IBM (NYSE: IBM) reports second quarter results after the close of trading, so I determined to undertake an EPS preview analysis. In the process, I grew increasingly comfortable with IBM's operations despite global economic uncertainties. Given its recent valuation adjustment, I believe the stock is attractively valued and incorporates a margin of safety for long-term investors. While I believe the stock might offer interesting commentary on the global economy in its conference call, I'm not worried about the current quarter or IBM's general EPS outlook today.
Yahoo Finance employs the reputable services of Thomson Financial for analysts' estimate information. Based on their survey of 22 analysts, the Street view is detailed here for the company.
FY 2012 (Dec.)
We employ several data points in our effort to best understand operating trends at publicly traded companies. One useful first-look statistic is the consensus EPS estimate trend. Over the course of the last 7 days, the consensus EPS estimate for the company's current quarter has been reduced by a penny. Over the course of the last 30 days, the consensus EPS estimate for the company's current quarter has been reduced by $0.02. Over the course of the last 90 days, the consensus EPS estimate for the company's current quarter has been reduced by $0.02.
Recent EPS History
The recent EPS reporting history of a company may prove relevant in forecasting how it might perform in the current period. However, today's dynamic environment could make results less predictable. IBM's consistently positive reporting history follows.
Significant Recent News:
Three Month Chart Against SPDR S&P 500 (NYSE: SPY)
Last 5 Days Against SPDR S&P 500 :
The Greek's Synopsis:
IBM shares have underperformed the S&P 500 over the last several trading sessions, perhaps indicating trepidation of shareholders and traders ahead of the company's EPS release. That concern is largely tied to investor anxiety about IBM's European exposure and slowing global economic growth. Investors were clearly worried about the company's EPS report heading into the release, which may or may not be warranted.
The three-month chart shows the company's market tracking performance, which extended until early July. It makes perfect sense, given the company's beta coefficient of 0.65. You might have expected IBM to be more of a cyclical stock, but the company is so well integrated into the global economy that it benefits from regular services revenues and replacement product orders. This is an important point, as a clear company initiative is adding value today. The company is also engaged in several smart strategic initiatives that I believe are adding value and diluting risk.
It's my view that the shares have declined of late purely on their valuation at the start of the month in relation to rising concern about the global economy. The P/E ratio of IBM one month ago was roughly 14.9X, versus 13.7X today and its five-year average of 12.9X. The stock has likely just adjusted to better suit a changing environment.
The company's recent earnings history paints a picture of consistent outperformance against expectations. Those expectations have, however, been reined in over the last 90 days. That data says to me that the company's EPS are likely in position to once again outperform against the consensus at the EPS report. However, because of its track record of doing so, this might not impact the stock on the report day as much as it would otherwise, especially given the economic outlook. However, because of the stock's adjustment, it may still have some upside potential. I expect the company to offer at least some global economic commentary and perhaps a tempered outlook, which would likely quell enthusiasm. Thus, I would not favor acquiring or selling the stock passionately ahead of the report on expectations of the report itself. Though, I see a better likelihood of rise on the news than decline.
Over the course of the last several weeks, the company has had two significant news events helping to clarify its outlook. The most recent event was its Business Perspectives 2012 presentation. Within that, the company highlighted its growth in services or "annuity" revenues, which is precisely why investors should reconsider perceived cyclical risks. Obviously, it continues to be sensitive to business spending, but to a lesser degree than in the past and to a degree that has its beta coefficient attractive for today's environment.
IBM's expansion into growth markets not including the troubled euro-zone serves as an important hedge as well here. In 2011, its non-U.S., Canadian and European markets made up 22% of the company's revenues, versus 16% in 2006. Obviously, management has added value here as well and should be commended for it.
The company has also expanded its profit margins and increased free cash flow generation through a new focus on higher value products. The company is adding pace to operating EPS growth through these initiatives and productivity improvement and cash flow utilization. The presentation, just about a month ago, might limit the prospect of an outlook change but it wouldn't eliminate the risk altogether.
Valuation & Recommendation:
IBM's valuation adjustment of the last few weeks was hopefully driven by smart money playing it safe rather than on channel information. I expect it was driven by both. We need to look at the stock based on today's value, and determine whether it is properly valued now. The company's P/E ratio has been discounted, as detailed previously. While trading at about 11.8X my estimate for the next 12 months, the stock compares well to its own 11% EPS growth target through 2015 and analysts' 11.5% 5-year growth forecast. My forward 12 month EPS estimate is simply based on the average of the analysts' consensus EPS forecasts for 2012 ($15.06) and 2013 ($16.60). Applying analysts' 5-year growth forecast, we get a P/E-to-Growth (PEG) ratio of 1.03 on that.
Comparing IBM to its competitors, its trailing P/E is greater than Hewlett-Packard (NYSE: HPQ), Microsoft (NASDAQ: MSFT), Dell (NASDAQ: DELL), Cisco (NASDAQ: CSCO), Xerox (NYSE: XRX) and Seagate Technology (NYSE: STX). IBM trades at a P/E discount to rivals Accenture (NYSE: ACN), Apple (NASDAQ: AAPL), NCR (NYSE: NCR), EMC (NYSE: EMC) and Toshiba (OTC: TOSBF). Relative to growth, I'm comfortable with IBM's relative valuation and do not see it out of place with regard to peers, given its strategic achievements and efforts.
Of course, there is risk of outlook degeneration, or more concerning today, outlook reconsideration. Still, I feel there is a margin of safety built in here because of the recent valuation adjustment and the current value. Therefore, I wouldn't sell IBM today and would add it to portfolios on any weakness on its announcement. I'm even comfortable adding some shares of the company to well diversified portfolios ahead of its EPS release, given enough possibility of a relief driven reassessment of value.
IBM reports earnings per share for its second quarter on Wednesday July 18 after the market close. Use this link to access IBM's earnings report and conference call.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in IBM over the next 72 hours.