Message-ID: <8607584.1075852670617.JavaMail.evans@thyme> Date: Fri, 28 Sep 2001 12:23:09 -0700 (PDT) From: david.morris@lehman.com To: larimore@enron.com, jordan.larimore@lehman.com Subject: The Morning Market Call - Friday Sept 28th, 2001. Mime-Version: 1.0 Content-Type: text/plain; charset=ANSI_X3.4-1968 Content-Transfer-Encoding: 7bit X-From: "Morris, David C." @ENRON X-To: Larimore, Jordan R. X-cc: X-bcc: X-Folder: \JSKILLIN (Non-Privileged)\Inbox X-Origin: Dasovich-J X-FileName: JDASOVIC (Non-Privileged).pst Good Friday Morning - Comments From The Local Guys! We read a great quote today. It was published by a technical newsletter which we are privileged to receive. "When people are emotional, it is difficult to envision a market environment that is opposite of what is making them so emotional in the first place" - Unknown.. We believe the market is in the early stages of repair. While we may have a rally over the next few weeks, we are on the lookout for a successful retest of the mid-September lows. If this were to occur, we would expect to see this coincide with positive technical market readings. What to do in the mean time?. This is the time to upgrade portfolios in anticipation of a longer term recovery. The 30 -year bond yield is 5.50%. The 10-year is trading at 4.63%. The 5-year is trading at 3.77%. Spot crude oil is trading at $22.38 p/b. Natural Gas - Henry Hub - is trading at $2.24 p/mcf IMPACT CALLS Textiles; Apparel & Footwear Robert Drbul Wait for the Sale q Given the current uncertain economic climate, we believe that footwear and apparel vendors face a high degree of risk related to three issues: 1) probable order cancellations; 2) lower than expected reorder business; and 3) direct retail exposure through their own stores. The timing of this economic downturn is coming at a very inopportune time for footwear and apparel vendors as goods have already been shipped for fall/holiday 2001. All three issues will lead to excess inventory levels and in turn significant markdown exposure for all footwear and apparel vendors both at department stores and company owned retail stores. q We are lowering many of our ratings to reflect both our lowered earnings expectations as well as our belief that many of the companies in our universe have further downside from current levels. Overall, we have reduced our average top-line estimate by 3% for 2001 and 2% for 2002 and our average EPS estimate by 9% in 2001 and 11% in 2002. We have reduced our average 2H01 top-line estimate by 5.5% and our average 2H01 EPS estimate by 17%. Our new earnings estimates for the majority of our companies are considerably below consensus estimates and in many cases by far the lowest numbers on the street. While we recognize that the stocks have already depreciated substantially, we believe that there could be another leg down as earnings expectations still remain overly optimistic. Chemicals Sergey Vasnetsov Reducing rating on commodity chem stocks q We have lowered our ratings on LYO from "Buy" to "Market Perform" and NCX from "Strong Buy" to "Buy" as they are the most leveraged ethylene players. q We are currently maintaining our EPS estimates, but plan to review them shortly. q The recent attacks on the US will have significant, negative effects on most industries as we forecast demand to slowdown for at least the next 12 months. q We expect chemical stocks to be negatively impacted by the volatility in oil prices and believe the upturn in the global chemical cycle will be delayed by a few quarters. Cendant Corp Jeffrey Kessler Thoughts Ahead of the Financial Update 1 - Strong Buy / 11.15 (USD) q Cendant has announced that it will provide updated guidance tomorrow in a 10:30am conference call with investors. Ahead of the call, we try to provide a quick examination of the company's sensitivity to much lower economic activity and the difficult travel industry outlook. q Avis (60% of vehicle services) and the Galileo acquisition clearly pose the greatest downside earnings risk because of their sensitivity to airline travel. We see lodging (30% of hospitality) and real estate brokerage (35% - 40% of real estate services) as moderately impacted, helped somewhat by their franchise models. q Trading at $11.20, Cendant shares seem to imply that the company will earn $0.70-$0.80 in '02 (assuming a 14-15x PE multiple). While we will wait for management's guidance, our initial thoughts are that '02 EPS are likely to be close to the '01 level, or somewhere around $1. Advertising & Marketing Services Kevin Sullivan Valuations Still Warrant Caution q Heightened global economic uncertainty, corporate