Markets & Finance

Downgrading Philip Morris after California Verdict


Philip Morris (MO): Downgraded to 4 STARS (accumulate) from 5 STARS (buy)

Analyst: Richard Joy

The downgrade is based on the $3 billion jury verdict issued against the company in a California court. While we believe the jury award is wildly out of line with the actual plaintiff injuries, Big Mo shares are likely to be pressured in the near term. Since the award is inconsistent with California law, we believe the trial judge will cut or throw out the award. The company has solid grounds for appeal. Despite the tobacco industry's string of legal victories across the U.S., the California litigation environment remains challenging. The company's operating results are still solid. The upcoming Kraft IPO could provide a catalyst for the stock, which remains attractive at only 11 times S&P's 2001 EPS estimate of $4.10.

Broadcom (BRCM): Downgraded to 2 STARS (avoid) from 3 STARS (hold)

Analyst: Thomas Smith

The company warned that Q2 revenue will likely be down 32%-35% sequentially, versus its prior outlook for a 20%-30% drop. It reports soft demand conditions but "some signs of stabilization in the business for the second half of the year". Broadcom is making net staff reductions and consolidating facilities, realigning to aim at the best broadband chip markets. S&P is cutting its 2001 pro forma estimate to a loss of $0.33 per share, from $0.01 EPS, and 2002's estimate to $0.10 EPS, from $0.45. Given dim visibility, and the disruption of research and sales amid the company's realignment, S&P advises greater caution.

IBM Corp. (IBM): Maintains 5 STARS (buy)

Analyst: Megan Graham-Hackett

A new industry forecast sees a first-ever decline for U.S. PC sales. International Data Corp. (IDC) cut its U.S. PC unit sales forecast and sees a 6.3% year-over-year decline versus its prior estimate of 2.2% growth. This reflects the 17.3% unit plunge seen in consumer sales, while commercial PC sales are expected to slow in the year's half. Most analysts already expected a drop in U.S. PC units in 2001. This revision cuts IDC's global unit growth estimate to 5.8% vs. its prior 10.3% forecast, in line with S&P's forecast. S&P still likes IBM, noting its limited exposure to the PC market and its exit from the U.S. PC retail space, where pricing pressures are likely to accelerate.

Wells Fargo (WFC): Maintains 3 STARS (hold)

Analyst: Stephen Biggar

The banking giant sees after-tax charges of $0.65 in Q2, mostly reflecting write-downs in its venture capital portfolio on lowered valuations of technology and telecom securities. The company is also taking a charge to adjust auto lease residual values given deteriorating prices in used car market. Wells Fargo was stung partly by accounting principles that previously forced unrealized non-cash write-up of certain holdings. The company becomes the latest big player in financial services to feel the impact of weaker equity environment, though its cash earnings were unaffected. S&P is lowering its 2001 EPS estimate to $2.20 from $2.90.

Advanced Micro Devices (AMD): Maintains 3 STARS (hold)

Analyst: Megan Graham-Hackett

AMD issued a press release after the close of trading June 6 quoting comments by COO Hector Ruiz at a press conference in Japan. Ruiz sees modest revenue growth for 2001, which is in line with S&P's forecast. Ruiz's comment that PC market showing signs of stabilizing in line with similar comments of other industry participants, although none are calling a bottom yet. The company also calls for a return to "normal" in PC market by Q4 of 2001, which S&P believes is too aggressive. Despite the uncertainty, with AMD's price to sales ratio of 2.3X, in line with peers, S&P thinks the shares are okay to hold.


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