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Weekly Earnings & Sector Update
May 24^th through May 28^th, 2004

 
Written By: Nick Raich, CFA
Director of Research

Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .I

Earnings & Sector Scorecard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .II

S&P Companies That Reported Earnings Last Week . . . . . . . . . . . . . . . . . . . . . III

This Week In Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IV

Key Companies Reporting This Week . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . V

Zacks Rank By Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .VI

Earnings and Sales Growth - Actual and Estimated . . . . . . . . . . . . . . . . . . . . . .VII

 
OVERVIEW
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First quarter 2004 earnings season turned out to be much better than expected. The final first quarter earnings growth number will be slightly above 32%. We base this on the actual results that have come in and also factor in the current estimates for the remainder of the companies yet to report. Therefore, first quarter 2004 earnings, which were supposed to be the first quarter where we would see a decelerating earnings growth rate, will actually turn out to be even better than the stellar fourth quarter 2003 numbers. Furthermore, second quarter 2004 earnings estimates continue to rise. Three months ago, the second quarter 2004 consensus forecast was for earnings to be up 13% from last year’s second quarter. Today, the consensus forecast stands at 17%.

We now believe the Fed will raise its target for the federal funds rate 25 basis points in June and another 25 basis points in both August and November. We note that the start of any rising rate cycle has often been a challenging period for the stock market, but unqualified generalizations are difficult to make. In recent weeks, we have seen growing expectations of an earlier Fed rate hike. The anticipation of rising interest rates has stalled what had been a healthy rise in stock prices going back over a year. Whether stocks resume a modest upward trend in the near-term, as we expect, or continue to languish will depend on investors’ expectations of rising earnings versus their expectations of rising rates. The greater the expected rise in earnings, and the smaller the expected rise in interest rates, the greater the chance stock prices will continue to rise. Our view is that the Fed action is not going to stop the positive earnings momentum. We believe this economy is just starting to pick up steam and current lean cost structures and improving top-line growth bodes well for many companies’ future bottom-line earnings.

We do note that from a valuation standpoint, the market is still not cheap by historic standards. The S&P 500 currently trades at 18x 2004 earnings estimates. Therefore, a sustainable market rally will only occur if forward earnings estimates continue to rise.

This week, we expect 200 companies to report earnings. Of which, eight will be in the S&P 500. We expect the results to become slightly more negative, as “late-reporters” generally have more negative things to say.

Despite the overall positive earnings news, we strongly recommend checking out the Zacks industry rankings provided in this report. The Zacks rank is based on a proprietary model that focuses on past earnings trends and forward earnings revisions from Wall Street analysts. The model has an excellent track record. Therefore, the Zacks industry rankings should provide an excellent starting point for your equity research.

Companies in the spotlight

In this section, we focus on two stocks that our independent equity analysts feel you should be buying or selling. Our analysts start with the quantitative Zacks model and build their final buy/sell decision by performing additional fundamental analysis on the company. To view the entire report on each of these spotlight companies or to gain access to our detailed analysis on over 1,900 companies, log on to: www.zacksadvisor.com.

Buy – Deere & Company (Ticker:DE - Analyst Report)
Illinois-based Deere & Company manufactures, distributes, and finances an array of farm equipment. The company’s primary markets are concentrated in North America and Europe. It also sells its products to Latin America and Asia. Deere operates through five segments – Agricultural Equipment (approximately 47% of revenue in 2003), Commercial and Consumer Equipment (21%), Construction and Forestry (18%), Credit Operations (9%), and Other (5%).

The agricultural equipment segment manufactures and distributes a full line of farm equipment and service parts — including tractors; combines, cotton and sugarcane harvesters; tillage, seeding and soil preparation machinery; and sprayers.

The commercial and consumer equipment segment manufactures and distributes equipment and service parts for commercial and residential uses — including small tractors for lawn, garden, commercial and utility purposes. The construction and forestry segment manufactures, distributes to dealers and sells at retail a broad range of machines and service parts used in construction, earthmoving, material handling and timber harvesting. The credit segment primarily finances sales and leases by John Deere dealers of new and used agricultural, commercial and consumer, and construction and forestry equipment.

There are several fundamental factors contributing to our favorable outlook on Deere, including the positive environment in North America for agricultural equipment. We think the low inventory level of key commodities (corn and soybeans) provides a backdrop supportive of higher agriculture prices. Consequently, customers will increase high-end combine purchases, with the intent to expand output to meet the supply shortfall in the market. As a result, farm equipment sales should respond favorably. In addition, Deere sales will receive a nice boost from U.S tax provisions that offer expanded depreciation and expense write-offs on equipment, as well as from an increase in overall farm income (which allows capital spending to expand).