profit pressures and the threat of a prolonged U.S. military strike will continue to weigh on ad/marketing expenditure growth over the coming months. While the global ad holding stocks have pulled back some, we remain cautious on the group in the near term. q We are lowering our U.S. ad forecasts following the events of Sept 11th. We now expect -5% to -6% growth in '01 vs. our prior forecast of -2.3%. Our '02 projection calls for just 0 to 1% growth (vs. 2.5%). q Concurrently, we are lowering our '01/'02 expectations for OMC and IPG, following LB's revised forecast for WPP on Sept 19th. q While valuations have begun to discount these developments, the group is still trading at 8.0x '02 EBITDA estimates vs. historical trough forward year multiples of 7-8x in '92-'97 and 6x during the last advertising recession ('90-'91). q Growing concerns over a global recession should limit any meaningful appreciation for the stocks in the near-term. We will be looking for signs of economic stability and improved consumer/business confidence before getting more aggressive around the names. COMPANY / INDUSTRY UPDATE Integrated Oil Jeremy Elden OPEC under pressure q Last month, we asserted that commodity prices were past their peak for this cycle. Since then, oil prices, US natural gas prices and refining margins have continued to trend down. Although we expect ongoing volatility, events of the last two weeks should, if anything, accelerate the cyclical decline. This week's OPEC gathering took much longer to reach a common position than in previous meetings, highlighting rising pressures as demand and prices fall. For the next year, demand will be the biggest price determining factor. Our analysis of history suggests this will not be as weak as recent market sentiment suggests. q OPEC quotas and targets reaffirmed q Demand hit to be less than market sentiment suggests q OPEC compliance likely to improve q Oil price forecasts maintained q Prices and margins trending down Exelon Daniel F. Ford, CFA Reiterating Our Buy Rating 2-Buy / $44.50 q Yesterday, EXC signaled 2001 EPS would likely fall 2-5% short of guidance due to weaker energy prices prompting a 12% sell-off (20% since 9/11). We reiterate our 2-Buy rating and our target is $54 which is 10.2x our revised $5.27 2002E. q We are lowering our 2001 EPS outlook $0.16/share to $4.39 due to weaker power prices, economic slowdown, and a $0.07/share telecom write-off. q We also lowered our 2002 forecast $0.33/share to $5.27. Specifics are: 1) Weaker forward power prices (-$ 0.21/share) and 2) 0% sales growth (-$0.12/share). q EXC also set Q3 EPS at $1.10-$1.20 versus $1.27 pro-forma in 2000 and raised layoffs by 450 people. q The sell-off leaves EXC trading at 8.4x our revised 2002E or a 20% utility group discount. q While M&A risk and weaker EPS growth visibility post-2003 pose concerns, we believe EXC stock represents a reasonable risk/reward as: 1) Earnings are mostly regulated (65% of EBIT); 2) Utility execution is top decile; and 3) The yield is 3.8%. Power Daniel Ford LEHMAN BROTHERS POWER AND UTILITY WEEKLY q We are previewing the calendar of events for the week of October 1 through October 5 q On October 3, the Public Utility Commission of Texas is anticipated to issue its final orders for the unbundling rate cases of the incumbent utilities including TXU Inc, American Electric Power and Reliant Energy. Bank of America Henry Chip Dickson 3Q01 Preview 2 - Buy / 55.75 (USD) q We expect BAC to report 3Q01 earnings of $1.25. Reflecting the more difficult operating environment, we are reducing our 2001 estimate to $4.90 and 2002 estimate to $5.60, on a new GAAP basis. With the recent exit of the auto leasing and subprime real estate, BAC appears to be in the businesses it wants to be in. We continue to rate BAC 2-Buy. q Management has been focusing on improving internal performance and the challenge now is to execute. We expect to see another quarter of steady confidence building versus quick-fixes. q Net interest income should rise, benefiting from greater than expected rate cuts, while fee income growth should be modest. q We continue to expect a challenging credit environment. JP Morgan Chase & Co Eileen Rooney Earnings Preview 1 - Strong Buy / 32.58 (USD) q We are lowering our 3Q01 estimate to $0.45 because we expect JPM once again to have to take an equity write-down and are assuming about $750 MM. We expect a turn in the private equity business to be pushed out and therefore next year's revenues should also remain well below trendline. We are reducing our 2001 estimate to $2.15 (-$0.40) and 2002 estimate to $3.60 (-$0.50), on a new GAAP basis. We are reducing our price target to $50 but staying with our 1-Strong Buy rating. q The current environment weighs on JPM as on other companies because of market pressures on private banking, investment banking, investment management and custody and processing. Our estimates reflect modest contribution from private equity, weaker capital markets, and higher credit costs. KeyCorp Eileen Rooney Third Quarter Preview 3 - Market Perform / (USD) q Third quarter earnings should reflect efforts to shed high risk and non-strategic businesses. We continue to rate Key Corp, 3 -Market Perform with a $27 price target. q We expect KEY to report 3Q01 results of $0.57, $0.01 below below consensus. Our 2001 and 2002 estimates are $1.75 and $2.40, respectively. q For 2001, our operating estimate is now $1.75, a $0.05 reduction. This assumes less balance sheet growth, modestly higher credit costs, and lower levels of fee income. Because we expect these conditions to continue into 2002, we have lowered our 2002 estimate about $0.12 and on a new GAAP basis we believe KEY will earn $2.40. q Third quarter earnings should be impacted by KEY's new strategic initiatives announced in the middle of May. Mercantile Bankshares Kristin Nemec Third Quarter Preview 3 - Market Perform / 39.00 (USD) q MRBK should report October 15th. Unlike last quarter, where the company pre-released lower than expected results due to a sharp, 25 bp decline in the margin, we believe there will be no fireworks this qtr. 3 - Market Perform. q We expect the margin, which was 4.84% in Q2 to remain under pressure and drop by 10+ bps. q Balance sheet trends should be mixed and we would not be surprised by a decline in loan growth to around 6% from 8%, given the industry trend of relatively high prepayments and borrowers that are often trying to pay down lines. q Fee growth should be good, particularly on an annual basis with another strong qtr from mortgage banking, but maybe not as high as Q2. q Expenses should be another strongpoint with incentive fees in the mortgage banking area potentially offset by lower directors fees in the form of deferred compensation accruals. Northern Trust Eileen Rooney Earnings Preview 2 - Buy / 48.76 (USD) q Due to weak market conditions, we have reduced our 3Q01 EPS estimate to $0.57, which is $0.01 below consensus expectations. We are reducing our 2001 estimate $0.03 to $2.27 and reducing our 2002 estimate $0.10 to $2.50, due to weak market conditions. We continue to rate NTRS 2 - Buy. We lowered our price target to $60. q Market conditions should restrict revenue growth in 3Q. However, operating results should be aided by flat to negative expense growth and a lower share count. q Spread income should be up due to modest balance sheet expansion, with a net interest margin that should be wider than the prior quarter. q Assets under administration and assets under management should decline in the quarter. Sky Financial Group Kristin Nemec Third Quarter Preview 3 - Market Perform / 20.00 (USD) q We have a $0.37 Q3 EPS estimate for Sky Financial, which is expected to report October 16th. Our full year estimates are unchanged at $1.45 and $1.55 for 2001 and 2002, respectively. We are comfortable with the attainability of this conservative, 7% EPS progression and would highlight our 2002 estimate is $0.04 below consensus. q We expect balance sheet trends to be largely in line with Q2 with 7-8% loan growth with equivalent percentage growth in deposits. q Expense control, a historical strength at SKYF, should remain tight brought about by the sale of the out-of-market brokerage operations and greater integration of the remaining non-bank subsidiaries. q Along with general industry trends, we would not be surprised by further upticks in NPA's to above 50 bps and NCO's of more than 40 bps. SunTrust Banks Eileen Rooney Third Quarter Preview 2 - Buy / (USD) q We continue to rate STI 2 - Buy, with a $70 price target. We expect the company to report 3Q01 results of $1.21 in line with consensus. q This should be the first quarter to include the acquisition of Robertson Humphrey, which was acquired during the middle of the quarter. Revenues and expenses are expected to be about $30mm. Only the optics of 3Q earnings should be affected. Like other investment banking firms, RH's revenues should be well below trend line this quarter. q Third quarter results should also include approximately $30 mm in expenses related to the attempted merger with WB. U.S. Bancorp Eileen Rooney Earnings Preview 3 - Market Perform / 21.00 (USD) q As a result of the continued economic deterioration, we are lowering our 2001 and 2002 estimates. Our 3Q01 estimate remains $0.44, but that implies a modest contribution from the NOVA acquisition. For 2001, we are lowering our estimate $0.03 to $1.72 anticipating a down 4Q. For 2002, our estimate is $2.00 on a new GAAP basis, or $1.90 on an old GAAP basis, a $0.10 reduction of our estimate. USB remains rated 3 - Market Perform. q 3Q results will include two months of operating performance from the recent NOVA acquisition. In our model, we increased credit card fees by $83mm, employee expenses by $53mm, amortization expense by $13mm and share count by 23mm share. 