Markets & Finance

Still Choose PepsiCo


PepsiCo (PEP): Maintain 4

STARS (accumulate)

Analyst: Richard Joy

PepsiCo reported Q4 EPS of $0.38 vs. $0.33, as expected. Worldwide beverage profits were up 18% on higher pricing and volumes. Frito Lay profits were up a healthy 11% on 10% North American sales and 12% international profit growth. We see continuing gains on new products and a favorable cost environment. Tropicana profits rose 17% on strong volumes and favorable costs. We see strong profit growth across businesses continuing in 2001 and we are raising our 2001 EPS estimate by two cents to $1.65. Given PepsiCo's strong brand and cash flow momentum, and improved earnings visibility, PepsiCo shares are attractive at 27 times our 2001 EPS estimate.

Harmonic (HLIT) Maintain 1 STAR (sell)

Analyst: Ari Bensinger

In an effort to cut costs, fiber-optic firm Harmonic will reduce its current workforce by approximately 10% (100 employees), resulting in a Q1 charge of $800,000. The cutback reflects slower sales to cable and satellite customers, particularly AT&T Broadband. Given the difficult capital markets, Harmonic's customers are reviewing their future upgrade-and-build plans. The company's visibility remains poor. Harmonic also will drastically cut production levels in 2001. We project quarterly losses throughout 2001, with a yearly loss of $0.55. Given the challenging near-term environment, we would sell the shares.

Eastman Chemical (EMN) Reiterate: 3 STARS (hold)

Analyst: Richard O'Reilly

We were somewhat surprised by the news that Eastman has decided to split into two companies. One company will have specialty chemicals and plastics units; the other will have PET resins, polyethylene, and acetate fibers. Strategically, Eastman has focused on the former group, and has talked for several years of reducing and/or restructuring its interests in the latter group -- and we had expected assets sales or joint ventures. The PET business has double-digit volume growth, but the acetate fibers group has little growth prospects. This segment returned to profitability in 2000 on price increases.

Tosco (TOS) Reiterates: 4 STARS (accumulate)

Analyst: Ephraim Juskowicz

The oil refiner agreed to be acquired by Phillips Petroleum at 0.8 Phillips share per Tosco share, with Phillips assuming $2 billion in Tosco debt. Based on Friday's market close, the deal represents about 35% of Tosco's premium value. The transaction will generate $250 million in pre-tax synergies and give Phillips more balanced earnings contributions between refining/marketing and exploration/production. Longer term, we believe Tosco holders will gain from being Phillips holders, since Phillips will expose shareholders to its exploration and production business, which will gain from strong commodity prices. Tosco is still trading at ten times the $3.82 EPS estimate we see for 2001, and the company is very attractive.

Phillips Petroleum (P): Downgrades to 3 STARS (hold) from 4 STARS (accumulate)

Analyst: Tina Vital

Shares of Phillips are down after its $7 billion bid for Tosco, while Tosco shares are higher. Phillips is changing its strategy from a pure exploration and production company to expanding its refining and marketing operations in an effort to become a major integrated company. Phillips is offering 0.8 share for each of Tosco's, valuing Tosco at $46.50 per share. The deal is expected to close by the end of Q3 2001. Although refining margins are expected to remain strong for the near-term, with the deal valuing Tosco at a premium at 12 times our 2001 P/E (vs. peer average of 8 times) and neutral/slightly dilutive to its EPS, we recommend a hold on Phillips' shares.

Exodus Communications (EXDS): Maintains 3 STARS (hold)

Analyst: Mark Basham

We are not surprised about the news that Exodus intends to sell 13 million common shares and $500 million worth of convertible subordinated notes. We had modeled $750 million in new financing during Q2 2001. But the offerings do not alter the near-term risks as Exodus integrates its recent GlobalCenter acquisition and strives to compensate for weakness among its dot-com customers. Exodus' enterprise customers are currently 57% of its revenue mix. We expect the mix to shift further by the end of 2001 to 70%-75% enterprise, with only a 25%-30% mix of dot-com customers. Execution issues limit the company's near-term upside.


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