Big Blue Has Investors Seeing Green

| About: International Business (IBM)

“IBM (NYSE:IBM), one of the big winners following news that the company expects profits to jump as much as 79% over the next five years…” – Bloomberg News 5/12/2010

According to management commentary at a recent investors meeting, the future looks rather bright at International Business Machines Corp. Its stock surged today after CEO Sam Palmisano told spectators that he expects earnings per share to be at least $20 for fiscal 2015. Considering the company earned a penny over $10 last year (fiscal 2009), he is essentially claiming the company expected profit to double in six years time. That rate would equate to a 12.23% annual earnings growth rate, which is supremely impressive considering the size and maturity of the company. Wall Street analysts have forecast about that level of growth for the current year (thanks to renewed business spending on technology), but they had expected earnings growth to slow to less than 9% in fiscal 2011. In addition to the upbeat long range guidance for earnings, Palmisano also said he expects sales will outpace estimates as well.

We appreciate management’s willingness to set long term goals and they have proved worth paying attention to. Remember than in 2007 IBM management forecast earnings for fiscal 2010 of $10 to $11 per share. Consensus analysts estimates has moved higher recently and now stands at $11.27 per share for fiscal 2010. This meeting served as a five-year road map and also as a way to say, “we told you so.”IBM

The CEO said that this impressive earnings growth would primarily come from a greater focus on more profitable business lines like software. He avowed that IBM will continue to create solutions that help its clients increase efficiency through cloud computing services and infrastructure and electricity monitoring and analytics systems. Years ago IBM began to shift its long term strategy away from hardware and toward software and services that come with far better margins. Based on what we learned from today’s discussion, that long term vision has changed very little. This gradual shift towards a more favorable margin segments is how IBM plans to grow profits at more than twice the rate of sales growth (their projects forecast about 5% annual sales growth).

The statements made are clearly bullish as far as its enterprise clientele as they emerge from their recession mindset. Furthermore, IBM foresees big opportunities in growth market such as China and other rapidly growing Asian markets. It anticipates a quarter of sales will come from “growth markets” by 2015, up from 19% last year. Also, the company has plans to accelerate their acquiring practices as management predicts $20 billion in acquisition spending through 2015. IBM has been in a lull as far as acquisitions go spending only $1.5B all of last year, after averaging more than twice that level of M&A spending in the six prior years under Mr. Palmisano. The company had a stock-pile of about $14 billion in cash sitting on its balance sheet as of last quarter end from which to start its buying spree.

Clearly, this bubbly outlook was met with excitement from the market as IBM and the tech sector as a whole benefitted today. We continue to believe that IBM is Undervalued, and today’s news only bolsters our opinion. Historically, IBM has traded for 12.2x to 18.1x cash earnings per share, while the current level is only 11.7x. That metric assumes that IBM will perform inline with expectations for the rest of the year, which we think is likely too conservative. Based on current fundamentals, if IBM were to trade at a similar valuation compared to historically norms, the stock could easily fetch north of $145 per share.

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