4Q results will include a full quarter of NOVA results. q The difficult market conditions should cause fee revenues from investment management, investment products and investment banking to be lower in 3Q and into 2002. q Spread income should be up due to modest balance sheet expansion and a modest expansion in the net interest margin. WestAmerica Bancorp Kristin Nemec oied 3 - Market Perform / 40.00 (USD) q Although not necessarily evident this quarter as it is a new initiative, we believe WABC has effectively turned over a new leaf by beginning to push for higher loan growth through more competitive pricing than it has in the past. This is important because WABC's past strategy of attaining roughly 10% EPS growth was heavily dependent on heavy share repurchase and expense savings as opposed to top line growth. q We carry a $0.60 EPS estimate for WABC in Q3. WABC is expected to report on October 16. This is two cents above Q2 and a penny ahead of consensus. q We believe the quarter will demonstrate additional NIM expansion, which should be the largest driver of spread income with funding costs continuing to drop faster than asset yields. q Non-interest revenue and expense dynamics should be in line with prior quarters. Wells Fargo Eileen Rooney Earnings Preview 1 - Strong Buy / 43.17 (USD) q Due to the deteriorating economic environment and difficult market conditions, we have reduced our 3Q01 EPS estimate to $0.68 and we are reducing our 2001 and 2002 estimates. These reductions assume the impact of this environment on most bank results will be slower loan growth, weaker to declining investment management results into early 2002, higher credit costs and even weaker private equity results. The net interest margin should be modestly stronger for most. We continue to rate WFC 1 - Strong Buy. q We are reducing our 2001 estimate $0.05 to $2.05 and reducing our 2002 estimate $0.15 to $3.35. For WFC, the 2002 estimate is on a new GAAP basis and would be about $0.30 higher than an old GAAP estimate. q We lowered our price target $5 to $60 reflecting the more difficult environment and our assumption of a higher embedded equity risk premium. Allmerica Financial J. Paul Newsome EPS Estimates Reduced; Rating Affirmed 1 - Strong Buy / 42.30 (USD) q ? We are maintaining our 1-Strong Buy rating on Allmerica following its announcement of sharply lower than expected third quarter earnings ($0.40 to $0.50) and our subsequent conversations with management. While our recent upgrade of Allmerica could not have come at a worse time, the thesis behind that upgrade is unchanged. q In this environment most insurers are talking about how much their book value will fall, but not Allmerica. Its limited exposure to the World Trade Center disaster ($17 million pre-tax), sustained (although greatly reduced) profitability, and its limited general account common stock exposure mean that it will see book value maintained. We are projecting third quarter book value to be $47.60 per share. Viacom Inc Stuart Linde Quantifying the Risk 1 - Strong Buy / 32.05 (USD) q Despite the fact that we are revising our estimates to reflect macroeconomic factors, we believe that VIAB's prominent brands, proven management team and strong balance sheet position the company to weather the storm. We believe VIAB will be one of the first stocks to react to a media resurgence. q We are reducing our 2001 revenues to $23.0B from $23.6B on lowered ad revs as large accounts pause to reformulate campaigns, although solid ratings from the fall lineup could help counter near-term weakness. Eastman Kodak Caroline Sabbagha Agfa Restructuring and Industry Comments 3 - Market Perform / 32.07 (USD) q Yesterday Agfa announced a major restructuring plan and discussed industry dynamics that confirm some of our concerns about long-term industry fundamentals. Although one could argue that there are differences between Agfa's and Kodak's market positioning as well as their profitability profiles, we do fear that some of what