IBM Could Come Up Big

SAN FRANCISCO -- Investors and analysts expect a solid performance from Big Blue Wednesday, despite the slowing economy.

Tech giant IBM(IBM Quote) is set to report first-quarter earnings after the closing bell.

"We remain constructive on the stock," Hester Capital Management portfolio manager John Gunthorp, who six months ago was bullish on IBM, said Tuesday. "We are anxiously awaiting their earnings.

"Through the fourth quarter of last year looking back, the company is generating improving return on investment," Gunthorp explained. During the final quarter of 2007, IBM had the highest level of ROI during its past 10 years, he added. "That makes us comfortable with the stock."

Hester Capital owns 128,500 shares, up slightly from six months ago.

Shares of Armonk, N.Y.-based IBM closed Tuesday at $117.17, not far off their one-year high of $121.46. At current levels, the stock is trading at 14 times 2008 earnings and 12.6 times 2009 EPS. During the past three months, shares have climbed 15% to regain all their value lost during the market's early-winter shakedown.

"We like the global exposure they have, which is up over 60% now," Gunthorp said. "We like the valuation here. Our internal [price] target is around $130. It's not that far from it, but it's still got some upside to go."

Analysts expect year-over-year top-line growth of 7.6% to $23.71 billion and EPS of $1.45, a 20% jump over EPS of $1.21 posted in the first quarter of 2007, according to Thomson Financial.

"We think the $1.45 the Street's looking for is achievable," Gunthorp said. "They might even exceed that.

"The company has done a relatively good job since the beginning of the year vs. the market," Gunthorp said. "If they can meet or exceed those numbers, I would expect this company to continue to outperform the market."

In October, Gunthorp expressed concern about the debt load IBM was carrying relative to cash on hand. "Ideally, we'd like that situation come lower." But IBM's debt-to-capital ratio has declined over the past two quarters, to below 55% at the end of 2007, Gunthorp noted.

Canaccord Adams analyst Peter Misek wrote in a note Tuesday that first-quarter growth is likely to come from IBM's software business, where the company competes with Oracle(ORCL Quote) and Microsoft(MSFT Quote). That business will generate 14% growth year over year to $4.8 billion, Misek estimates. Canaccord Adams does not make a market in IBM shares, nor is the company a client.

Oracle reported in March that it had difficulty closing deals at the end of February.

IBM's systems and technology business, which includes mainframes and other hardware, likely will be flat year over year at $4.6 billion, according to Misek. Systems competitor Sun Microsystems(JAVA Quote) will report revenue May 1, and Hewlett-Packard(HPQ Quote) will post its second-quarter earnings in May.

IBM's much larger technology-services business is expected to rise 7.5% to $8.9 billion. But Misek expects newly signed services business to be flat or even down slightly.

IBM is well-positioned to weather the macroeconomic downturn, Misek wrote. "However, we do not foresee any near-term catalysts for the shares in the current market environment."

On Monday, Citigroup analyst Richard Gardner raised his EPS estimate for the quarter by a 5 cents to $1.48, noting that "currency should contribute a better-than-expected 6.5 percentage points" to revenue growth.

And revenue from Cognos, which IBM aquired in a deal that closed at the end of January, appears to have been omitted from consensus estimates. The business-intelligence software developer should contribute $150 million to IBM's top line, according to Gardner. IBM is an investment banking client of the firm.

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