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June 30, 2010
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Chicago, IL – June 30, 2010 – Zacks.com Analyst Blog features: Union Pacific Corp. (UNP), International Business Machines Corp. (IBM), Hewlett Packard Co. (HPQ), Vornado Realty Trust (VNO) and KKR Financial Holdings LLC (KFN).
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Here are highlights from Tuesday’s Analyst Blog:
Union Pacific Downgraded
We are downgrading our recommendation on Union Pacific Corp. (UNP) from Outperform to Neutral, implying that the stock will perform mostly in line with the broader market. This move is based on the relatively unfavorable economic environment and the regulatory risks.
The current state of the U.S. and world economy is expected to keep Union Pacific’s top-line growth under pressure in the near future. It will not be feasible for the majority of sectors to escape this downturn unscathed. Volumes, as measured by total carloads, were down 16% for full year 2009, compared with a decline of 5% in 2008 and 1% in 2007. Moreover, certain operating expenses are likely to increase in the coming years. While Union Pacific has caught up on its backlog of hiring, the company still expects significant labor cost inflation, though improved productivity and lower headcount could offset this somewhat.
Interest expense should also prove to be a headwind to earnings growth. The company has added $1.4 billion of long-term debt to fund share repurchases, in part. This will cost the company an additional $60 to $75 million per year in interest charges.
In the first quarter of fiscal 2010, total operating revenues soared 16% year over year to $4 billion. The results for the reported quarter primarily benefited from increased operating revenues, given the growth in business volumes. Stable Customer Satisfaction Index, core pricing gains and strong cash from operations were also among the positives. However, higher operating expenses, primarily as a result of increased fuel costs and depreciation, constitute the primary risk.
Freight revenues also showed an improvement over the prior-year quarter in all six business groups. During the reported quarter, freight revenues spiked up 16% year over year to $3.8 billion.
Despite Union Pacific’s efforts to curtail costs, operating expenses increased 8% year over year in the quarter, primarily due to a 51% rise in fuel costs to $583 million, largely related to higher oil prices as well as an 8% increase in depreciation.
IBM’s Mainframe Wins New Customer
International Business Machines Corp. (IBM) announced that Comepay, a leading provider of self-service payment kiosks in Russia and the Commonwealth of Independent States (CIS), has chosen its System z10 mainframe to use it in its core business operations. Comepay is expected to deploy the new System z mainframe by the end of the second quarter of 2010. Financial details on the deal were not provided.
With operations in 11 regions of Russia, the new System z10 mainframe deployed from IBM will enable Comepay to expand its business operations across the country. This will aid the company to run a predicted three-fold increase in transactions from 10,000 to 30,000 per second. Moreover, the new systems will help augment growth for Comepay by providing cost effective services and adequate support to its customers.
The performance and virtualization capabilities of System z mainframe, running on z/os will enable Comepay to process the growing amount of transactions and meet business-critical data processing requirements at a lower total cost of ownership. IBM’s DB2 and WebSphere MQ software will facilitate Comepay to enhance its information management capabilities while improving the security and reliability of its transaction processing center, the company said.
IBM’s System z mainframe can help organizations in emerging markets to manage their businesses. IBM pointed out that Comepay will add to its expanding customer base in growing markets, already comprising major customers in China, Korea and Namibia, namely China Internet Network Information Center, Korea's BC Card and Dongbu Insurance and The First National Bank of Namibia.
Based on the strength of its global on-demand model (responding to customer demand with flexibility and speed), IBM plans to grow revenues in all geographical regions, with robust growth in emerging markets such as Brazil, Russia, India and China (BRIC).
IBM’s Systems and Technology segment is also witnessing growth. Systems and Technology revenues spiked up 9% (2%, adjusting for currency) year-over-year to $3.4 billion in the most recent quarter. Systems revenues rose 4%, attributable to an increase in System x revenues, which grew 36%. This was offset by a decrease of 17% in revenues from POWER Systems. Revenues from System z mainframe server products decreased 17%, while the hardware revenues that include servers and high-end mainframe computers soared 5% in the quarter.
IBM is expected to get a boost from new mainframe contracts. As virtualization drives richer server configurations, IBM is targeting $9.3 billion in gross profit, for 2010, for the Systems and Technology segment. We expect the next generation mainframe product to deliver a higher benefit to the company, thereby extending the company’s leadership in energy efficiency, security and resiliency.
Although global sever revenues fell, IBM has again topped the server market in 2009 with a 32.9% factory revenues share compared with Hewlett-Packard’s 29.9%, according to IDC. This growth was driven by a solid performance from its System x, System p and System z servers.
To focus on its investments on differentiating technologies with a high-growth potential, IBM has launched new products and solutions including its new WebSphere Portal software, version 6.1, POWER6, BladeCenter-S, BladeCenter QS22, System z10, Power, System x servers, high-performance computing, virtualization, energy efficiency, and IBM System Storage SAN Volume Controller (SVC) Entry Edition.
The next generation mainframe product will likely benefit the company, moving forward. This product will have a 50.0% additional capacity than the current system. This should give IBM a competitive edge over Hewlett Packard Co. (HPQ), whose next-generation chip is not expected to catch POWER6 Processor's speed.
Vornado’s 2Q Earning Likely to Dip
Vornado Realty Trust (VNO), a leading real estate investment trust (REIT), has recently announced that it will record a net loss of $21 million or 10 cents per share in fiscal 2010 second quarter, given the loss generated by Toys ‘R’ Us for its first quarter ended May 1, 2010.
Toys ‘R’ Us, a leading global retailer of dedicated toys and baby products, reported net loss of $55 million in the fiscal first quarter compared with $35 million in the year-earlier period. The lackluster performance was primarily due to weak demand for entertainment products like video game hardware and software in its International segment. In addition, its business is highly seasonal with fiscal fourth quarter accounting for over 80% of total annual sales.
Toys ‘R’ Us was acquired in 2005 by KKR Financial Holdings LLC (KFN), Bain Capital, and Vornado Realty for $6.6 billion. Vornado Realty currently owns about 32.7% of Toys ‘R’ Us. Consequently, it would record a proportionate share of the total net loss incurred by the toy company, and its second quarter FFO (fund from operations) would decrease by $9.5 million or 5 cents per share. Fund from operations, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.
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