-forma EPS of $4.92 was better than street estimates of $4.76 and DB at $4.62. Volume of paid clicks was in-line, up 18% (vs. our 19% estimate). While not much new information (should we expect much anyway?) came from the earnings call, it once again was quite apparent that costs appear to be the focus at Google, a trend that would likely continue going into 2009. Additionally, the company's hefty forex hedging programs kicked in 3Q, contributing ~$0.10 in EPS in the quarter, with sizable contributions (of up to $0.50-$0.75 in EPS) likely in 2009.”

NYT Times Editorial: Warren Buffett says to buy equities in an editorial in the NY Times. “I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities. Why? A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”


FCX (33.39): Freeport-McMoRan downgraded to sector perform from outperform at RBC Capital: The firm has significantly reduced their 2009-2012 forecasts for copper and sees limited upside for the shares. Target reduced to $35 from $120.

BK (31.08): Bank of New York Mellon upgraded to buy from neutral at Janney Montgomery Scott

BWA (21.22); ARM (8.07); JCI (19.84): Borg Warner (BWA) upgraded; ArvinMeritor (ARM), Johnson Controls (JCI) downgraded at Goldman Sachs: BWA upgraded to buy from neutral. ARM and JCI downgraded to neutral from buy.

SLB (53.20): Schlumberger reports Q3 EPS $1.25 vs Reuters $1.25: Company says that the recent rapid deterioration in credit markets will undoubtedly have an effect on its activity, but anticipates this will largely be limited to NA and in some emerging exploration markets overseas. The strengthening production of North American natural gas has also led a number of customers to reduce spending early. SLB anticipates a slowing in the rate of increase of customer spending.

Credit crunch threatening companies that sell big-ticket items - WSJ: Harley-Davidson (HOG)'s in-house financing unit finances more than half of all new bikes the company sells, but operating income fell 28% in Q3, and the unit made no gains from selling loans to third parties. But even companies without in-house financing arms are facing trouble: Without wholesale financing, dealers can't afford to stock inventory for consumers to be tempted to buy. The article looks at the problems that Winnebago Industries (WGO) and Brunswick Corp (BC), which has a JV with General Electric (GE) to finance qualified dealers' inventories, are facing.

RIMM (59.24): Parts, materials to make BlackBerry Bold found to cost $158.16 – Engadget: The total comes from research firm iSuppli. The article notes that if Research in Motion can get carriers to pay about $350 for the Bold, it will achieve a gross margin of 45%, after allowing $11.25 for assembly and testing costs

SPWRA (50.99): Merrill Lynch and Citibank downgrade SPWRA. Cit downgrades to sell and Merrill downgrades to neutral.

ZION: Zions Bancorp reports Q3 EPS $0.47 ex-items vs Reuters $0.65. Company reports revenues of $581.6M vs Reuters $622.2M. The return on average common equity was 2.59% compared to 10.50% y/y. Provision for loan losses was $156.6M vs. $55.4M y/y. Net loan and lease charge-offs were $95.3M or 0.91% annualized of average loans, vs. $18.1M or 0.19% y/y. Nonperforming assets were $924.4M vs. $196.6M y/y. JP Morgan and FBR downgraded ZION shares this morning.