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Solectron, contract equipment stocks stumble

    Contract equipment-manufacturing stocks were punished Tuesday after Solectron delivered a gloomy third-quarter outlook. Analysts said Solectron's reversal of fortune didn't bode well for its competitors.

    On Monday, Solectron (NYSE: SLR) announced that it expects to miss analysts' third-quarter estimates and plans to cut more than 8,000 jobs. The company said business dried up suddenly. Indeed, Solectron reiterated its outlook for the second quarter and fiscal 2001 in late January. Shares fell $1.35 to $20.14 Tuesday.

    Solectron is an electronics contract manufacturer that makes PC and telecom equipment for original equipment manufacturers (OEMs) such as Cisco Systems (Nasdaq: CSCO), Compaq (NYSE: CPQ) and Hewlett-Packard (NYSE: HWP), all of which have had financial troubles as of late.

    Most analysts said it wasn't Solectron's outlook that surprised them, but the timing and the severity of the inventory problems, and the halted orders that caused the revised outlook.

    Solectron said it now expects to earn 12 cents to 16 cents per share, excluding special charges, in its fiscal third quarter ending in May. Analyst consensus predicted a May quarter profit of 31 cents per share, according to tracking firm First Call. Worse, the company declined to provide its fourth-quarter and fiscal 2002 outlook.

    The "slowdown in demand was abrupt, especially in (the) communications area," said SG Cowen Securities analyst David Foropoulos, who downgraded the stock to "neutral" from "buy" on Tuesday.

    Goldman Sachs analyst Michael Zimm also said Solectron's reductions "extend beyond what we had imagined to be a 'worst case' scenario." Zimm cut his already reduced estimates for Solectron and its rivals.

    In a report entitled "Reality Hits Home in EMS Land," Lehman Brothers analyst Louis Miscioscia also said the results were a harbinger of bad news to come. (EMS stands for equipment manufacturing services.)

    "With results so significantly below expectations we believe this does not bode well for other EMS providers," Miscioscia wrote in a research report. He said that despite having already lowered projections, price targets and ratings on EMS stocks from December through February, he has "not gone far enough," and all estimates are currently under review.

    Shares of Solectron's rivals fell. Companies that took a hit include Flextronics (Nasdaq: FLEX), down $2.63 to $20.75, Celestica (NYSE: CLS), down $4.2 to $33.45, Jabil Circuit (NYSE: JBL), down 96 cents to $19.45, Plexus (Nasdaq: PLXS), off $1.13 to $28.44, Sanmina (Nasdaq: SANM), down $2.63 to $25.88, and SCI Systems (Nasdaq: SCI), off $1.44 to $18.50.

    Zimm of Goldman Sachs lowered revenue and earnings forecasts on Celestica, Flextronics, Benchmark Electronics (NYSE: BHE), Plexus, Sanmina and SCI.

    ING Barings analyst Patrick Parr downgraded Sanmina to "buy" from "strong buy."

    Parr downgraded Sanmina even though the company reiterated its second-quarter outlook. Parr said Sanmina's third quarter will likely be hurt by delayed orders.

    Jabil (NYSE: JBL) also fell ahead of its second-quarter earnings report, due Tuesday. Zimm didn't change estimates, but noted that Jabil is likely to follow Solectron's lead and cut its outlook.

    As for Solectron's shares, don't expect anything other than volatility in the near term, analysts said.

    "In order to get any kind of stabilization, investors will need to believe that current earnings estimates, even if at a lower level than prior expectations, can hold," said Lehman Brothers' Miscioscia. Projections for fiscal 2002 estimates are also needed.

    For the sector overall, Zimm sounded one positive note for the stock; he said he believes that "a good deal of the stock damage is behind us," but added that only long-term investors should consider contract manufacturing stocks.