EDS Gets Benefit of Doubt Thanks to Outlook

"Overall, we feel that a negative outcome from the GM recompete process could set back EDS' recovery into the 2007-2008 time period," Vafi wrote. "Nevertheless, management's comfort with establishing a 2006 target this early in 2005 suggests a higher degree of confidence in the business outlook than we have seen in several quarters," he acknowledged.

J.P. Morgan's Huang, meanwhile, ratcheted up his 2006 earnings estimate far higher, to $1.20 a share, and estimated free cash flow would jump to $860 million in 2006 from $600 million in 2005. But he shared some of Vafi's concerns.

"We remain concerned about anemic revenue growth but expect 2006 free cash flow to be attractive," Huang wrote. "We continue to view the GM contract as a key risk factor for the stock, but one that we expect is priced into the stock." EDS is a banking client of J.P. Morgan.

Still, not everyone was swayed by EDS' confidence. "The timing and precision of the calendar 2006 estimates and the high confidence level of a team often criticized for missing guidance targets has us puzzled," wrote UBS analyst Adam Frisch, who maintained his neutral rating. "There wasn't anything incremental to help us form a more logical path to EDS' big improvement projected in 2006."

"We can only help but wonder if there are renewed expectations about potential M&A scenarios in a sector expected to have increased consolidation in the next few years," he added.

Frisch further highlighted the uncertainty about the Navy and GM contracts, productivity gains companywide, and also another big complex contract with the UK Ministry of Defense. And he questioned why free cash flow is expected to increase 40% to 60% yet net income is expected to almost double.

Consequently Frisch said he was discounting the company's 2006 projections, with his estimate for earnings sitting at 80 cents. "If the management team does succeed, then we would consider it impressive," he said. "We, however, prefer to sit on the sidelines until we get a better understanding of the drivers of the improvement and are able to make some sense of the conflicting data points."