How Long Can Tax Tricks Keep Supporting IBM's Earnings?

With International Business Machines Corp. IBM set to report earnings on Tuesday, investors may start seeing diminishing returns on one of its key earnings drivers in recent years: taxes.

In the past three years, IBM has been able to boost its EPS by 7 percent by utilizing tax advantages, Credit Suisse analyst Kulbinder Garcha wrote on Monday. However, he expects IBM has limited tax flexibility headed forward.

Credit Suisse estimates that IBM’s effective tax rate could hit 11 percent in 2017, the lowest rate among large-cap S&P 500 peers.

“Following a detailed analysis, we conclude that current rates of tax are unsustainably low, and that this lever could run out over time, along with other non-operational levers such as IP sales,” Garcha wrote.

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Incredibly, IBM was able to register a negative 9.3 percent tax rate in Q1 by utilizing an intra-entity asset transfer that awarded the company a $582 million tax benefit, Garcha said. He said that move was a one-time earnings boost.

Looking ahead, IBM’s tax rate is “unsustainably low.” Credit Suisse estimates IBM’s long-term tax rate should be in the 18 to 20 percent range.

However, even using a 15 percent rate, the firm estimates IBM’s EPS potential at just $11.30, 18 percent lower than consensus 2017 estimates.

Even including IBM’s projected net tax benefits of $760 million in 2017, Credit Suisse still models for a 5 percent full-year earnings miss.

Without the potential for more tax maneuvering ahead, Credit Suisse maintains an Underperform rating and $110 price target for IBM.