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Let’s get our thoughts on calendar fourth-quarter performance from a few giants in their respective industries.
By Kris Rosemann and Brian Nelson, CFA
International Business Machines
IBM’s (IBM) stock is now back above the $170 per-share mark after falling below $120 per share just a little over a year ago. Five-year performance of the equity, however, still remains terrible, with shares of IBM languishing around the price they were changing hands at the beginning of 2012. Warren Buffett’s association with the stock has a lot of investors excited, but we think the Oracle of Omaha may be a bit too optimistic on this one. Year-over-year revenue at IBM has been under considerable pressure for some time, and the top line continued to drop during IBM’s fourth quarter, results released January 19. Although IBM’s ‘Strategic imperatives’ and ‘Cloud’ revenues are advancing at a nice clip, the company’s legacy business continues to weigh heavily on firm-wide performance, and a firm-wide assessment is what matters to the investor. IBM remains a cash cow though, pulling in free cash flow of $11.6 billion during the year, though we’d like to see its balance sheet in better shape. IBM ended the fourth quarter with $8.5 billion in cash, but debt (including global financing debt) totaled $42.2 billion. On a full-year 2016 basis, diluted earnings per share from continuing operations dropped 9%, to $12.39. Shares of IBM aren’t terribly expensive at less than 14 times trailing earnings, but they aren’t really that cheap either, particularly if earnings pressure is here to stay. IBM’s shares continue to trade roughly in line with our fair value estimate, and we think there are much more exciting and undervalued ideas in technology within the newsletter portfolios.
General Electric
Conglomerate and newsletter portfolio holding General Electric (GE) disappointed some with its 2016 fourth quarter report, released January 20, as revenue fell 2% from the year-ago period and “Industrial operating + verticals earnings-per-share” dropped ~12% to $0.46. Though the quarterly performance wasn’t as we would have liked, GE still reported 2% organic orders growth including Alstom thanks to a 20% increase in services orders (Predix-powered software orders leapt 36% on a year-over-year basis in the quarter). Importantly, the industrial giant’s services backlog advanced to $237 billion at the end of 2016 from $226 billion a year ago, while equipment backlog fell to $84 billion from $89 billion (total backlog jumped to $321 billion from $315 billion). GE’s backlog mix shift is indicative of the industrial giant pursuing a leadership position in the “Industrial Internet” — “The Next Industrial Revolution – Internet of Things.” GE expects 2017 operating earnings per share to be in a range of $1.60-$1.70 and 2018 earnings per share to reach $2, implying the company is trading at 15 times bottom-line numbers that are in sight. GE’s strong backlog performance gives us confidence that management will deliver on its revenue growth expectations, and productivity and share buybacks should offer the company added flexibility to hit bottom-line targets in coming years. GE has learned from its dividend cut during the Financial Crisis, having shed its SIFI (systematically important financial institutional) designation via asset sales, and we like the company as a part of the industrials exposure in the newsletter portfolios.
Procter & Gamble
Dividend Growth Newsletter portfolio holding and recently-transformed consumer staples giant Procter & Gamble (PG) impressed in its fiscal 2017 second quarter report, released January 20, as organic sales climbed 2% from the year-ago period thanks to 2% growth in organic volume (reported sales were flat). Price and mix collectively had no impact on sales in the period. P&G drove its core gross and core operating profit margins higher thanks to productivity cost savings more than offsetting unfavorable product mix and commodity cost increases. Core earnings per share leapt 4% compared to the second quarter of fiscal 2016 (currency-neutral core earnings per share increased 9%), while operating cash flow came in at a healthy $3 billion for the quarter. P&G maintained its fiscal 2017 guidance for core earnings per share growth in the mid-single digit range, but raised its organic sales growth guidance to 2%-3% from initial projections of ~2%. Though we’ve been skeptical of its transformation in light of how rapidly brands were sold, we’re looking forward to what the future might hold for shares of Procter & Gamble. The company has rediscovered volume growth, and if management is able to layer on meaningful product pricing gains above expectations, our fair value estimate of the consumer staples giant could be conservative.
Union Pacific
What can we say about our favorite railroad, other than its shares have come roaring back after being shunned by investors though almost all of 2015. The news with Class I rails has been rampant the past few days, with Canadian Pacific Railway (CP) chief Hunter Harrison stepping down from his role at the company to pursue other opportunities at operators in the industry. The whole group, particularly CSX (CSX) has been soaring, and Union Pacific hasn’t been left out. The M&A talk coincided with a rather strong fourth-quarter report from Union Pacific, released January 20. The Omaha-based railroad operator saw its earnings per share advance to $1.39 in the last quarter of 2016, up from $1.31 in the year-ago period, while its operating ratio remained at attractive levels, albeit higher than records set in 2015. We like the “moaty” characteristics of the rails, in general, and while the Union Pacific’s Dividend Cushion ratio is near parity (not good but not bad either), its free cash flow generation is among the best in class. Free cash flow came in at ~$11.6 billion during 2016, roughly double the mark of cash dividends paid of ~$5.3 billion. We continue to like Union Pacific, and the prospect for domestic coal to come back during the Trump administration is only icing on the cake for the railroads that ship it.