And one more - last one for me today. Re: IBM again...
K.
INTL BUS MACHS: Mixed Bag
07:33am EST 11-Dec-97 Merrill Lynch (S.Milunovich)
ACCUMULATE*
Long Term BUY
Reason for Report: Update on Quarter
Price: $106 1/2
12 Month Price Objective: $125
Estimates (Dec) 1996A 1997E 1998E
EPS: $5.56 $6.24 $7.15
P/E: 19.2x 17.1x 14.9x
EPS Change (YoY): 13.3% 13.5%
Consensus EPS: $6.18 $7.02
(First Call: 08-Dec-97)
Q4 EPS (Dec): $1.97 $2.20
Cash Flow/Share: $9.04 $10.29 $11.28
Price/Cash Flow: 11.8x 10.3x 9.4x
Dividend Rate: $0.70 $0.80 $0.94
Dividend Yield: 0.6% 0.7% 0.9%
Investment Highlights:
o Because IBM has been one of the strongest stocks in the server group the
past four months, the stock's correction may continue.
o Nevertheless, we would use IBM as a relatively safe haven. Our new 4Q
estimate is closer to consensus; we expect IBM to manage through the turmoil
fairly well.
Fundamental Highlights:
o We are modestly reducing our 4Q estimate from $2.26 to $2.20 (consensus is
$2.17). We have reduced our revenue growth assumption though an 8-9% local
currency gain is likely.
o Issues include the strengthening dollar/yen, flat PC sales in Japan, and
incremental pressure in disk drives and DRAMs.
o Bright spots could include services, software, and servers. We think the
tax rate will come in lower than most analysts estimate.
Outlook for 4Q
We are modestly reducing our estimate to from $2.26 to $2.20 to reflect
continuing strength in the dollar and PC weakness in Japan. Could the quarter
be worse? Yes, but probably not much. As always, there are puts and takes,
and management has shown an ability to manage the bottom line. IBM is probably
in better shape than many tech companies.
1. We have reduced revenue growth from 5% to 3%. Much of this reduction is
due to currency, in particular the weakening yen. Japan represents 13% of
IBM's revenue and the yen has depreciated about 8% this quarter. Currency
should reduce top-line growth by about 6% versus 5% in 3Q, so we still expect a
healthy constant currency increase of 8-9%. Currency should reduce EPS by
perhaps $0.20-0.25.
2. PC demand in Japan is poor. A few quarters ago, IBM was growing at a 50%
rate in Japan; this quarter we look for flat sales. Last quarter, IBM
commented on NEC's move to an IBM-compatible architecture freezing the market.
IBM is sold out in consumer PCs but that is rather small. We think the
corporate desktop and server businesses are fine.
Consequently, IBM's Asia/Pacific business is at some risk. Asia/Pacific growth
in 3Q was 7% (15% local), a very strong performance. We hear expense measures
are being taken to cushion any slowing. IBM still should outperform most
vendors in the Far East.
3. Server sales could improve a bit. IBM is losing to Hitachi at Wall Street
firms needing single engine performance but winning other deals. We expect
MIPS growth to accelerate from 3Q's 35% growth, resulting in about flat
mainframe sales. We think AS/400 demand is picking up but probably not enough
to show growth (3Q sales were off about 13%). New RS/6000 enterprise servers
should lead to a sales increase for the product line.
4. Disk drives and semiconductors should see some pressure but we wouldn't
overstate it. IBM's drive growth slowed from 80% to 30% last quarter and
further softening is possible. Nevertheless, IBM is outperforming the industry
because (1) it is strong in servers and notebooks while pricing is worst in
desktop drives, and (2) we think IBM's gross margin is twice the industry
average thanks to its technology edge (MR heads). DRAM prices have collapsed,
but DRAMs are only 10-15% of IBM's $2 billion merchant semiconductor
business.
5. Services should remain a bright spot with a 20% gain. IBM is winning deals
on its global capability and superior technology. Margins should rise over
time.
6. Software is slowly improving. Although it won't be much evident in 4Q,
IBM's software business should be strengthening. Host software is declining
less quickly as users move to parallel sysplex. IBM is likely taking share
from Oracle with DB2. Any improvement is important since software carries a
mid-20s operating margin.
7. The tax rate should be about 30%; we think the consensus number of 32% is
too high. Earnings quality should improve, however, with operating income
growth of 5-6% after a flattish first nine months. |