Agfa discussed is relevant for Kodak. We maintain our 3-Market Perform rating on Kodak q The industry dynamics include a tough pricing environment in film, the need for further industry consolidation and a digital transition that is occurring faster than expected. Microsoft Corp Michael Stanek Expedia Deal May Have Erngs Impact to De 1 - Strong Buy / 50.27 (USD) q Our Dec qtr estimate includes an $800M gain on the sale of Expedia (EXPE) - MSFT's travel website - to USA Networks (USAI), worth roughly $0.09 to EPS. q Since the deal was announced in July 2001, Expedia shares have fallen about 50% to $21.75, USAI shares have fallen 30-35% to $17.88. q Terms of the deal, set to close in Dec qtr: MSFT would sell 75% of its stake in EXPE to USAI, mostly completed in shares of common stock. There was a collar on the deal for shares between $23-$31. FSI International Edward White Positive Develop. Outlined @Analyst Mtg. 3 - Market Perform / 8.00 (USD) q FSII is doing all the right things during this downturn to preserve cash and maintain suitable infrastructure for rapid growth in the next upturn. q On Wednesday, FSI held its annual analyst meeting at its headquarters in Chaska, Minnesota. The company highlighted that its focus during the current downturn is on (i) preserving cash, (ii) developing new technologies, (iii) forming key alliances, (iv) aligning management and other employee interests with those of shareholders, and (v) maintaining sufficient infrastructure for rapid growth once the upturn appears. Enterasys Networks Timothy Luke Ests & Rating Lowered 2 - Buy / 6.38 (USD) q ETS reported an in-line 2Q02, but cautioned limited n-term visibility. To reflect weakening in macro conditions, we are lowering our ests & target. Maintain 2-Buy. q Last night, ETS reported an inline qtr, with $240m in revs and $0.11 in EPS vs our ests of $239m & 0.10. Book to bill > 1. Channel inventory flat QoQ. Change fiscal year to Dec and rev recog method. q Mgmt commented business has "grounded to a halt" in Sept post 911 tragedy and n-term visibility significantly impacted by changes in macro. As a result, no guid provided and will offer an update by end of Oct. q Against this challenging backdrop, we move our rev & EPS ests for 3Q02 to $202m & $0.05 from $251m & 0.10. Our CY01 & CY02 revs move from $956m & $1.1b to $895m & $944m. Target moves to $9, or 25x CY02 EPS. David C. Morris Sr. VP Lehman Brothers 713-652-7112/800-227-4537 dcmorris@lehman.com Disclosure Legend: A-Lehman Brothers Inc. managed or co-managed within the past three years a public offering of securities for this company. B-An employee of Lehman Brothers Inc. is a director of this company. C-Lehman Brothers Inc. makes a market in the securities of this company. G-The Lehman Brothers analyst who covers this company also has position in its securities. Key to Investment Rankings: This is a guide to expected total return (price performance plus dividend) relative to the total return of the stock's local market over the next 12 months. 1 = Buy (expected to outperform the market by 15 or more percentage points); 2=Outperform (expected to outperform the market by 5-15 percentage points); 3=Neutral (expected to perform in line with the market, plus or minus 5 percentage points); 4=Underperform (expected to underperform the market by 5-15 percentage points); 5=Sell (expected to underperform the market by 15 or more percentage points); V=Venture (return over multiyear time frame consistent with venture capital; should only be held in a well-diversified portfolio). This document is for information purposes only. We do not represent that this information is complete or accurate. All opinions are subject to change. The securities mentioned may not be eligible for sale in some states or countries. This document has been prepared by Lehman Brothers Inc., Member SIPC, on behalf of Lehman Brothers International (Europe), which is regulated by the SFA. ?Lehman Brothers, Inc. ------------------------------------------------------------------------------ This message is intended only for the personal and confidential use of the designated recipient(s) named above. If you are not the intended recipient of this message you are hereby notified that any review, dissemination, distribution or copying of this message is strictly prohibited. This communication is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial product, an official confirmation of any transaction, or as an official statement of Lehman Brothers. Email transmission cannot be guaranteed to be secure or error-free. 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