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Why Is IBM Down 10.7% Since its Last Earnings Report?

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A month has gone by since the last earnings report for International Business Machines Corporation (IBM - Free Report) . Shares have lost about 10.7% in that time frame.

Will the recent negative trend continue leading up to its next earnings release, or is IBM due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Recent Earnings

IBM delivered first-quarter 2018 non-GAAP earnings of $2.45 per share, which beat the Zacks Consensus Estimate by a nickel. Earnings per share (EPS) increased 4.3% from the year-ago quarter but plunged 52.7% sequentially.

The year-over-year growth in EPS can be attributed to higher revenues (10 cents contribution), improving gross margin trajectory, pre-tax margin expansion (four cents contribution) and aggressive share buyback (five cents contribution).

This was partially offset by higher tax rate (couple of cents negative impact) and headwinds related to initiatives in repositioning IBM’s business (five cents negative impact).

Revenues of $19.07 billion outpaced the Zacks Consensus Estimate of $18.72 billion and climbed 5.1% on a year-over-year basis. However, revenues declined 15.4% sequentially. At constant currency (cc), revenues remained flat at $18.20 billion.

Americas, Asia-Pacific Revenues Decline

Geographically, both Americas and Asia-Pacific revenues remained flat on a year-over-year basis.

In the Americas, growth in Canada and Latin America (strong growth in Brazil) was offset by lower revenues from the United States (down 2%). In the Asia-Pacific, Japan declined 1% year over year.

Europe, Middle-East and Africa grew 1% from the year-ago quarter driven by growth in France, Spain and Middle East/Africa. However, the U.K. and Germany declined 2% and 3%, respectively.

Strategic Imperatives Growth Continues

Strategic Imperatives (cloud, analytics, mobility and security) grew 10% at cc from the year-ago quarter to $9 billion. Security revenues surged 60% in the quarter.

On a trailing 12-month basis, Strategic Imperatives revenues were $37.7 billion and now represents 47% (up from 43% in the previous quarter) of the company’s total revenues.

Cloud revenues surged 22% from the year-ago quarter to $17.70 billion. The annual run rate for cloud as-a-service revenue increased 20% at cc on a year-over-year basis to $10.7 billion. Cloud revenue on a trailing 12-month basis is now $15.8 billion, more than 20% of the company’s total revenues.

Cognitive Grows on Robust Security, Analytics

Cognitive Solutions revenues increased 6.3% year over year to $5.08 billion, which comfortably surpassed the Zacks Consensus Estimate of $4.88 billion. Revenues (external) increased 2% at cc to $4.30 billion, driven by robust performance from security and analytics offerings.

Segmental revenues pertaining to Strategic Imperatives and Cloud grew 2% and 4%, respectively. Cloud as-a-service revenue annual run rate was $2 billion.

Solutions software revenues increased 2%, while Transaction Processing Software revenues grew 1% on a year-over-year basis.

IBM’s solid security portfolio is helping it to clients on a regular basis. Increasing demand for security solutions due to increasing hacking risks and data privacy concerns is driving growth. The company is also benefiting from the upcoming GDPR regulations in Europe.

Extensive Artificial Intelligence (AI) capabilities across the portfolio drove top-line growth in SaaS offerings within the security segment.

Blockchain has also become a major part of IBM’s product offerings. The company is now a part of more than 50 active blockchain networks. Recently, the company announced a beta version of IBM Blockchain Platform Starter Plan, which has already provisioned more than 750 networks.

Analytics grew driven by strong transactional performance. Growth was strong across both on-premise platform and SaaS offerings. Watson continues to impress with regular client wins like Orange Bank and Autodesk. IBM stated that demand for Watson offerings particularly digital assistant remains strong.

Global Business Services Revenues Decline

Revenues from Global Business Services segment were $4.26 billion, up 4.2% from the year-ago quarter and were better than the Zacks Consensus Estimate of $4.14 billion. Revenues (external) decreased 1% at cc to $4.20 billion.

Segmental revenues pertaining to Strategic Imperatives grew 6%. Cloud practice surged 12%. Cloud as-a-service revenue annual run rate was $1.2 billion.

Application Management and Global Process Services revenues decreased 2% and 6%, respectively. However, Consulting revenues were flat year-over-year driven by strong performance from IBM’s digital business and ix platform.

Application Management signings increased at a double-digit rate in the reported quarter.

