Big Blue ranks at the top of the list of defensive companies with its high level of recurring revenues and profitability, worldwide operations, and below-market valuation
While the stock market may have taken some comfort in the passage by the U.S. House of Representatives of the government's financial rescue plan on Oct. 3, investors remain nervous. They have been looking to recalibrate their portfolios with higher-quality investments as markets continue to be besieged not only by concerns about the spiraling financial crisis but by a looming global recession as well. In the search for solid stocks, stalwarts like IBM (IBM) stand out in troubled times.
IBM itself got pummeled in recent days, in part because of concern the crisis might hurt sales and earnings. IBM tumbled on Oct. 2 to 104 a share from 110 the previous day. On Oct. 3 the stock rebounded early in the day but closed at 103.44. Any negative consequences from events won't be immediate, although some analysts argue that the consolidation in the financial services industry may even benefit Big Blue.
Merger activity has certainly been heated, amid deals like Bank of America's (BAC) rushed acquisition of Merrill Lynch (MER) and the Citigroup (C)-Wells Fargo (WFC) contest for Wachovia (WB). "Even though many of the mergers may be shotgun marriages, these would still require integration of systems," says Amitabh Goel, tech analyst at investment firm First Global Markets. That would bring in more business for IBM. "We are closely monitoring the impact of the financial turmoil on IBM's business," says Goel, and the firm maintains a "moderate outperform" rating on IBM, he says. Some 30% of IBM's revenues comes from the financial services industry. "A major portion of this revenue is recurring in nature," notes Goel.
Some IBM bulls argue that any drop in the stock's price makes it an even more attractive buy. And analysts continue to favor it. As of Oct. 2, 16 of the 24 analysts who follow IBM still rate it as a buy and just one recommends selling, according to data from Bloomberg. Six rate it a hold.
A.M. Sacchonaghi Jr., technology analyst at investment firm Sanford C. Bernstein (it has done banking for IBM), is bullish on IBM partly because of its high level of recurring revenues and profitability, broad geographic dispersion, and below-market valuation. He rates the stock overweight, with a price target of 134 a share. "Our preference for stocks with more defensive characteristics is supported by the observation that IBM has historically outperformed both the tech universe (by an average of 30%) and the broader market (by 5%)," he says. The stock has outperformed the S&P 500 index year-to-date, but it continues to trade below the market's price-earnings multiple, notes the analyst, "thus mitigating the risk" of a reduction in IBM's p-e multiple.
Thomas Smith, tech analyst at Standard & Poor's, who rates the stock a strong buy, with a higher price target of 165 a share, says IBM should benefit from strong revenue growth in the emerging markets and from a widening of margins that reflects cost-cutting and improved profitability in its more mature markets. His price target is based on 11 times his estimated 2008 earnings of $9.66 a share. That p-e is below the company's recent five-year historical range of 13.90 and 19.6. For 2009, Smith expects IBM to earn $10.35 a share. In 2007, IBM posted profits of $7.18 a share on revenues of $98.7 billion.
One factor that tech companies like IBM, Hewlett-Packard (HPQ), and Dell (DELL) depend on is corporate spending on information technology. Such outlays are expected to be down through at least the end of 2008 because of weak corporate earnings, predicts Sacconaghi. But IBM, with its defensive characteristics and strong presence in the international markets, particularly in emerging countries, provides "the greatest degree of safety in a weak IT spending environment," he says.
software and services expansion
The dollar's recent appreciation isn't expected to make much of a dent in IBM's earnings. Its huge international presence will help the company "deliver reasonable growth" in a sluggish U.S., economy, despite less favorable currency effects resulting from the recent appreciation of the dollar, says Wendy Abramowitz, an analyst at independent research outfit Argus, who rates the stock a buy with a price target of 145 a share. According to IBM, about 65% of its revenues are derived outside the U.S. In 2007, Europe and the Middle East accounted for 36% of revenues, Asia Pacific 21%, and Canada and Latin America, 8%. The U.S. accounted for 35%
Abramowitz says she is maintaining her buy recommendation as IBM continues to expand into software and services. "These businesses provided more consistent growth and better returns than hardware," she notes. IBM still remains a major player on the hardware side, particularly in servers and storage, which have greater profit potential than other segments in the hardware business, she says.
As one of the world's largest tech companies, IBM's corporate history dates back to 1911. It has grown to be a major contributor to each major category in the IT market—in hardware, software, and services. It has the largest global services organization and is among the largest global software vendors, behind Microsoft (MSFT) and Oracle (ORCL).
With such a pedigree, why wouldn't IBM appeal tremendously to investors in these times of financial dislocation and economic uncertainty?
Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.