JUNE 24th Briefing.com "Story Stocks"

Jun 24, 3:07 pm ET

Xyratex Ltd.: 15.85 -3.52: The digital revolution has resulted in mind-boggling levels of data, which in turn needs to be captured, processed, and stored. Information is generated from a wide variety of sources from mission critical applications, e-mails, the Internet, to multimedia platforms all increasing demand for data storage. IDC forecasts worldwide disk storage system shipments by 2008 will reach 5,444 petabytes (1 mln gigabytes) - a 45% increase from 2003 levels. Further, enterprise data is becoming increasingly critical commanding a larger share of IT budgets for hardware, software, and services. This is where Xyratex comes in. A spin-off of IBM (IBM), this company manufactures modular enterprise class data storage subsystems and storage process technology and despite reporting earnings doubled in the second quarter, disappointing guidance sent shares on a tailspin.

Excluding non-operating items, earnings came in at $13 mln, or $0.45 per share - six cents above analysts expectations. The top line expanded 57% year/year to $169.6 mln and 19% sequentially. These eye catching figures were pushed aside as the market focused on its guidance, which was negatively impacted by a shift in revenues at Seagate. With the revenue shift and increased expenses for its acquisition of Oliver Design, earnings were hit hard for Q3. XRTX sees EPS in the range of $0.20-0.27 well below consensus at $0.41. On revenues it forecasts a range of $155-165 mln vs. $168.98 mln consensus.

Its recent acquisition of Oliver Design, a designer and manufacturer of disk drive media cleaning technology, is expected to be accretive to revenues and earnings this year adding $30-35 mln and $0.13-0.17, respectively. According to analysts, company's guidance is still less than the full contribution of OD. For the full year, the company did raise revenue estimates by $6-16 mln to $660-675 mln, while despite lower Q3, left full year earnings unchanged at $1.50-1.60 (consensus $1.56).

The upside was driven by its Storage Infrastructure business, which accounts for 40% of the top line up from 24% in 2004. This growth engine produced revenue growth of 28.7% sequentially. Management attributed the strength to solid hard disk volumes, increased demand for real density points, and new products from drive vendors. The Storage Network Systems (other 60%) generated 13% sequential growth in revenues to $100.5 mln on continuing strong demand of NetApp. XRTX said it shipped 43.6 petabytes of disk during the quarter up 18.7% q/q. The SI business contributed to the gain in gross margins from Q1 to 21.9%. Management forecasts margins will remain in the 21-22% range for the full year.

As expected, the market chose to focus on lower guidance sending shares down another three bucks in early trading. We suggest investors focus on the bigger picture here and take advantage of the exaggerated selling. It's reasonable to expect, a company like Xryatex with its large scale products and small customer base, lumpiness in quarterly earnings. This British company offers a strong growth profile generating 32% and 37% revenue growth over the last two years, on target for 42% in 2005. We feel considering Xyratex's market position, strong balance sheet, and compelling valuation of 9.8x forward earnings, investors will be rewarded over the long-run. ---Kimberly DuBord, Briefing.com




09:50 ET

Solectron: 3.74, -0.08: Solectron, one of the largest electronics manufacturing services (EMS) companies in the world, reported fiscal third quarter earnings after the close on Thursday. Following its second consecutive disappointing quarter, the company recorded Q3 EPS, excluding non-recurring items, of $0.04 on $2.6 billion in revenues versus the consensus estimate of $0.04 on $2.7 billion. While earnings were in-line with estimates, revenues failed to meet expectations and marked a 14.4% decline from the year-ago period. The company attributed the lower revenues to weaker demand in the networking and consumer segments, offsetting relative strength in computing and storage, communications, industrial, and automotive.

Looking ahead, the company issued mixed guidance for the fiscal fourth quarter, projecting EPS of $0.03-0.05 on $2.4-2.6 billion in revenues versus the consensus estimate of $0.04 on $2.7 billion. Concurrent with the Q3 results, the company stated that "(they) are pleased that in a lower revenue environment (they) delivered profitability within (their) guidance and achieved strong cash flow generation again (for the) quarter".

In response to a challenging pricing environment and increased global competition, Solectron has taken great strides in improving operations and enhancing relationships with key partners and suppliers through the institution of the Lean Six Sigma program. The program, which is based on the world-renowned Toyota Production System, has been the guiding light for the company's overall strategy and a differentiating factor within the industry. As management forges ahead with their turnaround efforts, the permeation of the disciplined operating principles should help reinvent the business. Moreover, strategic efforts to aggressively cut costs and diversify operations will help dictate the company's ability to successfully restructure itself and generate future growth.

Although Solectron has shown modest improvements in working capital and operational efficiencies as a result of ongoing efforts, the nature of the EMS industry imposes inherent risks, including high stock volatility, industry overcapacity, and increased global competition. The aforementioned industry-specific risks are largely related to changing demand forecasts and shifting cost structures. As such, the integration of strategic outsourcing plans have directed manufacturing trends to lower-cost Asian countries. The successful ability to create comparative advantages through cost reductions and streamlined operations continues to dictate the low-margin business environment.

Despite trading down considerably since December, Solectron's shares have failed to reverse momentum as the company's turnaround story continues to unfold. Having reported modest earnings on sequentially lower revenues, the company's fundamental shape remains uncertain. However, ongoing restructuring efforts and Lean Six Sigma program initiatives should help drive expectations for improved sales and margin growth. As valuation levels have yet to settle behind volatile price behavior and impending fundamentals, the company's current multiple of 50.4x trailing earnings trades at a premium to industry peers Flextronics (FLEX) and Jabil Circuits (JBL), which trade at 23.7x and 33.8x respectively. Until the company hardens its position within the competitive landscape and increases earnings visibility, the premium multiple will remain unjustified. ---Richard Jahnke, Briefing.com




09:01 ET

Page One - Sell-Off Not a Big Surprise: : The S&P 500 index was up four of the past five weeks. The week ended June 3 it dropped a minuscule 0.2%. It has been a good run. In hindsight, it is thus not surprising that some bearish sentiment finally burst through.

The sharp 13 point drop in the S&P yesterday was largely attributed to rising oil prices. That indeed was what sparked the selling, but it was also a case of underlying concerns finally rising to the surface

Earnings growth is clearly slowing. Second quarter earnings will be up about 8%. That is down from 13% in the first quarter, and 21% in the fourth quarter. That 8% is heavily bolstered by large gains in the energy and materials sectors. The broader array of companies is experiencing an even more significant slowdown.

There are also concerns about the economic outlook. Forecasts for second half GDP remain near 3%, but many traders are concerned that a more significant slowdown could develop. May durable goods orders released this morning showed a strong 5.5% gain, but that was due to the volatile aircraft orders component. Excluding transportation, orders the past three months have been 0.1%, -0.7%, and for May, -0.2%. This trend suggests that business investment may stall in the second half of the year.

None of this means that the stock market is in deep trouble. It is not at all surprising that economic and profit growth rates should slow from the boom levels of 2004. And, there is still good growth in each of those key metrics. But it is also not surprising given the run-up of over 5% in the S&P 500 index the past two months that a bout of selling would hit.

In terms of news this morning, oil prices are holding just below $60 a barrel this morning. A.O. Smith, PMC-Sierra, Maverick Tube, and Tektronix warned. Legg Mason picked up Citigroup's asset management business in exchange for its broker dealer.

The market is poised to open flat to slightly higher. Yesterday's sell-off was not the start of something big or an assessment that $60 a barrel is a magic number under which the economy will collapse. It was a significant down day in what is still a trading range market. Dick Green, Briefing.com