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Good Tuesday Morning - Comments From The Local Guys! If the market has indeed put in a bottom over the last few days, be prepared for us to 'retest' the lows. A successful test, is what is needed, followed by a meaningful rally! The market has already factored in most of the bad news from corporate America. We may also see individual stocks rise after releasing bad news. This would also prove to be very meaningful. Look to use this period to upgrade portfolios. The 30 -year bond yield is 5.57%. The 10-year is trading at 4.70%. The 5-year is trading at 3.81%. Spot crude oil is trading at $21.81 p/b. Natural Gas - Henry Hub - is trading at $2.30 p/mcf after having dipped below $2.00 earlier. Lehman's Research. Banks Henry Chip Dickson Impact of Recession on Bank Trends (CD) q Many expect that the precarious U.S. slowdown may already be in or tipping toward recession after the recent WTC incident. Regardless of whether the U.S. economy slips into recession, it has been undergoing a transition from rapid growth of the 1990s to a period of slow growth. This transition has created a challenging operating environment for banks. q This week we take a look at historical bank trends before, during, and after recessions. Banks Jason Goldberg Weekly Bank Facts (JG) q The Lehman Brothers Bank Index ended the week down 7.2%. Our Large-Cap Bank Index fell 11.2%, while the Mid-Cap Bank Index declined 6.7%. q All major indices also were down this week. The S&P 500 fell 11.6%. The Dow lost 14.3% and Nasdaq was off by 16.0% for the week. City National Brock Vandervliet On Target With an Even Better Valuation 1 - Strong Buy / 39.85 (USD) q Although the stock is still roughly 10% above where we upgraded it to 1-Strong Buy back in March, it has retraced most of its intervening gains. Once again, we believe it should be front and center in any discussion with investors in the smaller-cap financials at this time. q We carry a Q3 EPS estimate of $0.73 for CYN, expected to report October 12. Although confident in our estimate this is $0.02 less than consensus. q Given CYN's mildly asset sensitive positioning, we wouldn't be surprised by some margin decline this quarter, similar in magnitude to Q2. q Due to the declining runoff of the non-relationship syndicated book, we believe CYN's above average loan growth should be increasingly visible Commerce Bancorp Brock Vandervliet Q3 Preview and Mtg On Manhattan Rollout 2 - Buy / $65.50 (USD) q Although sharply below its highs along with so many other stocks, CBH trades at a six multiple premium to the rest of the group and we are maintaining our investment rating of 2-Buy. q We carry a Q3 estimate of $0.77, up $0.03 from Q2. CBH should report October 10. q We remain pretty confident in our numbers for several reasons. First, the NIM, which was up 16 bps in Q2 to 4.81% should push higher still. Second, and perhaps more important from the perspective of '02, CBH is far less dependent than most banks on incremental loan growth. Commerce Bancshares Brock Vandervliet 3Q Preview 2 - Buy / 35.99 (USD) q Based on the likelihood of continued margin compression for the balance of the year we are trimming our estimates for the second half of 2001. Due to valuation we rate the shares 2 - Buy q We believe there is a chance CBSH could better our revised 2001 estimates due to the quasi-non-recurring items including branch sale and student loan securitization gains. CBSH typically sells a portfolio of student loans twice a year depending on supply and market conditions. q We believe CBSH continues to repurchase shares at essentially the same pace of 450,000 shares/quarter. First Commonwealth Fin'l Brock Vandervliet FCF 3Q Preview: Watching the Margin 3 - Market Perform / $10.85 (USD) q Save the possibility of a sharp margin decline, which we view as unlikely from this level, or dramatically higher credit costs, we are confident in full year estimates of $0.84 and $0.90 which imply 7% EPS growth. FCF is rated 3-Market Perform. q We carry a $0.21 Q3 EPS estimate, in line with Q2 and consensus as well. We expect FCF will report October 18. As with Q2, this is inclusive of what may be a penny or two of investment securities gains. q We have been concerned for sometime in the margin dynamic as Q2's NIM of 3.44% was an all time low after falling 11 bps in the qtr. We believe it could fall somewhat further although balance sheet trends appear to be reasonably positive. First Tennessee Jason Goldberg 3Q01 Preview: Further Upside Doable 2 - Buy / $34.03 (USD) q We continue to be positive on our outlook for FTN and rate the stock 2-Buy. Not only lower interest rates, but fundamental improvements within this organization should aid results. q Earlier in the quarter FTN announced it expects to post 3Q01 EPS of at least $0.62. Our forecast pencils out to $0.63. The company should report on October 17. q We expect results to evidence continued strength in the net interest margin and growth in both mortgage banking and capital markets revenues. Asset quality metrics should remain relatively stable. Provident Financial Group Jason Goldberg 3Q 01 Keeping an Eye on Asset Quality 2 - Buy / $24.90 (USD) q ? We rate PFGI 2-Buy and expect the company to put down EPS growth rates ahead of its peers once current issues are put to bed. However, we believe the next few quarters could be bumpy and that PFGI's business model, which is heavily exposed to commercial loans, is more susceptible to downturns in the economy. q We expect PFGI to report 3Q01 EPS of $0.70 on October 17. This compares to $0.63 in the prior quarter. q While continued loan growth and fee income expansion should lead to double-digit revenue growth, higher credit costs and the lack of net interest margin expansion should restrain further improvement. Synovus Financial Jason Goldberg 3Q01 Preview: Keeping an Eye on TSYS 2 - Buy / $40.78 (USD) q We rate SNV 2 Buy. SNV should benefit from its decentralized banking approach in the Southeast, the build-out of its wealth management unit and the growing contribution of Total Systems. q We expect SNV to report 3Q01 EPS of $0.27 on October 17. q Continued net interest margin expansion and solid loan growth should lead the bank's results. q We will keep a close eye on TSYS, its 80.8% card processing unit, to see if new business related to its European rollout is enough to offset weaker than expected volume in mid-September. TSYS should report on October 16. q We expect SNV to remain one of the few banks posting an ROE in the 20.00% area and a ROA in the 2.00% range. Ace Limited J. Paul Newsome Upgraded to 1 Buy; Estimates Lowered 1 - Strong Buy / 23.71 (USD) q We are upgrading ACE to 1-Strong Buy from 2-Buy with a $30 per share price target. Among the large cap. insurers ACE's stock is one of the most inexpensive and it has among the most upside to better prices in the future in commercial insurance and reinsurance. q The stock is trading at about book value under what we feel would be a worst-case scenario (double ACE management's projected WTC loss). Historically ACE has traded at 150% of book value. q Our price target assumes the company trades at roughly a 40% discount from its historic price-to-book value one year from now. Allmerica Financial J. Paul Newsome Change of Recommendation 1 - Strong Buy / 45.04 (USD) q We are upgrading Allmerica to 1 Strong Buy from 2 Buy following the decline in its share price after the World Trade Center disaster. Our new price target is $54 per share, down from $65 per share. q Allmerica, as a relatively large regional insurer, represents one of the better "safe havens" among the insurers largely unaffected by the World Trade Center disaster-little World Trade Center loss exposure, little investments in equities, and strong balance sheets. q At just 87% of projected third quarter book value ($48.14 per share), we think Allmerica represents compelling value. HCC Insurance Hldgs J. Paul Newsome Rating Affirmed 1 - Strong Buy / $23.95 (USD) q We are maintaining our 1 Strong Buy rating on HCC Insurance Holdings with a price target of $27 per share, down from $30 per share. q HCC Insurance Holdings falls nicely into the category of commercial insurers well poised to take advantage of the accelerating insurance prices following the tragic World Trade Center disaster. Countrywide Credit Makiko Coakley CCR Will Report Its 2Q Earnings Tomorrow 2 - Buy / $40.21 (USD) q Countrywide will report its fiscal 2Q earnings (for the quarter ending August 30) on Tuesday 9/25. The current consensus estimate for its 2Q is $1.19. We are raising our estimate from $1.18 to $1.20. Due to the fact that CCR typically benefits from lower interest rates, and that it has very limited credit risk exposure, the stock seems to be working as a "place to hide." We believe this trend will likely continue as long as the equity market remains volatile and depressed. q Mortgage rates declined and refinance activities picked up in Jul. and Aug. CCR recently reported its August production volume, which was the highest monthly number in CCR's history. Thus, we are raising our 2Q EPS estimate by $0.02 to $1.20. Paychex Inc Adam Waldo In-Line Qtr-Slight F2002 Guidance Reduc. 2 - Buy / $29.64 (USD) q Reflecting F1Q02 results and new F2002 guidance, our DCF model shows the current $30 share price assumes a far too pessimistic low-teens EPS growth rate over the next five years relative to our 19% projection and management's 25% target. We would actively put new money to work in this blue chip Business & Professional Services company. q On September 20, PAYX reported F1Q02 (ended August) EPS of $0.19 up 20% year over year and in-line with our estimates and the Street consensus. Adept Technology Edward White Insight into Photonics Area 2 - Buy / 4.25 (USD) q While fundamentals in all of the company's served markets are particularly weak, we believe the company's position in photonics assembly automation supports purchase of the shares for long-term risk-oriented investors. q Recently, we attended a presentation by Adept Technology, highlighting the company's capabilities in photonics assembly automation. We believe the key takeaway is that the company's strategy of designing and developing platforms is progressing well. q We believe a critical differentiating factor for Adept in the photonics market is the company's software simulation capability, which has been critical to the co's initial successes with customers, but is not currently appreciated by investors. JDS Uniphase A Arnab Chanda Preannounces; Remain Cautious 3 - Market Perform / 5.36 (USD) q We continue to be cautious on JDS Uniphase and would look for entry points once carrier capex stabilizes. q As we expected, JDS lowered its FQ1 rev forecast to $325M (down 46% q/q) vs our previous forecast of $400M (down 33% q/q). Although the company is seeing early signs of stabilization in demand, we continue to believe that margin compression could be a bigger issue due to pricing. q We are reducing CY01 revs from $2,281M (down 20% y/y) to $2,155M (down 24% y/y) and CY02 from $1,588M (down 30% y/y) to 1,356M (down 37% y/y). We believe gross margins will continue to decline and are modeling 38% in FQ1 and 36% in FQ2. We are also reducing FQ1 EPS from ($0.02) to ($0.03), CY01 EPS from $0.13 to $0.11, and CY02 EPS from $0.07 to $0.02 National Semiconductor Shareholder Mtg.-FQ2 Guidance Reaffirmed 3 - Market Perform / $22.50 (USD) q NSM hosted a shareholder meeting on Fri., reiterating FQ2 guidance of revs up 5-7% q/q. Although the company made positive comments on recent order activity, NSM was uncertain about the near-term prospects for end demand. This view is in-line with our concerns. q National indicated that its turns business has remained healthy through last week. The company is seeing relative strength particularly in wireless (25% of revs) and displays (10% of revs). Similarly to our view, however, NSM is uncertain about the implications for real end demand given the weakening economy and this month's tragic events 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. Therefore, we do not represent that this information is complete or accurate and it should not be relied upon as such. 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