IBM: The Quintessential R&D to Earnings Story

 |  Includes: AAPL, DELL, HPQ, IBM
by: Jason Merriam
International Business Machines Corp. (NYSE:IBM) is set to announce first quarter 2011 earnings on April 18th.
Big Blue has seen its stock price rise more than 30% since Sept. 2010. The company has come a long way in the nine years since Sam Palmisiano took the reins as CEO in 2002.
This is a man who not only stepped into the shambles of a popped internet bubble, he also guided the behemoth IBM through the worst recession in decades.
R&D spending over the past two years has averaged about 6% of sales. IBM also has a rich library of patents. In comparison, Apple’s (NASDAQ:AAPL) R&D budget was less than three percent of sales during the same period.
Yet, IBM has changed a lot from its big-box mainframe days. It is now a peer leader in servers, although HP (NYSE:HPQ) and DELL are often seen nipping at the heels. HP too is marching into war with its “Instant-On Enterprise” systems under the leadership of new CEO Leo Apotheker. In the “cloud” space you have the folks at Acadia Enterprises in cahoots with Cisco (NASDAQ:CSCO), EMC and VMWare (NYSE:VMW).
Yet, IBM’s bread and butter still comes from services, global systems and consulting. Competition is good for any industry, but Big Blue will always be...BIG. - Big, International and Gargantuan.
How do IBM’s financials stack-up going into Q1 earnings? For starters, the company has a very strong balance sheet for a company of its size with breadth of offerings.
We do note a 15% spike in accounts receivable during Q4, but this is inline with the 19% sales growth in the same period. IBM’s dual cash flow trend flashed a “recent bearish” signal in the latest two quarters after peaking at 1.2 in Q2.
IBM Dual Cash Flow Click to enlarge

(Click to enlarge)

Earnings yield is declining modestly in recent periods and Q4 EY is below the average for all periods shown. Revenue metrics displayed weakness in R&D and Cost-of-Sales, offset by improved S/G/A and Accounts Payable (when compared to sales).
Accruals: IBM’s accrual trend has been drifting towards bearish territory in recent periods, but remains well-below our +5%> danger zone. We would like to see accruals heading back to negative territory.
IBM Accrual Ratio and Capital ProductivityClick to enlarge
Operating cash-flow (as a % of sales) declined in Q4, offset by similar declines in balance sheet cash flows during the same period. It’s very rare we see OCF and BSCF equally reflected as a percentage of sales. It’s hard to read anything into this, but worth keeping an eye on going forward.Click to enlarge
Goodwill / Intangibles: IBM has made several acquisitions in the past year as the company broadens its reach into analytics, data collection, information management software, sensors, etc.
Goodwill from the recent acquisitions has mostly been assigned to software and it is expected that approximately 25 percent of the goodwill will be deductible for tax purposes. Goodwill on the balance sheet (as a % of equity and assets) is shown in graph form on page two the Merriam Report (here - pdf).
Earning’s Quality: B+
Estimated Fair-Value: $150.23
Summary: IBM has been beating analyst estimates by an avg. 5% on sales and almost 2% on earnings during the past four quarters. Aside from the gradual rise in recent accrual trends, we don’t see any significant issue within the financial statements that would be a surprise, come April 18th.
Traders might find opportunities between the $155 and $163 area. Investors looking for an entry point may want to wait for a pull back to $150 or under. You can view the complete IBM report (here - pdf).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.