November 6, 2008: Morning Call

November 6, 2008: Morning Call

Fair Value: SP500 – 951.63; NDX: 1302.08; DOW – 9120.73


Technical Levels:

SPX: 848-850, 908 support/ 998, 1098-1100 resistance

NASDAQ: 1423, 1650 support / 1890 resistance:

Events:

Pre-market EPS: AN (.29/3.86B); BX (.08/176.0M); CEG (.84/5.27B); DTV (.35/4.89B); DYN (.10/968.9M); EP (.34/1.34B); FNM (-1.44/3.26B); HK (.20/281.0M); NDAQ (.52/956.7M); PCG (.86/3.56B); SE (.47/1.1B); WMB (.66/3.46B); BUD (1.05/4.86B)
07:00: Select Retailers release October Same Store Sales
07:00: Bank of England Rate Decision
08:00: WMT October 2008 Sales and Revenue Call
08:30: Non-Farm Productivity (Q3): 1.0%; Unit Labor Costs: 2.7%
08:30: Initial Jobless Claims
10:35: EIA Natural Gas Storage Change
11:00: BX earnings call
16:30: PCLN earnings call
19:00: Fed’s Warsh speaks on “Promise and Peril of the New Financial Architecture.”
Post-market EPS: CBG (.23/1.15B); DIS (.49/9.35B); DRYS (3.60/301.5M); FLR (.91/5.8B); NVDA (.12/893.8M); PCLN (2.10/547.9M); QCOM (.57/2.82B); VRSN(.26/238.9M)

Foreign Market Summary/Key Macro News/Commentary:

The S&P futures are trading 15 points below fair value while the NASDAQ futures are trading 35 points below fair value at 8am due to weakness in CSCO following lower earning guidance, an ominous 8-K filing by LVS, and disappointment that the ECB only cut interest rates 50 basis points (BOE cut rates 150 basis points and rumors swirled that the ECB may cut rates more than 50 following the BOE announcement). European markets are down 3%-3.5% with mining and financial stocks the worst performing sectors. Decliners on the FTSE 100 lead advancers 9-1. Deutsche Telekom (DTE.GR), Man Group (EMG.LN) and Groupe Danone (BN.FP) are trading lower after earning reports. Asian markets closed sharply lower following US markets down. The Nikkei fell 6.53%, Hong Kong fell 7.08%, and India fell 3.8%. Airlines fell regionally after a profit warning from Cathay Pacific (293.HK), and steelmakers reacted badly to ArcelorMittal (MT.NA)’s profit warning from yesterday. Korea Exchange Bank (004940.KS) fell after reporting lower Q3 profits. Shipbuilders Samsung Heavy Industries (010140.KS) and Hyundai Heavy Industries (009540.KS) also declined by the 15% daily limit. The won lost almost (5%) of its value. Isuzu Motors (7202.JP) plunged after the Nikkei reported the company was considering buying part of GM’s midsize-truck business and the company cut its earnings forecast. Toyota Motor (7203.JP) fell on fears about its earnings reported after the Japanese close. News Corp (NWS.AU) dragged Australia down, slumping (19%) after issuing a profit warning.

As we discussed in Tuesday’s morning call, the 998-1002 level on the S&P is formidable resistance area and traders should look for tactical short-term trading opportunities from the short side off that level. Right now (S&P at 945 or lower), traders should cover tactical short positions and adopt a neutral posture purely as a function of discipline. There is definitely going to be a barrage of bad news over the next 2 months and I am skeptical that the market is prepared for the headline risk. The only strong buyer of assets is the US government or other GSE’s like the sovereign wealth funds. Private capital has been psychologically shattered by the global rout in asset prices and does not appear strong enough to defend the market. The market has acted terribly to bad headlines over the last 2 trading days (MT, CSCO, MDR) and this is an ominous sign. .


