(IBM) IBM Third Quarter 2011 Earnings Preview

IBM Corp. (IBM) is scheduled to announce its third quarter 2011 results after the closing bell on October 17, 2011, Monday. We noticed the quarter’s estimates treading in a positive direction, and considering the past trends, we continue to believe another earnings beat is on the cards.

Prior Quarter Recap

IBM reported strong second quarter earnings and revenues that surpassed the Zacks Consensus Estimate. Results were positively impacted by IBM’s key initiatives, such as Business Analytics, Smarter Planet and Cloud offerings that reported strong growth in the first half of 2011.

Moreover, the company has been selected by many government agencies from different countries in the Asia-Pacific to provide services and technical support for their operations, thus ensuring a steady flow of orders and market share gains across various regions.

Total revenue increased 12.4% year over year (5.0% adjusted for currency) to $26.67 billion, surpassing the Zacks Consensus Estimate of $25.4 billion. The year-over-year growth was driven by strong performances from the transactional businesses in hardware and software.

IBM posted non-GAAP EPS of $3.09 per share in the second quarter, up 18.0% on a year-over-year basis, thus representing double-digit growth in 16 of the last 18 quarters. The significant upside was primarily driven by solid revenue growth (which was 33 cents a share) and share repurchases (another 18 cents), which fully offset weak margins in the quarter.

Current Quarter Expectations

For the current quarter, the Zacks Consensus Estimate for IBM’s earnings is pegged at $3.22, a 4.21% upside from the previous quarter. Total revenue as per the Zacks Consensus Estimate is $26.24 billion, down 1.6% from revenues earned in the prior quarter.

We note that IBM has consistently exceeded estimates in the four preceding quarters. The average surprise during this time was a positive 2.13% and another positive earnings surprise is expected from the company.

Based on the strong first half of 2011, IBM raised its fiscal 2011 operating EPS estimate to at least $13.25 from its previous guidance of at least $13.15. GAAP EPS guidance was also raised to $12.87 from the earlier projection of at least $12.73 for the same period.

Currently, the Zacks Consensus Estimate for fiscal 2011 is pegged at $13.31 per share.

Estimate Revision Trend

In the last thirty days, four out of the 16 analysts covering the stock raised estimates for the current quarter, while none moved in the opposite direction, leaving the Zacks Consensus Estimate at $3.02 per share.

For fiscal 2011, one upward revision was noticed from the 18 analysts covering the stock. The Zacks Consensus Estimate for fiscal 2011 is pegged at $13.31 per share.

Analysts covering the stock are positive on IBM’s strength in its services division, enterprise spending, share repurchase activity, and product refresh cycle. Moreover, the company’s expansions in its cloud and analytics portfolio through strategic acquisitions and product innovations will contribute to its top-line and bottom-line.

Conclusion

We believe IBM’s growing initiatives in the smarter planet, business analytics and optimization space will drive long-term growth. Besides, the ability to generate strong free cash flow, expand margins and improve the already robust balance sheet make the stock attractive over the long term.

IBM remains a heavyweight in the cloud computing market and its strong cash balance enables IBM to acquire companies with high intellectual property (IP), which will drive further growth in the upcoming quarters. We have a long-term Neutral recommendation on IBM and are optimistic about its strong fundamentals and robust growth prospects going forward.

The cloud computing market is expected to grow at a CAGR of 40.0% from 2010 to 2015, crossing $7.0 billion in revenues by 2015. Cloud computing leads to improved services and elevated security requirements for companies that use it and IBM’s product portfolio is well positioned to benefit. Additionally, by 2015, IBM expects the Smarter Planet initiative to generate revenues of $10 billion.

IBM is experiencing strong revenue growth across all geographical regions, coupled with robust growth in emerging markets worldwide. IBM expects these growing markets to drive revenues and increase growth in 2011 and beyond.

However, the competitive landscape includes technology giants, such as Oracle Corp. (ORCL), Hewlett-Packard Co. (HPQ), Microsoft Corp. (MSFT) and EMC Corp. (EMC), so the company is unlikely to have it all smooth-sailing.

We currently have a Zacks #3 Rank for IBM, which translates into a short-term Hold rating.

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