From Baron's (Thursday, October 11):
Three Tech Names With Earnings Upside
Goldman Sachs
IN THE SEPTEMBER QUARTER, THERE are enough special situations to keep the technology sector interesting.
We would be buying Seagate Technology shares into the quarter on the strength of its potential upside. We expect upside from Apple, Seagate and IBM (on the bottom line) even though for our enterprise-facing companies, the quarter was tougher than expected, with strength coming from the consumer, Europe and the weakening dollar.
Despite a 11% increase in hardware and a 12% increase for tech overall since mid-August, we see the setup going into the fourth quarter of 2007 as generally positive, aided by the fact that our stocks are not overowned, with the possible exception of Apple. There are few signs in our checks that spending patterns for fourth-quarter 2007 will be much different from normal and, in general, we expect a seasonally strong December quarter for our companies.
That said, the missing link revolves around corporate-spending intentions for 2008. Although we are not going to be able to adequately take the temperature of chief information officers until November or December, our placeholder assumption for now is that tech capital spending will again decelerate going into 2008, making for a more selective and difficult stock-picking environment, leaving us to generally favor special situation-type names.
A softer enterprise-spending environment coming from macro concerns could influence critical information technology capital-spending decisions by chief financial officers and CIOs during the October-to-December budget period.
We would buy Apple shares into year end as market momentum and earnings upside drive the shares higher. Our new target price of $190, prior $165, is based on growth-adjusted earnings multiples, cash flow metrics, and discounted cash flow.
Apple will undoubtedly remain characteristically conservative with its December quarter targets, probably providing targets below the Street's revenue forecast of $8.5 billion and earnings estimate of $1.35 (we are at $8.1 billion and $1.31). The European launch of iPhone together with a seasonal jump in iPod sales after the recent lineup refresh should add to strong Mac sales in the December quarter.
Ongoing Mac share gains coupled with the ramp of iPhone and better gross margins are the main contributors to our increased calendar-2008 revenue estimate of $30.1 billion (prior $29.2 billion) and earnings-per-share forecast of $4.70 (prior $4.38).
With the third quarter of 2007 behind it, we would continue to own IBM heading into its best seasonal quarter, supported by likely seasonal upside, currency, and a market multiple.
The fourth quarter is IBM's time to shine and, despite current macro conditions, we expect that again. IBM will undoubtedly stick with its no quarterly guidance policy but reaffirm comfort with 2007 Street earnings of $6.96, excluding any upside from the third quarter of 2007. We expect IBM to be able to beat these numbers.
We are forecasting services bookings of $49.2 billion for 2007, slightly higher than 2006 totals, implying $15 billion in bookings in fourth-quarter 2007 (assuming $11.5 billion in the third quarter), led by strength in consulting and integration.
Seagate remains a Conviction Buy. We expect Seagate shares to close in on our $30 target price as Street estimates for calendar 2007 and calendar 2008 (currently at $2.17 and $2.42, respectively) move closer to ours at $2.21 and $2.74.
The December quarter is shaping up to be strong as notebook-demand strength should add to normally positive seasonality. We expect Seagate to target revenue in the range from $3.4 billion to $3.5 billion, with our estimate of $3.39 billion and consensus estimate of $3.4 billion. Sequentially higher revenue and gross margin should result in an EPS target range starting above the Street's current 68 cents (we are at 72 cents).
-- Laura Conigliaro
-- David C. Baile
-- Min Park
-- Hongyu Cai
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