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Turn Volume Down on Handset Makers

The current bounce is a chance to lighten up on these stocks.

This column was originally published on RealMoney on July 20 at 2:04 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Handset pricing was surprisingly strong in the reports from the top five mobile-phone makers, and this pricing strength is giving the sector a much-anticipated short-covering bounce.

However, I think the element of uncertainty in the results will reverse the rally relatively soon. These stocks won't make it back to their spring heights on the basis of this set of numbers, so this move may best be played as an opportunity to lighten up holdings.

The question of a possible phone market slowdown remains unanswered. Despite surprisingly strong pricing, volume growth wasn't as perky as in previous quarters.

Three of the five biggest vendors came up short on phone sales volumes, and two beat expectations.

Samsung

,

LG

and

Nokia

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taken together were perhaps 3 million to 4 million units below the consensus.

Sony Ericsson

and

Motorola

(MOT)

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together were roughly 4 million above consensus, driven by Motorola's 3 million-unit upside surprise. It's very close to a washout. It should be noted, however, that for several quarters running, the top five managed to beat the consensus.

Taking another tack, the top five vendors saw sequential volume growth of about 11.5 million units from the first quarter to the second. If we assume that the other vendors have continued sliding by perhaps 3 million units, that gives us about 8 million to 9 million sequential volume growth globally. I know this is all very open to interpretation, but I don't think this is enough.

Global volumes seem to come up barely above 230 million units in the second quarter, and the implied 3% to 4% sequential growth would be just a bit tepid. It's not really a shortfall but a conspicuous lack of the kind of upside that phone volumes have shown over the past couple of quarters.

Of course, these numbers are so close to the median consensus that several analysts are claiming that second-quarter volumes came in ahead of expectations. The issue is going to be debated at some length over the coming weeks.

Is this just a blip -- a semisoft quarter that may be followed by stronger growth? The guidance from key companies is a merry quilt of conflicting evidence. Sony Ericsson raised its global volume estimate to 900 million in 2006, but this is still way below the 930 million to 960 million forecast by many other leading companies and analysts. Motorola's guidance was extremely strong, but Nokia noted that third-quarter global sequential growth may fall from the pace of the previous quarter.

Does that mean that sequential growth could dip below 3% to 4% during the historically strong autumn quarter? In addition, Qualcomm's revenue guidance for the following quarter is just a tad light; this is a major reversal after an extended period in which it raised sales guidance like clockwork.

2Q Profit Bonanza the Last Hurrah?

Of course, Motorola's profits grew 46% and Nokia's 43%. Motorola's phone margins vaulted above 11% and Nokia's average sales price was a euro above consensus at 102 euros. LG and Samsung both held the line with pricing. Sony Ericsson's ASP level didn't dip as much as anticipated.

This pricing strength is giving the phone sector a short-covering bounce now, but whether it tells us much about prospects for autumn is another matter. The hot new midrange models are only now ramping seriously, including Nokia's N series, the Motorola Q, Samsung's slim phones and LG's Chocolate phone. Sony Ericsson reached big volumes with its new range prior to its key rivals.

But some of the numbers imply that the European upgrade market may not be as healthy as it was last winter, when upgrade sales were strong enough to yield volume surprises for four of the top five. Nokia's European device unit sales growth barely topped 12% year on year.

LG didn't get the boost many were expecting it to get from the early European rollout of its new range. Samsung's hot winter phones have faded in Europe a lot faster than anticipated. Of course, Motorola had an excellent quarter in Europe, and Sony Ericsson found phenomenal traction with its music phones.

Asia is still going strong, but the incoming wave of mid- to high-priced fashion phones and smartphones is clearly dependent on strong demand in Europe.

I think the element of uncertainty in the second-quarter results means that the current bounce in stock prices will be short-lived. The Wednesday/early Thursday telecom move looks suspiciously like a bear market rally -- it's sharp and violent. Its length is hard to gauge, but I don't think any of the big-cap mobile telecom names will recover much more than 40% to 60% of what they lost on the way down from March/April heights.

This could be the kind of big countertrend rally that the sector goes through from time to time. It also provides an opportunity for investors to lighten up before the next big leg down.

At time of publication, Kuittinen held none of the issues mentioned, although holdings can change at any time.

Kuittinen is a senior product specialist for Nordic Partners, Inc., a pan-Nordic brokerage firm. Although Kuittinen is an employee of Nordic Partners, Inc., the statements above are being made in Kuittinen's personal capacity and are in no way are the statements of Nordic Partners, Inc., nor attributable to the company. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Kuittinen appreciates your feedback;

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