What, no hand clapping?
Are you kidding me? Several months ago, when the world was saying "tech is back," I had a pretty simple message: watch those inventories, watch that optimism. Company after company started jumping up and down about a technology recovery that to me just didn't seem that likely given the massive amount of pre-existing idle capital base from the 1990s spending binge that still either needed to be liquidated or put into use. "Oh, no," quoth the raven, "spending is back."
Technology company shares responded with gusto to the sentiment that it was safe to go back into the water. Some of the old standbys were saying just a month and change ago that the "action" in companies like Broadcom (NASDAQ:BRCM) demanded that investors buy it. Broadcom is down 36% in the interim -- not a very good outcome for those who heeded the call. What we have here are the results of prophesies that fulfill themselves only until reality steps in. By reality, I mean pain.
Cisco (NASDAQ:CSCO) reported earnings last night that offered the signs that sales had actually increased: 16% top-line improvement from the previous year, and a 26% increase for the quarter, though both results were certainly aided by the sinking dollar. Cisco also created more than $6.5 billion in free cash flow for its fiscal 2004, an increase of more than 40% from 2003. But at what was a market capitalization of $137 billion, the multiples the market granted Cisco were massive. The company, like many technology firms, has been optimistic -- its inventories have skyrocketed for two consecutive quarters -- far in excess of combined top-line growth.
Cisco didn't start singing campfire songs in its conference call, saying that it saw continued strength, that it would continue hiring, or any such thing. Instead, that 9% increase in inventory -- now sitting at $1.2 billion -- foretells that Cisco is going to be under pressure to sell to a worried customer base with the potential for nearly zero growth. This matters not just to Cisco, but to all of the companies that sell to end users like Cisco, like Solectron (NYSE:SLR), Jabil Circuit (NYSE:JBL), National Semiconductor (NYSE:NSM), and others. They're going to have to contend with a monster of a company that is concentrating on generating enough sales to clear out inventory that it built expecting better times. Those times don't look like they're coming any time soon. The capital expenditures that were supposed to increase as a result of the money the Fed has been dumping from airplanes just have not transpired, and don't seem to be in the offing. That's trouble for stocks that are priced as if increases in spending are fait accompli.
Not a happy report for a whole host of companies -- Cisco most of all.
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Bill Mann owns none of the companies mentioned in this article.
