IBM with Nobias technology: Is IBM A Buy After Its Post Earnings Double Digit Sell-Off?
In a Nobias article on IBM in July after the company reported its second quarter results. Last week, IBM reported its third quarter numbers and due to the battleground nature of this equity, we wanted to update subscribers on what vetted analysts are saying about the stock.
The reason that IBM is such an interesting company for so many is because this name - Big Blue, as the company is affectionately called by many investors - was an integral part of the tech sector and the broader market at large for a couple of decades, prior to its recent struggles.
However, unlike many of its peers in the technology space, IBM has underperformed over the last decade or so, having largely missed the significant shift from the PC to mobile and the ongoing enterprise migration to the cloud. These secular trends have driven the growth which ultimately created several of the largest companies on Earth today. What’s more, many of IBM’s peers in the “old tech space”, such as Cisco (CSCO), Microsoft (MSFT), and Oracle (ORCL), have latched on and adapted over the years, allowing the secular growth associated with the digital age to re-accelerate their top and bottom line trajectories as well. During the last 1 and 5 year periods, Cisco is up 56.86% and 82.97%, respectively. During these same periods, Microsoft is one of the market’s top performers, up 61.99% and 453.90%, respectively. Oracle has posted strong performance as well over the trailing 1 and 5 year periods, up 71.26% and 151.53%, respectively. IBM remains a major laggard, up just 14.87% during the last year and down 18.03% during the trailing 5 years. During this 5-year period, not only has IBM underperformed its “old tech” brethren, but it has also underperformed the broader market by a wide margin as well. The S&P 500 has posted gains of approximately 116% during the last half-decade.
With all of this in mind, investors continue to wait to see whether or not IBM’s new management team, led by Arvind Krishna, who took over the reins as CEO in 2020, are going to be able to turn this behemoth of a company around (even after its relative underperformance, IBM sports a $112.8 billion market cap). Only time will tell, but the company’s earnings results are the best way to track its progress and therefore, we wanted to see what the credible analysts that the Nobias algorithms tracks have had to say about the company in light of its recent report. Prior to the Q3 report, Nobias 5-star rated analyst, Richard Saintvilus, wrote an article titled, “IBM (IBM) Q3 Earnings: What To Expect”.
In this piece, Saintvilus highlighted IBM’s relative underperformance as names like Microsoft and Amazon (AMZN) have taken the lion’s share of the cloud growth pie; however, with regard to IBM’s continued cloud-related operations, he said, “The company’s cloud ambitions have shown some promise in recent quarters and has provided ample revenue strength to support a higher multiple, thanks to the Red Hat acquisition which modernize the cloud business. The company is now forecasted to grow revenues by high single digits annually over the next 5 years.”
Saintvilus quoted Krishna, who highlighted his bullish outlook for IBM once it spins off its Managed Infrastructure Services unit into Kyndryl (right now, this transaction is expected to occur during Q4), saying, “With the spin-out of Kyndryl and the acquisition of Red Hat, you’re seeing that just under half of our portfolio is software, a little under one-third of it is consulting.”
Nicholas Rossolillo, another Nobias 5-star rated analyst, recently penned an article highlighting the Kyndryl spin-off and what he believes investors should expect, ultimately providing an outlook which appears to be mixed, with regard to the future potential of the names on either side of the spin-off deal. Rossolillo said, “The new IBM won't be an exciting high-growth company. Still, it will be rejuvenated enough that its stock will be worth another look, especially for investors who are interested in assets that offer a balance of gradual growth and income too.”
Rossolillo did go on to say that, “Corporate spinoffs -- where a company divests itself of one or more of its operating segments -- can be fantastic events for shareholders in aging businesses.” Oftentimes, when spin-offs like these occur, the market talks about the company “unlocking value” because various segments aren’t seeing rational cash flow multiples attached to them. Furthermore, smaller, pure-play companies tend to be more nimble and with a more focused leadership team, can begin to see accelerating growth. But, with regard to the Kyndryl spin-off, Rossolillo is not very bullish. He wrote, “The practice of offloading legacy operations that no longer dovetail with a company's main priorities can help a company focus more tightly on its highest-growth and most profitable segments. In the case of the Kyndryl spinoff, there might be good reasons for IBM owners to sell the new shares shortly after they receive them. Kyndryl will be a large-cap business right off the bat, valued at some $19 billion, but its profit margins will be dismal, and the underlying operation has a history of slowly evaporating market share.”
