Citi Previews Hardware Names Ahead Of Q3: Upgrades Lexmark While IBM Concerns Remain

Jim Suva of Citi previewed the IT hardware sector ahead of the group's third-quarter results.

Upgrading Lexmark To Neutral

Suva upgraded shares of Lexmark to Neutral from Sell with an unchanged $31 price target following the stock's 25 percent decline over the past year, even though he noted the company still has "its work cut out for itself."

Suva pointed out that the stock has dropped nearly 39 percent since its second-quarter print when the company lowered its full-year earnings per share guidance range to $3.55–$3.75 from a previous $3.60–$3.80, primarily on a channel inventory issue. The analyst added that management remains focused on bringing the channel into line, with expectations of the bulk of inventory worked-down during the third quarter with a resolution to come by the end of the fourth quarter.

Suva continued that "execution is clearly the focus" as the company heads toward 2016 with a focus on integrating software acquisitions, wringing gout synergies and maintaining strict controls over cost and expense. Nevertheless, an upgrade is warranted as the analyst's thesis of "overly-optimistic management expectations" has largely played out.

Suva is estimating the company to earn $0.59 per share on revenue of $919 million in the quarter.

Challenges At IBM To Continue

Suva stated that IBM's challenges will continue into the end of the year despite moderating foreign exchange headwinds in the third quarter relative to guidance.

Suva continued that the company's poor performance has been consistent with his prior thesis. Its "relatively high" percentage of revenue from legacy segments pressures the overall service growth. The analyst added that while the company has made some "good" investments, the net result of the cloud transition is "often painful."

IBM also has made some "very good" investments in analytics and digital, but it has "lagged" in monetizing Watson and the full-company impact is "relatively small."

Other areas of concern include the breakup of legacy contracts into smaller pieces, limited BPO/platform exposure and significant capex investments in cloud data centers, which could "hamper" margin growth. In addition, the company's software segment has been a "serial under-performer" over the past few quarters.

Looking forward to the print, Suva expects IBM to continue showing cyclical and secular challenges, although the impact of these challenges is "moderating."

Suva is estimating IBM will earn $3.26 per share on revenue of $19.88 billion in the quarter.