Impact Research Calls/Market Moving News:

CSCO (17.39): Cisco Systems guides Q2 (Jan) revenue to be down 5-10% y/y - conf. call: Additional targets for the quarter: consolidated non-GAAP gross margin 64% (note Q1 came in at 65.6%), opex 39-41% of revenue and cash from operations $500-700M per month. Expounding on the business environment during Q&A, Chambers says that August was pretty good and September was bumpy but generally held up. October saw a marked shift in activity and they began to hear from customers that their business had slowed. Given the current environment, they have decided to extrapolate using the October trends when setting guidance. However, Chambers comments that he would not be surprised if final results came in above or below the guided range; he says there is that much uncertainty in the market at this time. He has also reiterated their belief that downturns are a good time to expand market share and move into adjacent technologies; this will continue to be a focus in the current slump. Despite the planned cost cuts, they will not be halting investments to the point of not gaining share or missing a good acquisition opportunity. Finally, management confirms that they will continue to repurchase shares in the coming quarters; there is no change to their repurchase philosophy.

CSCO (17.39): Piper Jaffray comments on CSCO’s weak earning guidance: “Cisco provided extraordinarily weak guidance for the January quarter, which is an extrapolation of the results from the month of October. Cisco guided for revenues to decline 5-10% on a year/year basis. Cisco's top line guidance equates to January quarter revenues of $9.1 billion at the mid-point, which is well below the consensus estimate of $10.4 billion. Cisco also guided for gross margins of 64% and operating expenses to be 39-41% of total revenues. Cisco anticipates interest income of $130 million, a tax rate of 22% and total shares outstanding to decline by 50-100 million shares. Based on this guidance and our previous growth assumptions, we are lowering our January quarter revenues and FY09 revenue and proforma EPS estimates. The following exhibit highlights our revenue and EPS revisions.” Piper Jaffray also comments on weak order growth: “Cisco noted slowing order growth in both the U.S. and in Western Europe, which cumulatively account for roughly 70% of total revenues. Orders in the U.S. were down approximately 8% on a year/year basis. Enterprise orders within the U.S., not including the public sector, were down in the high teens. Commercial, service provider and public sector orders were down in the mid-single digits on a year/year basis. Despite the slowdown, Cisco believes the U.S. will be the first major country to recover from the economic downturn. Order growth in Europe slowed to the negative mid-single digit range. The UK, Italy, Netherlands and Spain experienced a double digit decline in orders on a year/year basis. Enterprise orders within Europe were down in the mid-single digits while service provider orders in Europe were down in the mid-teens, both on a year/year basis. In Japan, order momentum was strong, with growth of approximately 20% year/year. Orders in Asia Pacific declined 4% on a year/year basis, driven by declines in the high teens in the enterprise sector.”

LVS (11.66): LVS shares are trading down 23% after filing an 8K that signals they may not be able to meet debt covenants. "Based upon current Las Vegas operating estimates for the quarter ending December 31, 2008 and quarterly periods during 2009, as well as the fact that the Company has continued to fund its development projects outside of Las Vegas, in whole or in part, with borrowings under the U.S. senior secured credit facility, the Company expects the amount of its material domestic subsidiaries' indebtedness will be beyond the level allowed under the maximum leverage ratio. If the Company's Las Vegas Adjusted EBITDA levels do not increase sufficiently, the Company does not adjust spending on its global development projects, which the Company is currently evaluating, and the EBITDA true-up is not sufficient or available to enable the Company to maintain compliance under the maximum leverage ratio, the Company will need to obtain significant additional capital at the parent level. As previously announced, the Company is working with its financial advisor to develop and implement a capital raising program that would be sufficient to address the Company's current and anticipated funding needs; however, no assurances can be given that the program will be successful. If none of the foregoing occurs, the Company would need to obtain waivers or amendments under its domestic credit facilities, and no assurances can be given that the Company will be able to obtain these waivers or amendments. If the Company is unable to obtain waivers or amendments if and when necessary, the Company would be in default under its domestic credit facilities, which would trigger cross-defaults under the Company's airplane financings and convertible senior notes. If such defaults or cross-defaults were to occur and the respective lenders chose to accelerate the indebtedness outstanding under these agreements, it would result in a default under the senior notes.”

