Earnings Preview: Computer Sciences

Computer Sciences Corporation (CSC) is scheduled to announce its fourth quarter 2011 results on May 25, 2011, and we do witness a substantial variation in analysts’ estimates at this point.

Third Quarter Recap

The company reported decent third quarter 2011 results, with earnings per share (EPS) of $1.54 exceeding the Zacks Consensus Estimate of $1.48 and the year-ago quarter earnings of $1.36. Computer Sciences generated revenues of $4.01 billion, up 1.5% from the year-ago quarter, driven by robust revenue growth in the company’s Commercial businesses.

The company won new business worth $2.3 billion in the third quarter. Of this, NPS accounted for $0.5 billion, BSS $0.8 billion and MSS $1.0 billion.

Computer Sciences posted operating margin of 6.6%, down 172 basis points from 8.32% reported in the year-ago quarter. The margin was negatively impacted by higher cost of services and selling, general and administrative expenses.

The company exited the quarter with $1.63 billion in cash and cash equivalents, down from $2.43 billion reported in the previous quarter. Computer Sciences has a total debt balance of $2.34 billion and a debt-to-capitalization ratio of 28.0%.

Computer Sciences expects new business awards in excess of $16.0 billion, revenue of approximately $16.2 billion, operating margin of between 8.0% and 8.5% and EPS of approximately $5.20 for fiscal 2011. Free cash flow is expected to be equal to or greater than 90.0% of net income for the year.

Agreement of Analysts

Out of the twelve analysts providing estimates for the fourth quarter, eight analysts lowered their estimates over the last thirty days. Out of the eleven analysts covering the stock for fiscal 2011, seven analysts lowered their estimates in the last thirty days, while none moved in the opposite direction. Similarly, for fiscal 2012, seven analysts made downward revisions to estimates over the last thirty days.

The company’s U.S. federal business is expected to face challenges and some analysts are a bit concerned about it. The business constitutes around 40% of CSC’s total revenue.

Revenues from this segment may be impacted by tighter U.S. government budgets, which could limit expenditure on technology, as indicated by Standard & Poors (S&P) lowering its outlook for America’s long-term credit rating to “negative” from “stable.”

The change in rating signifies the fact that there is a one-in-three chance that the S&P could downgrade the nation’s “AAA” credit rating within two years. That would make it harder for the U.S. government to borrow money to fund its activities.

According to some analysts, revenues from the NHS contract (estimated to be 2.0% to 3.0% of revenues) can serve as a swing factor for quarterly and annual results given that the company never discloses the size of the contract. The NHS contract is considered as a major risk for the company as it has forced CSC to lower its guidance for fiscal 2011 as realization from the NHS contract is pushed future quarter.

Magnitude of Estimate Revisions

The magnitude of revisions is also substantial since CSC reported its third quarter results. Overall, estimates for the upcoming quarter have gone down from $1.56 to $1.30 in the last 30 days. For fiscal 2011, estimates have come down to $4.97 from $5.20 in the last 30 days. Moreover, for fiscal year 2012, the estimates have decreased from $5.46 to $5.23 over the same period.

Recommendation

We are apprehensive about the intense competition in the IT and cloud computing space from both big and small players such as Accenture (ACN) and Hewlett-Packard Company (HPQ). Moreover, with government orders expected to dry up to a certain extent and the NHS realization getting pushed out further, things look difficult for Computer Sciences.

Moreover, the demand for the company’s products in Europe is not encouraging for the upcoming quarters.

The company has a Zacks #5 Rank, implying a short-term Strong Sell rating.

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