Rossolillo is more bullish on IBM moving forward, writing, “Post-spinoff, IBM will reorganize and begin reporting its business in four new segments: consulting (which is expected to deliver annual revenue growth in the high single-digit percentages for the next few years), software (mid-single-digit percentage growth), infrastructure (no growth), and financing (mid-single-digit percentage growth). Overall, IBM should be a mid-single-digit percentage growth company in the coming years.” He maintained this line of thought, saying, “Plus, though this will remain one of the more pedestrian names in the tech industry, IBM is expected to accelerate its free cash flow growth to a high single-digit percentage rate in each of the next three years.” And therefore, he concludes that investors - especially those interested in passive income (because IBM pays a dividend yield which is 5.24% right now, well above the broader market’s ~1.3% yield) - may very well be interested in IBM once it has shed the slow/negative growth drivers attached to Kyndryl.
Closing out his piece, Rossolillo wrote, “Simply put, completing the spinoff of Kyndryl won't totally transform IBM. Still, this long-awaited offloading of some of the company's legacy services will be a good thing. So if dividend income is what you're after, this is the best time in a decade to own IBM stock.” It appears that he wasn’t the only one relatively bullish coming into the Q3 report.
Saintvilus noted that the market responded positively to Krishna’s comments regarding the spin-off earlier in the year, saying, “IBM stock has rallied from about $115 back in January to over $150. While there is some near-term resistance, it appears the market is giving IBM more credit for the recent traction the company has made towards the cloud. But for the the shares to maintain their uptrend, the company on Wednesday will need to demonstrate continued operating leverage and revenue growth acceleration.”
So, did the company live up to Wall Street’s expectations?
When IBM reported the company did manage to beat analyst estimates on the bottom-line, posting non-GAAP EPS of $2.52/share, which was $0.01/share ahead of the analyst consensus. However, IBM missed on the top-line, posting sales of $17.62 billion (which were $190m below consensus estimates). IBM’s sales did increase, ever so slightly, up 0.3% on a y/y basis.
During the trailing twelve months, Q3 pushed IBM’s free cash flow generation up to approximately $11 billion (however, much of this was during Q4 2020; year-to-date, IBM’s adjusted free cash flow comes in at ~$5b). IBM’s Cloud and Cognitive Software segment and its Global Business Services segment both posted slow and steady growth. Yet, its Systems segment saw its revenues shrink by 11% and the company’s Global Technology services saw its revenues shrink by 5%.
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
During the quarterly conference call, Krishna noted that ex-Kyndryl, IBM’s quarterly revenue growth would have been 2% on a y/y basis. Management also highlighted IBM’s improving balance sheet position, with cash sitting at $8.4 billion and the company’s long-term debt being reduced by approximately $7 billion. With regard to shareholder returns, IBM’s CFO, James J. Kavanaugh said, “In addition to debt reduction, year to date, we've used $3 billion for acquisitions and over $4 billion for shareholder returns through dividends. However, even with all of this in mind, IBM shares sold off after the report, making it clear that their numbers did not live up to investors’ expectations.
The stock trended down 11.57% on the week (last week). This week the negative momentum continued, with IBM falling another 2.17%. Overall, after this post-Q3 sell-off, IBM shares are down trading at an 18.15% discount to their 52-week high. But, the selling pressure here appears to have created an attractive opportunity for patient investors.
Looking at the credible analysts that Nobias tracks, we see a 92% “Bullish” sentiment rating. And, amongst the 4 and 5-star rated Wall Street analysts that we track, the average price target for IBM shares currently sits at $161.25. Today, IBM shares trade for $125.10, which means that relative to that average price target, shares present upside potential of 28.9%.
Disclosure: Of the stocks mentioned in this article, Nicholas Ward is long AMZN, CSCO, and MSFT. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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