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Merrill Lynch bullish on PC giants

The second quarter may look bleak for some dot-coms, but technology hardware companies are building momentum for a strong second half.

    The second quarter may look bleak for some dot-coms, but technology hardware companies are building momentum for a strong second half.

    In a conference call this morning, Merrill Lynch analysts Steve Fortuna, Steven Milunovich and Joe Osha offered second-quarter projections, with Dell Computer, EMC, Intel and Sun Microsystems leading the pack.

    While hardware companies are suffering some seasonal sluggishness, demand for servers helped Compaq Computer and Dell offset slowing consumer PC demand. Other PC makers also are managing well, despite slower consumer sales. Overall, most companies will meet or beat expectations, the Merrill Lynch analysts predicted.

    "Investors should not be overly focused on seasonably week second-quarter results, but rather be building positions in the PC names in anticipation of a very strong second-half year," Fortuna said.

    The upside forecasts strongly contrast a rash of earnings warnings from e-commerce companies and mainframe software makers Computer Associates and BMC Software.

    Dell and Intel top the list of companies most likely to beat estimates.

    Osha predicted Intel would at least meet expectations, "but we would not be surprised to see the company report upside to our estimates."

    Osha forecast earnings per share of 72 cents, or 99 cents when factoring one-time gains, despite a second-quarter sales slowdown.

    "Our channel check suggests the company is seeing a standard season deceleration in demand for the corporate market," he said. But "demand for the company's recent additions to the Celeron line appears to be quite strong."

    Sun and storage giant EMC were helped by strong server and storage sales and would likely beat estimates.

    "EMC is benefiting from a new product cycle and accelerating growth, Milunovich said. "We see revenue there up 24 percent, with earnings of 34 cents (a share), possibly a little better."

    For Sun, Milunovich predicted a minimum 33 cents a share, with 32 percent growth. Despite a strong quarter, Sun must get new systems to market quickly.

    "Sun needs to get these UltraSparc III products out or risk falling behind in performance, as IBM highlighted with its ad in the (Wall Street) Journal," he said.

    Dell would appear ready to top estimates, despite recent concerns about component shortages continuing to drag on profits.

    "We believe that Dell is experiencing strong demand in the U.S. corporate market in the July quarter, especially on the server side," Fortuna said. Dell also is expected to post strong education sales, particularly selling notebooks and PCs equipped with wireless networking, where it competes with Apple.

    Fortuna forecast $7.9 billion in sales, up 29 percent year over year, and about $100 million ahead of other estimates. The earnings per share (EPS) estimate is about 21 cents, without factoring investment gains. Any major gains are expected in gross margins rather than top-line results.

    Fortuna reiterated his "buy" rating for Dell and "accumulate" for Apple, Compaq and Gateway.

    "We think there is a 20 to 40 percent stock appreciation potential in these names through year end," he said.

    A strong uptake in call volume and sales activities in the last two weeks of June bode well for Gateway, which Merrill Lynch expects will bring in $2.13 billion in revenue for the second quarter.

    "We think the bottom line, 36 cents (a share), is a virtual lock," Fortuna said. "This is a must-own stock at these levels, in light of the fact the company is going to muscle sales in the back half of the year through aggressive expansion in retail outlets."

    Gateway has been aggressively pursuing a retail strategy. The company launched a so-called store-within-a-store promotion with OfficeMax and recently said it would go into Canada with a retail strategy.

    Server demand helped Compaq, which Fortuna predicted would bring in about 21 cents a share. But Houston-based Compaq could be hard-pressed to make $10 billion in revenue, which would mean single-digit growth for the quarter.

    Concerns over Compaq's second quarter surfaced on June 29, with analysts issuing conflicting reports, some speculating the PC maker had too much inventory on dealers' shelves.

    "Investors should be buying the stock for a strong second half, and also for what we believe will be accelerating revenue growth, in the double-digit range, as well as expanding operating margins in the back half of the year," Fortuna said.

    The Merrill Lynch analyst forecast for the year an estimated share price of $40 for Compaq and $75 and $70, respectively, for Gateway and Dell.

    Apple is expected to post revenue of about $1.9 billion, with 13 percent growth in unit shipments and 8 percent in average unit price.

    "With respect to Apple, we think there is an attractive short-term opportunity here leading up to the July 19 Macworld event in New York," Fortuna said.

    IBM is expected to post mere 1 percent growth for the second quarter, pulled down by services and mainframe hardware and software sales.

    "We expect that IBM will be generally positive about the second half, though we think there is some risk to our third-quarter revenue estimate of 9 percent," Milunovich said. "We would have investors wait to see the quarter, but do we expect the stock will perform better in the second half."