IBM Set To Outperform

The drivers behind our Outperform rating on International Business Machines (IBM) are the company’s strong fundamentals, substantial free cash flow, strong earnings momentum, improving operating performance, effective restructuring initiatives and new growth opportunities.

IBM is the leader in software, services and storage business. Its second-quarter results beat the Zacks Consensus, fueled by higher gross margins and cost controls. With continued cost-cutting efforts, the company raised its 2009 profit guidance by 50 cents to $9.70 per share. Despite falling sales, IBM’s efforts to generate earnings through a combination of margin expansion, growth initiatives, acquisitions, expected benefits from retirement-related costs and effective capital deployment are commendable.

IBM has been better insulated from the recent weakness in the U.S. economy than many of its peers owing to a large international revenue base. Moreover, management returns value to customers through regular share repurchases and dividend payouts. We believe that with a strong liquidity position, operational efficiency and improving profitability, IBM is well positioned to benefit from the market recovery.

We also believe the company’s strong position in the Services and Storage business, growth in Analytics solution revenue and focus on investments in diverse technologies with high growth potential further add to its prospects.

However, we are cautious of currency fluctuations which are hurting sales and may be critical to earnings growth. Apart from this, increasing competition from Cisco (CSCO), Hewlett Packard (HPQ) and Dell Inc. (DELL) threaten IBM’s market share.

IBM is set to release its third-quarter results on Oct 15. As per the Zacks Consensus Estimate, quarterly profit is expected to be $2.41 per share. This assumes about 12.8% earnings growth and 2.1% sales growth. We remain positive on the company’s long-term growth prospects.

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