Tech giant International Business Machines Corp. (IBM) expects to release its third quarter 2010 results on October 18, 2010. We maintain a Neutral rating on IBM over the long term while the stock currently has a Zacks #3 Rank, implying a Hold on a short-term basis.
Shares of IBM are currently trading near its 52-week high price. The share price represents approximately an 11.2x, 2011 earnings per share estimate, which is a discount to both the peer group and S&P 500. We believe that IBM shares should continue trading at a discount to the broader market.
Second Quarter Highlights
IBM’s second quarter 2010 earnings (reported on July 19, 2010) beat the Zacks Consensus Estimate, but revenues fell short of expectation.
IBM’s quarterly earnings marginally exceeded the Zacks Consensus Estimate of $2.58 per share by 3 cents per share. Net profit improved 9.1% year over year to $3.39 billion while earnings per share rose 12.5% to $2.61. Net margin upped 100 basis points year over year to 14.3%. The company cited that it has posted earnings-per-share growth in the last 30 consecutive quarters with double-digit growth in the 12 of last 14 quarters.
Total revenue in the second quarter 2010 was $500 million, below the Zacks Consensus Estimate. Revenues of $23.72 billion in the second quarter were up 2.0% (up 2% when adjusted for currency) compared with the year-ago quarter. The change in currency rates reduced revenues by approximately $500 million in the reported quarter.
Estimate Trend
With a strong portfolio of products and solutions, IBM has raised its EPS guidance for almost every quarter over the last two years. For fiscal year 2010, the company again raised its earnings forecast to at least $11.25 per share from the previously projected $11.20 per share, a 16.0% compound growth rate from 2006 levels. Management expects to achieve earnings of at least $20.00 per share by the end of 2015 with strong revenue growth, operating leverage and geographical expansion.
Estimates for 2010 and 2011 revenues and earnings are marginally up, attributable to strong earnings growth potential, margin expansion, strong free cash flow growth, operational efficiency, cost containment efforts, growing high margin software and services business, increased acquisition and robust product pipeline.
The current Zacks Consensus Estimates for the third quarter and full year 2010 are earnings of $2.75 and $11.28 per share, respectively, above the company’s expectations.
Recommendation
IBM’s growth initiatives, such as smarter planet and industry frameworks, growth markets, business analytics and optimization and cloud computing have driven significant growth opportunities and generated high profit margins for the company. These initiatives are expected to deliver $30 billion in revenues in fiscal 2010. We remain highly positive on these initiatives.
IBM is experiencing a strong revenue growth in all geographical regions, with a robust growth in emerging markets worldwide. The emerging countries of Brazil, Russia, India and China (BRIC) together grew 22.0% in the second quarter of 2010, validating the company’s strength in emerging markets.
Growth markets represented 20.0% of IBM’s revenues and were up 14.0% year over year in the second quarter of 2010. The growth market is expected to contribute 25.0% to IBM’s total revenue by 2015, up from 15.0% in 2005.
With increased payout and share repurchases, IBM is a long-term value stock for investors. We remain positive on IBM’s growth potential.
However, currency headwinds, European weakness, increasing competition, late hardware recovery, lower service contract signings and weak IT spending are headwinds. We believe IBM will need to grow its top line, in addition to encouraging profit guidance to restore investors’ confidence.
We do believe that IBM is fundamentally a sound company and has a strong market position but our caution is based on expected near-term headwinds. We advice stockholders to wait for a favorable entry point.
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