Another positive factor affecting Deere includes Agricultural equipment sales strength in Brazil and Australia. The positive environment in these end markets provides a nice boost to Deere’s foreign sales figures and offsets continued weakness seen in Europe. In Brazil, farm equipment demand should rise from strong commodity prices and the extension of government financing programs. In Australia, improving weather conditions support higher purchases of tractors. Given the growth prospect in its global markets, we expect a worldwide 2004 sales increase of agricultural equipment of 25% on a volume increase of 20% (excluding the impact of currency translation).

Finally, commercial and consumer equipment demand are benefiting from the success of new product rollouts, including an expanded utility vehicle line and the 100 series lawn tractor. Therefore, we think revenue can grow along with the increase in retail demand. Given the positive outlook for global farm equipment sales, we recommend investors buy the stock.

Sell – Weight Watchers International (Ticker:WTW - Snapshot Report)
Weight Watchers International is the largest provider of weight control programs in the world. The company operates in more than 30 countries through a network of company-owned and franchisee operations. The weekly meetings comprise its core business, at which are presented a scientifically designed weight loss program incorporating group support and education about healthy eating patterns, behavior modification, and physical activity. These meetings provide exercise tips, nutrition advice, and group support through success stories.

Weight Watchers also provides these services through its web site, where it also sells recipe books and vitamins. The company has a host of products including books and cassettes, calorie counters, eating-out guides, heart-rate monitors, recipe books, running and walking shoes, treadmills, and vitamins.

In 2003, the company recorded revenue of $944 million. Meeting fees generated 64% of revenue, 29% was from product sales, 3% from franchise royalties, while others accounted for the remaining 4%. Weight Watchers generates 60% of revenue from domestic operations, and the remaining 40% comes from international operations. The company’s growth strategy includes greater penetration in existing markets, expansion in other international markets, venturing into new customer segments (e.g., men), garnering higher license revenue, selling more products, and developing publishing opportunities.

Lackluster growth in meeting attendance, declining product sales, and higher marketing expenses are troublesome issues for the company. Domestic attendance declined 4% during the first quarter of fiscal year 2004, which we believe is primarily due to the low carbohydrate diet craze. Though management believes that the demand for low-carb diets has peaked, we feel the timing and magnitude is still uncertain. Increased media focus on low-carb diets and their increasing popularity adds to the uncertainty. Management expects a double-digit decline in domestic attendance growth in the second quarter. Weight Watchers does not incorporate a low-carb diet program in their business model.

The launch of new programs like Flexpoints and Fast Track have not achieved their expected results. Flexpoints was not successful in attracting new members to Weight Watchers, and Fast Track (which contained meal guides and exercise games) was offered only in the month of January. We expect U.S. attendance to remain at depressed levels in the first half of fiscal year 2004, with uncertainties surrounding the improvements in the second half.

Product sales in North America company-owned (NACO) meetings have declined drastically due to tough year-over-year comparisons and lower-than-expected customer response to foodbars. Higher prices have also resulted in lower demand for these food bars. A significant turnaround in this trend is unlikely in the near term. Though NACO will be launching a new product this fall, its success remains to be seen. Weight Watchers plans to keep its marketing expenses flat. However, feel that to drive attendance growth in the core U.S. market, the company may have to opt for higher marketing expenses later this year, leading to margin compression.

Management gave guidance for fiscal year earnings of $1.70 - 1.80 per share. We have lowered our estimate for fiscal year 2004 to $1.75, from $1.90. Our estimate for FY2005 was decreased from $2.20 to $1.99 per share. We have lowered or rating to a sell, with a price target of $28.00.

 
1Q 2004 Earnings Scorecard – S&P 500

Of the 485 companies that have reported, the average earnings gain has been 34% with top-line sales growth of 13% from last year.

75% (of the companies in the S&P 500) exceeded estimates
12% matched estimates
13% missed estimates

 
Actual 1Q 2004 Sector Scorecard – S&P 500
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Note: EPS and sales growth compare current quarterly results vs. prior year ago quarter

 
S&P 500 COMPANIES THAT REPORTED EARNINGS LAST WEEK
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Note: EPS and sales growth compare current quarterly results vs. prior year ago quarter

 
THIS WEEK IN EARNINGS
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Below is a list of key companies that should report this week. To view the entire list of companies reporting on a given day, remember to check out the Zacks earnings calendar.

 
KEY COMPANIES REPORTING THIS WEEK
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INDUSTRIES RANKED BY ZACKS (1= STRONG BUY, 5 = STRONG SELL)
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EARNINGS AND SALES GROWTH - ACTUAL AND ESTIMATED FOR THE S&P 500
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