LVS (11.66): Las Vegas Sands files mixed shelf registration of indeterminate amount.

MDR (15.56): MDR shares are trading down almost 15% on weak earnings. McDermott reports Q3 EPS $0.37 vs Reuters $0.70: Company reports revenues of $1.67B vs Reuters $1.85B. The company notes increased costs experienced and expected on three marine pipeline installation projects in Qatar. Consolidated backlog was $9.4B, compared to $9.3B and $9.8B at September 30, 2007 and June 30, 2008, respectively. Credit Suisse and Jefferies downgrade MDR shares. (My comment: The backlog at infrastructure companies means as about as much as the backlog at the homebuilders at the peak of the housing bubble).

HPQ (36.25): Hewlett-Packard downgraded to reduce from add at Calyon Securities: The firm cites CSCO's guidance, noting HPQ is also leveraged to non-US weakness, as well as slowing PC growth

AAPL (103.30): BMO lowers iPhone expectations for the December quarter: “We are taking the opportunity to modestly trim our iPhone expectations for December and subsequent quarters. Given September quarter channel fill, December will likely prove a tough sequential compare. We are assuming that iPhone sequential unit sales ramp for the December quarter is 15%, compared with September quarter sell through of 4.9 million units. Our previous estimate in the December quarter was 6.6 million units versus our new estimate of 5.6 million units. We are lowering FY2009 to 21.7 million units from 22.8 million units, while we are increasing FY2010 to 26.2 million units from 24.5 million units, or 20% unit growth in FY2010. We are lowering our estimates as follows: FY2009 GAAP earnings to $5.11 from $5.20, economic FY2009 earnings to $6.60 from $6.70 (adding back deferred revs), and FY2010 GAAP earnings to $6.33 from $6.42. Economic earnings of $7.55 in FY2010. Our free cash flow estimate in FY2009 is $9.97 from $10.52.”

RIG (80.35): Deutsche Bank comments on RIG’s earnings. “RIG's heavily contracted fleet provides strong and visible cash flow even in the face of tough market conditions. We believe market concern over contract cancellations is overdone and see RIG's contracted cash flow as relatively secure. However, a lack of catalysts prior to the company's re-incorporation in Switzerland and leverage to what we see as weakening international jackup markets are offsets to a still strong deepwater story. We therefore continue to rate RIG a Hold. Q3 misses expectations: RIG reported Q3 operating EPS of $3.44 versus $3.04, below our estimate of $3.51 and consensus of $3.48. Downside to our estimate was almost entirely below the line as operating income was in-line with our expectations. Adjusting estimates; rolling out 2010: We are lowering our 2008 estimate to account for downtime shifted into Q4 as noted in the updated fleet status report and some adjustments to below the line items. As such our '08 estimate goes to $14.48 from $14.73. Our 2009 estimate remains unchanged at $15.35. We are rolling '09 quarterly estimates and a 2010 estimate of $14.35. Valuation & Risks, Raising Target Price: We are raising our target price to $76 from $72 to account for lower projected net debt (as a result of higher contracted cash flows). Our target price is based on a historical low TEV/ Replacement value multiple (0.53x) applied to current replacement value and net debt. Net debt is adjusted to reflect the present value of the cash flow from contracted backlog. Upside risk includes a re-acceleration of rates in the international jackup markets. To the downside, further commodity price deterioration is the biggest trading risk. Execution on additional upgrades and newbuilds are also risks to the downside.

COST (53.71): Costco reports October comps (1%) vs consensus +4.3%. US comps were +2%; int'l (10%). Total net sales for the period increase 2% y/y to $5.30B. Excluding the negative effect of foreign exchange (particularly in Canada, the U.K. and Korea), international comparable sales for October increased 9% in local currency, and total Company comparable sales would have increased by 3% for the month.

AMZN (51.98): Amazon.com downgraded to hold from buy at Citi: Though downgraded, the price target is increased to $60 from $52. The firm cites valuation and sees increased risk to Street estimates.