EDS Gets Benefit of Doubt Thanks to Outlook

EDS continued its ride Thursday as two analysts upgraded their rating on the IT services giant after it issued 2006 guidance late Wednesday that blew away expectations.

Shares of EDS recently soared $2.48, or 11.7%, to $23.77 in trading that was more than two times average volume.

While expressing concern about revenue growth, Jefferies analyst Joe Vafi raised his rating to hold from underperform, while J.P. Morgan analyst Tien-tsin Huang raised his call on EDS to neutral from underweight.

"Chronic revenue contraction ultimately needs to reverse at some point," Vafi wrote Thursday morning. "However, we expect that efficiency gains extracted from what is still extremely depressed P&L profitability should translate into an earnings-and-cash-flow recovery story over the next several quarters." His firm has not done banking with EDS.

Vafi introduced an estimate for 2006 earnings of 93 cents, representing a 72% increase from his 2005 estimate. However, that was still slightly short of the company's surprisingly optimistic outlook from a day earlier, when EDS said it expects 2006 earnings of at least $1 a share. The company said it introduced the guidance earlier than usual because it was so far above the consensus estimate, which sat at 66 cents.

EDS executives, repeatedly peppered late Wednesday with analysts' questions about why they are so confident, attributed their bright outlook to productivity gains from cost cutting and said improvements in its massive contract with the U.S. Navy should offset any lost business from General Motors.

Vafi said his target of $600 million to $700 million in free cash flow in 2005 -- flat year over year -- is still "somewhat disappointing" but called management's view of free cash flow of $800 million to $1 billion next year "more encouraging."

Vafi said he believes it's still too early to have a very accurate gauge of free cash flow because of the uncertain impact of future business with General Motors. The auto giant, which currently generates about 9% of EDS' revenue, is opening up its contracts with EDS to competitive bidding, with final decisions expected at the end of this year or early next year.