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|  | AUGUST 12, 2004
 INDUSTRY IN FOCUS By Megan Graham-Hackett Downtime for Computer Hardware In light of Cisco's diminished optimism, Standard & Poor's has lowered its guidance on four of the biggest names in the sector Amid some disappointing news on prospects for the computer hardware industry and the overall U.S. economy -- including a cautious outlook from networking-gear maker Cisco Systems (CSCO ) on Aug. 10 -- Standard & Poor's Equity Research Services lowered its investment opinions on four marquee computer-hardware names on Aug. 11: • Cisco (CSCO ; recent price, $18.40), to 4 STARS (accumulate) from 5 STARS (buy); • Dell (DELL ; $33.40), to 3 STARS (hold)from 4 STARS; • Hewlett-Packard (HPQ ; $19.80), to 3 STARS form 4 STARS; and • IBM (IBM ; to 4 STARS from 5 STARS The downgrades came in the wake of the reduced optimism expressed by Cisco CEO John Chambers in comments after the company's Aug. 10 earnings release (see BW Online, 8/10/04, "Cisco: Strong for How Long?"). While the company's July-quarter pro forma earnings per share of 21 cents, vs. 15 cents a year earlier, was one cent above our estimate, Cisco didn't make the progress we expected cutting inventories. Sure, it said it saw strength in U.S. enterprise and commercial orders in the most recent quarter. But it now expects flat-to-2% revenue growth for the October quarter, vs. the preceding period -- a bit below our model. DEPRESSING NEWS. We have kept our fiscal 2005 (ending July) earnings per share estimate on Cisco at 81 cents. (Our S&P Core Earnings estimate is 53 cents per share, reflecting our stock option expense estimate.) Given its more cautious outlook on information-technology spending, and based on the slightly lower free cash-flow growth assumed in our discounted cash-flow (DCF) model, we lowered our target price on the stock to $25 from $36. Looking at the overall industry, we think demand held up well up to the 2004 second quarter. But based on second-quarter earnings reports to date, we cannot ignore the implications of recent economic news, including slower job growth and the impact of higher oil prices on consumer demand. We are therefore including a higher risk premium in the DCF models we use to arrive at our valuation estimates. We continue to see signs of an upturn in demand for information-technology products, and forecast 2004 PC unit growth of 11%. However, we note that recent indications of a potentially weaker economy in the second half of the year put this forecast at risk. We think this outlook is currently being reflected in the valuations of the stocks in the group and therefore remain neutral on the group. Still, we see long-term fundamentals in the computer industry as remaining attractive, as we think a global appetite for technology products should boost productivity and communications. We see global competition forcing companies to be more productive, and we think this is being achieved largely through technology. Many vendors have also streamlined operations during the industry's downturn, and we see this boosting long-term profit potential. Note: Megan Graham-Hackett has no stock ownership or financial interest in any of the companies in her coverage area. She's a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion. For Required Disclosure information and Price Charts for all STARS ranked companies go to http://www.spsecurities.com, click on "Investment Research", and then click on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts". All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Additional information furnished upon request to Standard & Poor's  Analyst Graham-Hackett follows shares of computer hardware companies for Standard & Poor's Equity Research Services All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
BW MALL
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