Technology Services & Cloud Platforms: Revenues Dip

Revenues from Technology Services & Cloud Platforms increased 4.7% from the year-ago quarter to $8.77 billion, which was better than the consensus estimate of $8.44 billion. Revenues (external) decreased 1% at cc to $8.60 billion. Signings grew double-digit in the quarter.

Segmental revenues pertaining to Strategic Imperatives advanced 19%, driven by hybrid cloud services, security and mobile. Cloud increased 20% from the year-ago quarter. Cloud as-a-service revenue annual run rate was $7.4 billion.

Integration Software increased 1% from the year-ago quarter driven by solid SaaS performance. The company now has more than 200 clients using IBM Cloud Private offering.

Technical Support Services revenues decreased 4% from the year-ago quarter.

Infrastructure Services remained flat on a year-over-year basis. IBM stated that Infrastructure Services signings grew 40% year over year, primarily driven by cloud.

Power, z14 Drive Systems Revenues

Systems revenues increased 5.8% on a year-over-year basis to $1.65 billion, which lagged the consensus mark of $2.05 billion. Revenues (external) increased 4% at cc to $1.50 billion.

IBM Z revenues grew 54% year over year on more than 100% MIPS growth driven by broad based adoption of the z14 mainframe. Power revenues increased 3% from the year-ago quarter. However, Storage hardware declined due to stiff competitive environment and increasing pricing pressure.

Segmental revenues pertaining to Strategic Imperatives surged 24%, while Cloud revenues jumped 12%.

Operating Systems Software revenues declined 1%, while Systems Hardware increased 6% from the year-ago quarter.

Finally, Global Financing (includes financing and used equipment sales) revenues increased 3% at cc to $427 million.

Operating Details

Non-GAAP gross margin contracted 70 basis points (bps) from the year-ago quarter and 580 bps sequentially to 43.7%. IBM stated that 40 bps year-over-year negative contractions (out of 70 bps overall) resulted from actions that the company has taken to improve long-term Systems cost structure.

Management also stated that gross margin trajectory (better by 70 bps as compared with previous quarter performance) has improved driven by favorable mix and productivity led by services business.

Operating expense increased 9.4% year over year and 9.1% sequentially to $6.60 billion primarily due to unfavorable foreign currency exchange rate and higher expenditure toward initiatives to reposition the business. Lower IP income also increased operating expense.

Pre-tax margin from continuing operations was 9.1% down from 11.2% in the year-ago quarter and 22.7% in the previous quarter.

Cognitive Solutions, Global Business Services and Technology Services & Cloud Platforms segment pre-tax margins contracted 30 bps, 350 bps and 310 bps, respectively, on a year-over-year basis.

Sequentially, Cognitive Solutions, Global Business Services and Technology Services & Cloud Platforms segment pre-tax margin contracted significantly.

However, Global financing segment pre-tax margin expanded 470 bps and 30 bps sequentially in the reported quarter.

Systems pre-tax loss was $203 million compared with a loss of $188 million in the year-ago quarter and a pre-tax income of $579 million in the previous quarter.

Balance Sheet & Cash Flow Details

IBM ended first-quarter 2018 with $13.20 billion in total cash and marketable securities as compared with $112.80 billion at the end of fourth-quarter 2017. Total debt (including global financing) was $46.4 billion, down $0.4 million from the end of previous quarter.

IBM reported cash flow from operations (excluding Global Financing receivables) of $2.2 billion and generated free cash flow of $1.3 billion in the quarter.

In the reported quarter, the company returned $2.2 billion to shareholders through dividends and share repurchases. At the end of the quarter, the company had $3 billion remaining under current buyback authorization.

Guidance

IBM reiterated EPS forecast for 2018. Non-GAAP EPS is expected to be at least $13.80. Almost 40% of this figure is expected in the first half of 2018, which means EPS of at least $3.07 in the second quarter of 2018. The Zacks Consensus Estimate is currently pegged at $3.01.

IBM still anticipates 2018 free cash flow of $12 billion.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in fresh estimates. There have been four revisions higher for the current quarter compared to one lower.

International Business Machines Corporation Price and Consensus

 

VGM Scores

At this time, IBM has an average Growth Score of C, however its Momentum is doing a bit better with a B. Charting a somewhat similar path, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Based on our scores, the stock is primarily suitable for value investors while also being suitable for those looking for momentum and to a lesser degree growth.

Outlook

Estimates have been broadly trending upward for the stock and the magnitude of these revisions looks promising. Interestingly, IBM has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.




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