Enterprise Hardware earnings to normalize in 2010 on
the back of a return to revenue growth and related
operating leverage that we believe is currently
underappreciated in consensus estimates. We upgrade
our industry view to Attractive (from In-Line) and see
19% upside to share prices, on average, with 24%
upside for our Overweight names. We highlight QLGC,
HPQ, NZ and EMC as the enterprise names that offer
the best risk:reward as server/storage spending begins
to show sequential revenue improvement in C2H09.
Increasing Evidence of a Revenue Recovery: We
highlight that: a) more tech hardware companies beat vs.
missed revenue estimates in 2Q09; b) we see early
signs of an enterprise channel inventory rebuild; c) July
server/storage orders came in above plan; and d) CIOs
expect to spend more on storage in 2H09, more on
servers/PCs in 2010. We now model CY10 median
revenue growth of 7% (vs. 6% consensus view).
We Differ Most on Operating Leverage: Fixed
manufacturing, sales, and services costs drive operating
leverage as revenues recover, highlighted by a 67%
average incremental margin in C2Q09. Our CY10
incremental margins match levels in the CY03 recovery
and shift our EPS to 8% above consensus.
Where We Could Be Wrong: In our view, the risk is to
the upside in the near term, as revenue comps become
easier in C4Q and a combination of aggressive
restructuring and the resumption of share repurchases
could drive EPS growth that is more powerful than we
model. In the medium-term, if top-line growth surprises
to the upside, companies may need to invest more in
SG&A, R&D and CapEx than we currently model which
could cause margins to disappoint.